Markets react after Ukraine invasion – Episode 141 of Damien’s Midweek Markets

The 141st episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about the impact of the Ukraine invasion on investment markets.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 141

A week on from last week’s show and investment markets continue to be preoccupied with the situation in Ukraine.

Up until close of play, on Wednesday (yesterday) if you had taken a look at the S&P 500 over the interim period it has been a beautiful example of a downtrend with a series of lower lows and lower highs, with no sign of letting up. However, the downtrend has been devastating as it is brutal.

Up until that point, which was prior to today’s news of Russia’s invasion of the Ukraine, the key market driver continued to be concerned over rising tensions on the border of Ukraine, against a backdrop of rising inflation and tightening monetary policy, especially from Western central banks.

Gold continued to shine as described last week having finally breaching the $1900 level. As mentioned in my 80-20 Investor newsletter on Saturday if/when the $1900 was breached the next upside target would be the June 2021 highs of $1907. A break above there could see an even more aggressive move higher back towards $2,000, which we last saw in August 2020.

At the same time, it has been interesting to note the volatility in the price of bitcoin. Go back to the spring of 2021 and Bitcoin was playing a role as an inflation hedge in a risk-on environment (i.e when equity markets rally). This was because real yields were rising. Such an environment makes gold less attractive, which explains why its performance had been lacklustre over the second half of 2021.

However, bitcoin’s correlation with US technology stocks has been steadily increasing over the last year. So much so that after the tech-heavy Nasdaq 100 hit a new all-time high in November 2021 and then slumped 15%, bitcoin followed suit. In fact, the price of bitcoin also hit a peak of $68,789 in November 2021 and had fallen by 40%, by close of play Wednesday and below the crucial $41,000 support level. Below that price bitcoin looks vulnerable to further weakness.

But obviously today we’ve woken to the news that Russia has invaded Ukraine and the trends we’ve been seeing in recent weeks exploded aggressively. At the time of writing global stock markets are in the throws of an aggressive sell-off. The FTSE 100 is down over 3%, while the German DAX is down almost 5% so far today. The Russian stock market (MOEX) is down 35% today alone, taking its fall in the last week to 45%. The price of oil meanwhile has surged past $100 a barrel helping push energy stocks, such as the likes of Royal Dutch Shell higher. The oil and gas company’s share price has risen 2% today while the rest of the stock market crashes around it. Gold has soared, as the perfect storm of geopolitics, inflation, fear and falling real yields push the precious metal higher. The price of gold has leapt almost 3% today and currently sits at $1960 an ounce, a 17 month high, with the $2,000 target in its sights. Bitcoin, meanwhile, has crashed over 9% today down towards $35,000 adding further evidence to the view that it is nothing more than a risk asset correlated to tech stocks, rather than a good portfolio diversifier.

There has been a flight to haven assets such as government bonds, in the wake of the invasion, with the 10 year US treasury yield dropping from 2% to 1.88%. That is a big move in just one day. We’ve seen similar moves in UK gilt markets. But while falling yields are positive for the price of bonds (as it means your bond holdings increase in value) bonds are a complicated haven play right now.

As highlighted last week, bonds have struggled in 2022 as central banks monetary policy outlooks turn increasingly hawkish. With the market betting that we will see at least 6 interest rate hikes in the US, 2 in the eurozone and the Bank of England base rate hitting 2% by this time next year, bonds continue to struggle against this backdrop. It means that bonds are being pushed and pulled by contrasting forces. In a risk-off environment (such as the one sparked by the Ukraine crisis) bond prices tend to soar as investors seek safety, however, with oil and commodity prices rising from the economic fallout of the invasion, it’s put further pressure on central banks to raise interest rates in the coming months. That is ultimately bad news for bonds which is why their price rises have been somewhat contained so far, despite the flight to safety..

Unless you had moved into cash ahead of the crisis your portfolio will be suffering significant losses right now. But if you had remained invested in the market but rotated your equity exposure towards energy stocks, financials and UK stocks more broadly along with exposure to gold (as I had previously done with my own £50k portfolio which I run on 80-20 Investor) then you will have reduced the damage from the current sell-off. The question then becomes how much further will equity markets fall?

Unfortunately no one has a crystal ball but the market weakness we’ve seen was already happening beneath the surface of the headline indices (such as the S&P 500) for months now - as I’ve explained on these shows. Some analysts suggest that equity market shocks, centred around the break out of war, tend to be aggressive but relatively short-lived. However, even if that is true, the inflationary backdrop, tightening monetary policy and slowing economic growth remain headwinds - and the Ukraine crisis could exacerbate the inflation issues globally given the rise in oil and commodity prices. If you want a benchmark to keep an eye on in the short term then the S&P 500 has entered correction territory (fallen 10% from its recent high) this week and has now fallen below the January intra-day low of 4222 - after opening 2% down today. It means that 4100 and 4000 are the next downside targets if the S&P 500 doesn’t find a bottom soon.