November 26, 2022
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Opinion: How to respond calmly as an investor to chaos and fear

IN THIS ARTICLE

By Arthur Swalley

Last Wednesday, Feb. 23, I wrote the following in a news release:

“A Russian invasion of Ukraine appears more likely with each passing day, especially now that the Olympics have ended. U.S. intelligence has 24/7 surveillance of Russian troop movements and communications. Because Putin knows this, he is making no effort to hide possibly the most easily forecast war in history. It appears that much of recent market volatility has been forecasting the war. We see this because of the rapid rise in fossil fuel and precious metal prices, and quick market reactions to each new detail of the unfolding crisis.

“At Arlington, we see this pre-event volatility as a common market response to uncertainty. Typically, as events actually unfold, uncertainty is answered with knowledge and markets stabilize. A disciplined investment approach is critical at times like these to avoid overreaction and panic-selling at the wrong time, when short term stock prices are generally down and ‘safe’ assets like cash and precious metals feel better.”

As it turned out, the Russian invasion began the very next day. Markets initially sold off, but then enjoyed a massive rally, leaving the S&P 500 up for the week by 0.82%. While the fog of war will almost surely cause more short-term volatility, it’s critical for the long term investor to remember a lesson of post-World War II history: Major geopolitical events will have almost no impact on markets after 6 to 12 months.

Oil is moving toward $100 a barrel. The last time we saw these prices was in 2014-15, not coincidentally when Putin annexed Crimea in his first move against Ukraine.

Russia is a massive energy exporter and benefits from higher energy prices. Our nation, and we in Santa Barbara, are all affected by the Ukrainian crisis because of short-term energy price changes, but there are other factors in play causing market volatility.

Energy and oil prices are also rising because of the continued strong post-vaccine consumer demand driving high levels of consumption. We are driving more, going out to eat more, and traveling more, as COVID-19 restrictions have eased and pent-up demand has been unleashed.

During the pandemic, many energy producers slashed output by shutting facilities. Reopening takes a lot longer than shutting down, so the lower supplies combined with higher demand has pressed energy prices higher.

The higher post-vaccine demand we are experiencing has driven inflation higher quickly, leaving businesses to catch up by paying more for basics like labor, materials and food. The Federal Reserve has said directly that it will be responding to higher inflation by raising short-term interest rates several times this year. Over the past 40 years, these Fed rate rises have successfully kept inflation in check.

We don’t know if this time will be different, but we do know that we should expect interest rates to be higher than the extraordinarily low rates we are enjoying today. The uncertainty of the impact of higher interest rates and where inflation will be is a much bigger economic and market risk factor than Ukraine, in our view. We do know that when the Federal Reserve begins raising interest rates, there has never been a simultaneous recession or bear market.

Finally, with last week’s announcement of a possible new omicron variant, there is risk of a new COVID-19 outbreak putting the brakes on the economy’s post-pandemic surge. Unfortunately, it appears that we will have to manage through variants for some time to come. Our view is that market reaction to COVID-19 has become less severe with each new outbreak. Hopefully, effective vaccines will be able to keep the effects of the disease muted and manageable, but the risk of a new, more virulent variant cannot be completely discounted.

Market volatility is to be expected in times of uncertainty, chaos, and fear, which is to say, market volatility is a “normal” condition. Each investor should have a disciplined plan which helps them avoid rash, fear-based decision making. Ideally, a good plan can help investors take advantage of the rash decisions of others.

• Arthur Swalley is a partner and director of investments at Arlington Financial Advisors in Santa Barbara.