Markets Resilient Amid Russia’s Invasion of Ukraine

Clearly, the Russian invasion of Ukraine captured the world’s attention last week. Although forecast for weeks, it still came as a surprise when airstrikes hit Ukrainian cities, including the capital, and troops moved across the border in a full invasion. Markets plumbed the depths of fear and pessimism Thursday morning, but rallied sharply off the day’s lows and closed the week with strength. Investors eyed a quicker resolution to the conflict than initially thought, given that on Friday Moscow signaled an openness to talks with Ukrainian leadership. Markets had also priced in some of this, given the invasion appeared imminent for weeks.

Honestly, no one knows how this all plays out from day to day. Throughout the pandemic, we have emphasized to readers of this commentary that we aren’t public health experts and won’t make a call on the trajectory of the virus. Similarly, we are not geopolitical scholars, so we aren’t going to make a call on how the war develops in Ukraine.

Instead, we simply always expect the unexpected and hedge portfolios accordingly. Diversification across asset classes and financial instruments is a core principle and, in our view, is paramount to durable returns over the long term. Rather than going deeper into the conflict here, please watch or read our complete perspective on the conflict for investors.

Ukraine will likely remain a hot issue, but as the calendar turns to March, the market will shift its focus to the Federal Reserve, which is entering a critical stretch for monetary policy. Fed Chairman Jerome Powell will testify before Congress Wednesday and likely provide a preview of the Fed’s policy meeting later in the month.

Now, let’s dig into the week that was and get you ready for the week ahead.

Wall Street wrap

Inflation High in January, But We’re Looking Forward: The Fed’s preferred measure of inflation, core PCE, notched a 38-year high in January, rising to 5.2 percent over the same period in 2021. Month-over-month core PCE rose 0.5 percent, in line with the prior three months.

Goods inflation was up 8.8 percent year over year, while services rose 4.6 percent. The key here is goods spending, and we think a lot of that demand was pulled forward in 2021. We expect to see a notable downshift in goods spending in 2022, and that will help pump the brakes on inflation. We’re finally seeing evidence of that shift in the data, which makes sense given the retreat in omicron cases (see “Services Are Roaring Back” below). 

We expect another elevated inflation read in February, but the year-over-year number will likely start to decline as we begin lapping higher inflation reads that started in March 2021. Again, this is a backward-looking metric. Going forward, we still believe inflationary pressures have peaked and will start rolling over as consumption patterns shift, the Fed begins modestly raising rates and supply chains start to catch up. Of course, the Russia-Ukraine conflict is a new element to factor in, particularly for energy prices. Economic sanctions could also have knock-on financial impacts in the U.S. and for its allies. Still, we don’t believe these factors are significant enough to impact our outlook.

Services Are Roaring Back, Here and Abroad: The U.S. services sector (by far representing the largest share of GDP) posted strong growth, reflecting another step back to “normal” following the pandemic. The IHS Markit services PMI reached 56.7 (anything above 50 indicates expansion) in February compared to 51.7 in January, when omicron cases were on the rise. 

In the eurozone, services by the same measure reached 55.8 in February from 51.1 the month prior; U.K. services rose to 60.2 from 54.1; even Australia saw services accelerate in February, rising to 56.4 from 46.6. We’re seeing people going back out and spending on experiences, dining and traveling; and these industries are finally climbing back to pre-pandemic levels. Data from OpenTable show a sharp uptick in patrons over the past few weeks, and restaurant reservations are 7 percent above 2019 levels on a seven-day average. That’s compared to 30 percent below 2019 levels in January as omicron surged.

We expect to see services momentum continue through the year as consumer behavior changes.

Consumer Confidence Dips Slightly, but … Consumer confidence dipped to 110.5 in February from 111.1 the month prior. Inflation continues to weigh on the outlook, but there’s a notable callout in the data: The proportion of consumers planning to purchase homes, automobiles and major appliances over the next six months declined. Consider this another proof point of that sizable deflationary shift from goods to services spending we’ve been outlining since the year began.

The week ahead:

Here’s how the week is shaping up:

• Tuesday: The ISM manufacturing data and construction spending reports are due in the morning.
• Wednesday: Payroll data from ADP and the Fed’s Beige book will be released on a lighter day for data. However, Fed Chair Jerome Powell will testify before Congress today, and markets will be keen to see if the Ukraine-Russia conflict is affecting the Fed’s policy calculus.
• Thursday: The ISM services, factory orders, productivity reports will all give us good insights into key inflationary forces and monitoring a shift in consumer spending.
• Friday: The week closes with the unemployment report for February.

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