Monthly Market Recap – February 2022

The S&P 500 lost another 3% in February 2022, as headlines quickly pivoted from inflation and interest rate concerns to the dangerous situation unfolding in Ukraine as Russia’s military began its invasion on February 24^th.

Some investors are understandably anxious about how these geopolitical tensions will end. Europe is experiencing its largest ground war since WWII and Russia holds more nuclear warheads than any nation in the world, so times are, without a doubt, grim.

From purely an economic standpoint, the numbers aren’t that scary. Russia and Ukrain make up less than 2% of worldwide GDP, and global banks have less than $100B of exposure to Russia. To help make put that number into perspective, as of September 2021, the largest 15 US banks hold a combined total of $13.19 trillion in assets. Per the FDIC, qualifying community banks are required to have a leverage ratio of greater than 9%, which means the top 15 US banks have roughly $1.18 trillion in equity capital that can be used to eat credit losses.

It is increasingly likely that this conflict escalates into a larger-scale European clash or a recession-inducing energy crisis as Russia pumps about 12% of the worlds oil and supplies over 40% of the EU’s natural gas imports.

Forecasting how this event plays out is impossible, but if history is any guide, U.S. stocks take most geopolitical events in stride. LPL research featured in a blog post a review of major geopolitical events starting with Pearl Harbor. On average, the S&P 500 experienced a total decline of 5% and bottomed after 22 days followed by an average recovery time of 47 days. Thank you to @GenExDividend on twitter for sharing this information.

Vanguard did a separate analysis of geopolitical events but arrived at the same conclusion: sell-offs related to these risks are typically short term.

There’s always the chance that history does not repeat itself. But fortunately, only about 1% of S&P 500 companies’ sales come from Russia and Ukraine. Few American-based businesses should experience a substantial financial hit as a result of these conflicts. Some business are benefiting, as evident in the oil and defense sectors ($CVX and $LMT are my most notable holdings in this aspect).

Recently, numerous countries have announced plans to invest more in armed defenses, Russia is a loose-cannon when it comes to cyber-attacks, and oil and gas prices are surging which could encourage more energy independence via more oil/gas production or renewable resources within the US. If you’re looking to benefit off of the conflict, I recommend looking to stocks involved in oil, energy, defense, and cybersecurity for those reasons.

That said, war still introduces various risks to the world’s economy, including the potential for a long term energy crisis. With global inflation running high, a restriction of the world’s energy supply from Russia would only serve to worsen inflation. High oil prices affect everything from transportation and manufacturing and utilities. It is very likely that we will see a period of sustained inflation. This hurts consumer purchasing power and slows growth. This also increases the pressure on the Federal Reserve to stabilized prices by lifting interest rates and shrinking balance sheets, both of which are actions that the Fed have committed to throughout this year. The Fed needs to walk a fine line of using these actions to cool the economy while also being weary that doing too much can cause a recession.

From high inflation, to Fed actions, to the Russia-Ukraine conflict, investors will always have to be ready for these risks. However, a calm approach to a well diversified portfolio is more than enough for simple investors, like myself, to ride out any crisis with positive returns given a long enough holding period.

This is why I like dividends. Companies that pay dividends consistently (through the good and bad times) are companies that are built to last. They tend to have strong cash flows, healthy balance sheets, wide economic moats, safe debt levels, etc. While not all dividend paying stocks have these traits, I believe through research and screening we have built a portfolio of companies that embody most, if not all, of those characteristics.

As Warren Buffett says, “Risk comes from not knowing what you’re doing”. Every time I see a dividend hit my account, I am reminded about the durability of my positions. Stick to the plan and you will succeed!