The most significant issue impacting markets as the month of February ended was the Russian invasion of neighboring Ukraine. After declaring the Donetsk and Luhansk regions of Eastern Ukraine as independent, Russian President Vladimir Putin sent “peace-keeping” forces into those areas. Shortly thereafter, Russia launched a full-scale invasion of the country by attacking the capital city of Kyiv as well as other major metropolitan areas. This has led to several sanctions from U.S. and European counties as well as numerous individual companies pulling their products from Russia. The loss of Russian oil supplies from the global market have driven the price of crude oil higher. As of the end of February, West Texas Intermediate (WTI) crude oil was just under $100 per barrel, a level not seen since the middle of 2014.
The Stock Market
The stock market has been on edge throughout the first two months of 2022. For most of the year investors have been focused on persistently high inflation and the Federal Reserve’s well-telegraphed intention to begin increasing interest rates in the coming months. Fallout from the geopolitical instability caused by Russian aggression in Ukraine has served to compound investor angst. The S&P 500 officially entered a correction (defined as a decline of 10%) on February 23rd when the index closed down 12% from the all-time high reached on 1/3/22. For the month of February, the S&P 500 posted a decline of 3% (including reinvested dividends.) This follows January’s return of negative 5.17%. The year-to-date decline of 8.23% was the worst stretch for the market since March of 2020.
The other two large-cap benchmarks, the Dow and NASDAQ, were both down slightly more than the S&P 500 for the month. For January and February combined, the NASDAQ, which has a higher weighting to growth and technology stocks, declined 12%. Mid-cap and small-cap stocks were the lone standouts during the month, with both the S&P Midcap 400 and the Russell 2000 each rising just over 1%.
Source: Bloomberg Finance, L.P.
The behavior of the bond market during the month of February reflects the confluence of events facing investors. On one hand, expectations for higher interest rates have fueled a sell-off in bonds over recent months. The yield on the 10-year Treasury rose above 2% in mid-February for the first time since 2019 as bond yields rise when prices fall. On the other hand, when wars start investors tend to sell risky assets such as stocks and buy safer assets such as U.S. Treasurys, which is what happened during the final trading days of the month, pushing the yield on the 10-year back down to 1.83% to end the month. All of this is happening within the context of inflation that remains at multi-decade highs and expectations for the Fed to begin raising interest rates. Higher oil prices will also tend to act as a natural brake on economic activity.
The net impact has been a flattening of the yield curve, or the difference between longer-term and shorter-term interest rates. The “steepness” of the yield curve as measured by the 10-yr minus the 2-yr Treasury is an indication of the market’s perception of future economic growth. The steeper the curve the more robust the economy. A narrowing of the spread indicates that investors expect the economy to cool in the coming months. An inverted yield curve, where short-term rates are higher than long-term rates, usually indicates that the Federal reserve needs to loosen monetary policy or risk a recession.
Source: Strategas Securities, LLC
Looking back throughout history, the correlation between the markets and geopolitical or military events has often been very counterintuitive. As the table above shows, on average the S&P 500 has been up over the one, three, six, and 12-month periods following the twelve major geopolitical or military events going back to Pearl Harbor in 1941. In the three instances in the table above where the S&P was down over the subsequent 12 months the economy was in recession at some point during the measurement period. What this would indicate is that despite the horrific consequences and tragedy of war, the market’s path has hinged on the path the economy takes.
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