Volatility is back, and recent geopolitical events and moves in commodity markets have sent stock indexes lower over the past month. While more than enough to raise investors’ collective blood pressure, the rapid pullbacks have also created opportunities for long-term-focused investors.
index has lost about 5% since mid February, when markets began to worry about an imminent Russian invasion of Ukraine. Energy, metals, and grain prices have soared. The S&P 500 and the Dow Jones Industrial Average are each down roughly 10% from their records set earlier this year, while the
is down 20% and in a bear market.
The big moves come despite little direct exposure for U.S. companies to Russia’s economy. The outlook for monetary policy has also been fairly stable. Meanwhile, the trajectory for economic growth has diminished a bit, but not dramatically. On Friday,
Goldman Sachs economists lowered their forecast for 2022 U.S. gross-domestic-product growth to 1.75% from 2%.
“Because they’re caused by exogenous events, the corrections we’ve seen are a bit more emotional and broad-based, rather than specific and fundamental,” says Eric Schoenstein, chief investment officer of Jensen Investment Management, with $14.5 billion in assets.
History shows that mean reversion is a powerful force. After falling into bear-market territory—defined as a 20% decline from a recent peak—the Nasdaq has averaged a six-month return of 10% and been in positive territory nearly two-thirds of the time, going back to the index’s inception in 1972. The Dow Jones Industrial Average, meanwhile, has posted average six-month gains of 5.2% after falling into a correction (a fall of 10% from the peak.)
The indiscriminate selloff is giving investors another swing at long-term trends and investment themes.
“It does feel like we’ll have some changes in defense spending, cybersecurity, and how Europe in particular receives its energy,” says Matthew Moberg, who co-manages the growth-focused Franklin DynaTech fund (ticker: FKDNX), with $23 billion in assets. “But it doesn’t change that we’re going to work from home more, that we’re going to use e-commerce more, that there will be innovation and growth in genomics.”
That’s not to say the short term will be smooth for investors. Russia is the world’s 11th-largest economy but its second-largest commodity producer, active in energy, metals, and grains. The U.S. has banned imports of Russian oil and gas, while European governments have generally avoided targeting commodity exports directly. Western companies are cutting back on trade with Russia and on operations in the country. Jeff Currie, Goldman Sachs’ global head of commodities research, calls those moves “shadow sanctions.”
“Rerouting commodity supplies won’t be easy,” Currie wrote last week. “With or without a blanket ban, commodity supply will likely remain extremely restricted until the conflict is resolved and sanctions ease, or until flows are effectively redirected into potentially China or India, which might take months if it happens at all.”
The surge in commodities prices as a result of the Ukraine-Russia war has pushed back by at least a few months the peak in monthly inflation readings in the U.S. Many economists had predicted that inflation would begin to moderate by this spring or summer.
The S&P GSCI Commodity Index is up 32% in 2022. Thursday’s consumer price index for February showed a 0.8% rise from a month earlier, for a 7.9% annual pace of U.S. inflation.
Those readings heap additional pressure on the Federal Reserve to increase interest rates more aggressively in order to get inflation under control, so much so that it may tip the economy into a recession when paired with sky-high oil prices and consumers’ potential cutbacks on discretionary spending.
Currently, futures pricing implies seven quarter-point interest-rate increases in 2022, according to data from CME Group. That number first dropped when Russia invaded Ukraine two weeks ago, and has rebounded since. Changes in interest rates can’t do anything for wartime raw-materials shortages, but the Fed still needs to maintain its inflation-fighting credibility.
“[The Fed] went through a fairly tortuous process late last year to pivot to a position of saying inflation-fighting is job No. 1,” says Dave Donabedian, chief investment officer of CIBC Private Wealth Management. “To pull back from that now would be a significant problem that might even cause a confidence issue in the markets, if the Fed looks like a weather vane.”
The Fed’s policy committee meets this Tuesday and Wednesday.
Edward Yardeni, president of Yardeni Research, now sees a more stagflationary outlook for the remainder of 2022. “Everything that has happened recently points to more persistent and higher inflation and slower economic growth,” he says.
Yardeni dropped his year-end S&P 500 forecast to 4000 this past week, from 4800 previously. That’s down 5% from current levels.
Broader market trends will probably depend on how long commodity prices remain elevated. Futures pricing has oil declining to about $88 a barrel by the end of the year, from a recent $107 and last week’s peak of about $130. That’s probably manageable for the U.S. economy, and not enough to turn a forecasted year of above average growth into a recession. And it’s unlikely to be a significant drag on earnings for most companies.
In fact, estimates for 2022 earnings from the S&P 500 actually went up this past week, despite the war, according to data from Refinitiv. Higher inflation could still be felt in the stock market’s price/earnings ratio, currently at about 18.5 times for the S&P 500. That’s down from 21.5 times at the start of the year.
“These kinds of dislocating events can create really good opportunities for long-term investors, because the market is too short-term focused and paralyzed by fear, and just throws the baby out with the bathwater,” says David Giroux, chief investment officer of T. Rowe Price Investment Management, and manager of the
T. Rowe Price Capital Appreciation
fund (PRWCX), with close to $34 billion in assets.
Giroux, a member of the annual Barron’s Roundtable, sees value in some technology, industrial, and healthcare names that are down more than the market over the past month but whose fundamental outlook hasn’t changed.
Health Care Select Sector SPDR
exchange-traded fund (XLV) has held roughly flat since mid-February, but many components of the ETF have lost much more and even lagged behind the S&P 500’s roughly 5% decline in that period.
People will still need healthcare, though, and there should be little to no impact on a U.S.-focused medical-device maker’s business as a result of soaring commodity prices or even a global slowdown.
Those unfairly tarnished stocks include
Baxter International (BAX), which makes treatments for kidney disease as well as medical tools and devices;
Mettler-Toledo International (MTD), which makes a wide range of medical and laboratory devices and instruments; and
Abbott Laboratories (ABT), made famous of late for its Covid-19 rapid tests but also widely diversified.
Another buying opportunity amid recent volatility could be U.S. banks. The
SPDR S&P Bank ETF (KBE) has lost about 9% since mid-February and is now in negative territory for the past year.
Citigroup (C) is the most exposed to Russia of major U.S. banks. It has loans, cash, and other commitments totaling nearly $10 billion, the bank has said, along with a consumer banking presence in Russia.
Despite the war in Ukraine, interest rates in the U.S. are still going up this year, which will boost banks’ bread-and-butter lending businesses. Shares of
Bank of America (BAC) and
Wells Fargo (WFC) are both 15% cheaper than a month ago; neither has cited material exposure to Russia.
Investors shouldn’t feel tempted to chase this year’s biggest winners, though. S&P 500 energy stocks are up almost 40% in 2022. Some of the biggest gains have come from shares of upstream producers—such as
Occidental Petroleum (OXY), up 100%—which benefit from higher prices today, says Kimball Brooker, who co-heads the $49 billion
First Eagle Global
Other companies more tied to levels of oil and gas production—like
Schlumberger (SLB) or drilling-equipment maker
NOV (NOV)—haven’t climbed nearly as much. They could benefit, Brooker notes, if oil prices remain elevated for at least the medium term, which is necessary for higher-cost methods of production like offshore drilling to turn back on.
There’s no way to dismiss the fear and tragedy that is filling daily headlines. But they shouldn’t change long-term trends. In that sense, volatility brings opportunity.
Write to Nicholas Jasinski at [email protected]