Stocks decline as Russia and Ukraine tensions rise

The problem with the person who thinks he’s a long-term investor and impervious to short-term gyrations is that the emotion of fear and pain will eventually make him sell badly. – Robert Wibblesman

Geopolitical tensions, high inflation and the prospect of tighter monetary policy from the Federal Reserve all weighed on market sentiment last week and the three major stock averages each dropped about 2%. It was another volatile week for stocks as fourth quarter earnings and economic data seem to have taken a back seat to concerns over Russia and Ukraine. There was a dramatic acceleration last week in the buildup of Russian troops on the Ukraine border, which worried investors who feared an invasion was imminent. Although there were reports that some Russian forces were being withdrawn, the reality showed the number of troops along the border was actually increasing as warnings were issued about a possible attack. Rising geopolitical tensions weren’t the only negative news headline that investors had to deal with last week. The producer price index (PPI) for January rose 1%, twice what was expected for the month, and has now risen nearly 10% year-over-year, just below a record high. The core PPI, which excludes volatile food and energy prices, was also higher than forecast. Comments by St. Louis Federal Reserve President James Bullard only added fuel to the fire as he said that the Fed needed to fight inflation more aggressively as the last four consumer price index (CPI) reports indicated that inflation was broadening and possibly accelerating. In response to the unexpected rise in the inflation data, the yield on the 10-year Treasury jumped to over 2%. Federal Reserve minutes from the January monetary policy meeting shared Bullard’s concerns but indicated that the Fed would take a measured approach in tightening monetary policy. Fed officials noted that inflation was beginning to spread beyond pandemic-affected sectors into the broad economy. To combat the rise in inflation, they outlined plans to raise interest rates and reduce the asset holdings on the balance sheet, suggesting that the unwind of the bond portfolio could be more aggressive. It will be another busy week for corporate earnings reports, but investors will likely focus instead on the situation in Ukraine.

Last Week

Retail sales in January jumped nearly 4%, much higher than expected, as consumers continued to spend despite high inflation. Import prices in January also surged and recorded their biggest increase in 11 years while January industrial production was higher than expected. Leading economic indicators in January fell compared to expectations of a modest increase due to a resurgence of Covid-19 cases, high inflation and supply chain disruptions. Weekly jobless claims were 248,000, higher than last week and above 218,000 that was expected. Housing starts in January recorded their first decline in four months and fell more than expected.

For the week, the Dow Jones Industrial Average fell 1.9% to close at 34,079 while the S&P 500 Index lost 1.6% to close at 4,348. The Nasdaq Composite Index dropped 1.8% to close at 13,548.

This Week

The second estimate of fourth quarter gross domestic product (GDP) is forecast to be 6.0%, less than the preliminary estimate of 6.9%. January durable goods orders are expected to increase nearly 1% after declining in December while January new home sales are expected to be less than in the previous month. Both the February consumer confidence index and the final University of Michigan consumer sentiment index for February are expected to approximate levels reported in January as high inflation continues to weigh on sentiment.

The most prominent companies that are scheduled to report quarterly earnings this week are Agilent Technologies, Palo Alto Networks, Autodesk, Dell Technologies, eBay, Home Depot, Lowe’s, TJX Cos., Macy’s, Medtronic, Moderna, Public Storage, Molson Coors Beverage, Anheuser-Busch InBev, American Electric Power, Occidental Petroleum, Newmont and Royal Bank of Canada.

Portfolio Strategy

For the second consecutive week, the major stock averages finished in the red as investors took a risk-off approach to the market in the face of significant headwinds in the form of likely Federal Reserve monetary tightening and possible conflict in Ukraine. Although quarterly earnings have been mostly positive and economic data mostly favorable, investors don’t seem to care as geopolitical tensions and Fed policy have trumped fundamentals for the time being. This week promises to be no different even though a plethora of companies will report earnings and there are key pieces of economic data to be released, including the personal consumption expenditures (PCE) index, which is the Fed’s preferred measure of inflation. Last week’s higher than expected producer price index (PPI) caused the 10-year Treasury yield to spike to 2.06%, but the threat of war in Ukraine led to a flight to safety as investors sold stocks and piled into safe havens such a Treasuries later in the week. (Bond prices and yields move in opposite directions). The 10-year Treasury yield ended the week at 1.92% while the yield on the 2-year Treasury fell to 1.47% after briefly touching 1.60%. Odds of a 50 basis point (a basis point is one hundredth of one percent) hike in the federal funds rate when the Federal Open Market Committee (FOMC) meets in March were also reduced even though some Fed officials have argued for such an increase. The most likely scenario now is a 25 basis point increase from the current range of between 0% and 0.25%. While Fed officials are nearly unanimous in their thinking that the Fed bond buying program should end, interest rates should increase and its holdings of Treasuries and mortgage-backed securities should be reduced, they differ on the pace and degree of such moves in transitioning to tighter monetary policies. The market does not like uncertainty but that is what it must deal with in the near-term as the situation in Ukraine and Fed policy remain the primary focus.