Ukraine a year later: The war and markets still enduring a rocky landing

With the tragic war in Ukraine now reaching its one-year anniversary, its perhaps instructive, maybe just sad, that despite a lot of volatility in both the war and markets, not a lot has really changed. Both are grinding forward, through alternately optimistic, then pessimistic, then optimistic again forecasts of when each might “land.” Our own view, as readers of this space know, is that we are already in a landing of sorts, though one with a lot of bumps and bruises along the way—i.e., a “Rocky Landing.” And while being in the midst of a rocky landing is never comfortable, that’s at least better than being at the beginning of one.

First, a summary of where we are and what’s changed

On the war itself, one could argue that not a lot has come of the Russian aggression, other than death and destruction. Tragically, some estimates suggest there’s been more than 300,000 deaths in Ukraine, shared by both sides but probably disproportionately Russian soldiers who have been thrown like cannon fodder into the Ukrainians’ determined defense of their country. And the tally of economic damage in Ukraine grows daily, with some estimates as high as $500 billion or more, including roughly $140 billion to civilian infrastructure. For all this, the Russian army has given back roughly half the territorial gains achieved in the war’s early days, when they occupied roughly 27% of the country, and now only hold some 17% of Ukraine compared to the 7% they already controlled before the invasion. We’ll see if they can even manage to hold that. Net net, a lot of bloodshed and destruction for relatively minimal gains by the Russians. And now both sides seem to be running short of men and arms. 

For the markets, the last 12 months have seen a ton of volatility. But stocks as a group haven’t changed as much as you might think. The S&P 500 stands about 5% below where it was a year ago, though at times over those 12 months was down a lot more. Within the S&P, growth stocks are down double digits, mostly a valuation correction from hyper levels as discount rates shot up. Defensive dividend-paying stocks, where we’ve fortunately been leaning heavily, are flat to up since the Russian tanks rolled across the border. Oil, thought to be one of the key transmission mechanisms of the war to the markets, is actually down, not up, since the invasion, although again it initially spiked to much higher levels—about 25% above some estimates of fair value at the time. Natural gas, a key vulnerability of Europe to Russia, has been far more significantly impacted, at least in Europe, though they’re well off their highs. European gas prices currently average about $16 per Metric Million British Thermal Units (MMBtu), compared to our fair-value estimate of $8 in Europe and the current price of natural gas in the U.S., where it’s approaching $2. (Because it’s difficult for U.S. natural gas to enter the global market other than fairly limited liquid natural gas shipments, natural gas markets tend to trade regionally, not globally.) While off its $41 peak, European natural gas continues to trade at elevated levels, making it a key driver of outsized inflation Europeans have been experiencing, including today’s 8.6% year-over-year CPI print. That and stagflation concerns had driven the euro and stocks lower, though again, they’ve since recovered these losses. For instance, the Euro Stoxx 50 Index rose 9% in euro terms and 2% in dollar terms over the past 12 months, the difference reflecting the euro’s nearly 7% decline vs. the dollar over the period.

The biggest change in markets over the last year actually has come from bonds, not stocks. One year ago, the fed funds target rate was hovering around 25 basis points compared to 4.75% today, while a 10-year Treasury yield that was under 2% is almost 4%. So much for the axiom that “The bond markets are all knowing”—they clearly missed this truck coming. Still, not too much of this sell-off in bonds can be attributed to the war. While it certainly disrupted global supplies of food and energy, at least in the early months, our own estimates are that much of this and inflation more generally can be attributed to a toxic brew of events: underinvestment in commodities and energy over the past several years; further supply disruptions emanating from the global Covid lockdowns including only recently ended “Covid Zero” policies in China; government incentives not to work in the Covid and post-Covid era; baby boomer early retirements during and following the Covid scare; and a Fed that waited way too long to start the rate-hiking cycle. 

More rocks ahead

While both Ukrainians and the markets have endured a difficult 12 months, the near-term road ahead looks still rocky to us. Regarding the war, Putin has clearly backed himself into a corner with no easy way out. Our guess is he presses on until he literally runs out of rockets, maybe sometime over the next 12 months. As difficult as the past 12 months have been, Ukrainian morale remains high and it’s tough to bet against them; they and everyone else can see that they have the edge in the fight and are likely to prevail as long as they have enough materiel and bodies. Importantly, they know that the inevitable Russian withdrawal from their country is at least 12 months closer than it was 12 months ago. Small comfort, for sure, given the tallies of dead soldiers, but at least that’s something.

For markets, absent some big and unexpected escalation, the war’s time of having a big influence arguably is past. What matters now, more than ever, is the battle of the Fed with the labor markets, which remarkably are still holding up. No one knows for sure, of course, of the force with which the lags of 450 basis points of hikes already on the books will fully work themselves out. But surely this process has already begun. Layoffs among the most drunk of the sailors in the room, the tech companies whose stocks were once trading at 40x revenues, are up, and this alone should begin to impact wage demands at the margin. The housing market has slowed to crawl. Corporate earnings are coming down across most sectors, though sell-side estimates remain about 10% above our more realistic estimates ($200 for this year).  As profits continue to come down in this rocky landing, the economy and inflation almost surely will adjust lower. 

Most importantly, as we look forward 12 months, a brighter future should emerge. The war in Ukraine should almost certainly be over. Inflation should be closer to the Fed’s hoped-for range, maybe nearing 3%. Earnings will have bottomed and should be once again on a growth path. Bond yields will have peaked, stabilized and might even already be heading modestly lower. All good reasons to remain cautious for sure, but to get to “the other side of zero.” Bumps and even scary dips in stocks are likely ahead, in our view, as data in a rocky landing are inevitably, well, rocky. But with better days ahead, and “ahead” getting closer by the month, we’ll keep buying the dips from here on out.