War in Ukraine reminds us of role for bonds
By Kyle Tetting
Russia’s invasion of Ukraine has raised important questions about the direction of global markets. The devastation and humanitarian impact have been immediate. At the same time, uncertainty surrounding international response has challenged efforts by global central banks to navigate inflation while sustaining economic growth. Though uncertainty is an ever-present part of investing, the market response to this conflict so far reflects unknowable questions, let alone unknown answers.
The immediate economic impact of war between Russia and Ukraine appears modest. According to the World Bank, Russia and Ukraine combined accounted for less than 1.9% of global gross domestic product at the end of 2020. Though modest in size, reductions in the two countries’ contributions to the global economy for oil, gas and wheat are likely to exacerbate certain inflationary pressures.
Despite accounting for less than 7.5% of the CPI basket of goods, energy prices contributed 25% of the annual rise in the Consumer Price Index in January. With likely further reductions in supply, oil prices stand at their highest level in a decade, a development that will continue to pressure energy costs. Further, while nearly all the wheat imported to the U.S. is from Canada, global supply imbalances for wheat have the potential to disrupt food prices here as well.
The Federal Reserve and other central banks around the world are now faced with an interesting dilemma. With continued inflationary pressures increasingly driven by supply constraints and the potential for slowing economic activity amid the fog of war, the path for aggressive rate increases is less clear.
What is clear, at least for appropriately balanced investors, is just how important bonds have been. Rising interest rates have put significant pressure on bond prices recently, yet bond portfolios have vacillated modestly. Most high-quality short-term bond funds are down less than 1.5% this year. Conversely, broad measures of U.S. stocks continue to flirt with correction territory. A bad year so far for both bonds and stocks, to be sure, but it’s hard to equate the two.
While it’s difficult to see past the current risks, especially amid so much uncertainty about the war in Ukraine, there are signs of light peeking through the gray clouds.
Perhaps most importantly, the latest wave of the pandemic seems to be fizzling out. More than a month out from record daily cases, the seven-day average of new cases has been quickly falling back to the levels of late last summer. With continued progress on vaccination, testing and treatment and the potential importance of the “test to treat” program outlined in the State of the Union Address, we may be seeing a renewed confidence that the pandemic is under control.
Add in the continued transition toward more resilient supply chains and the productivity gains learned through surviving the pandemic, and the overall economic outlook is strong. Employers and employees alike have the tools and resources to better navigate future pandemics while we continue to better navigate the current one.
These are reasons for long-term optimism and a reminder that falling prices during periods of uncertainty are a result of short-term thinking. Further, the swings in stock prices provide opportunities to buy more cheaply — though we tread lightly here, understanding that buying something cheap doesn’t mean it won’t get cheaper.
Here too, we’re reminded of the importance of bonds.
Bonds provide the foundation for a strong portfolio. Bonds let investors look at a bad stretch and trust their dry powder, years of safety and a damper on volatility across nearly all environments. Bonds don’t eliminate all the uncertainty that will continue to push stock prices around, but they do help investors refocus on what comes next.
Staying the course is not staying still, by Kyle Tetting
Investors: Prepare for stock corrections, a Money Talk Video with Paige Radke
A note on coronavirus volatility, by Kyle Tetting
When Should I …rebalance my portfolio? by Art Rothschild
Beginners Guide to Asset Allocation, Diversification and Rebalancing, from the U.S. Securities and Exchange Commission
Rebalancing Your Portfolio, from the Financial Industry Regulatory Authority
(initially posted March 4, 2022)