Why Russia's Invasion of Ukraine Adds to Inflation Pressures and Should be 'Unsettling' to Stock Market, Says This Strategist

Dow Jones2022-03-03

Inflationary aspects of Russia's invasion of Ukraine hold worrying parallels to the Yom Kippur war in 1973, says Clocktower Group's chief strategist

Russia's invasion of Ukraine may lead to more sustained pressure on the U.S. stock market than investors may be betting on, warns Marko Papic, chief strategist at alternative asset manager Clocktower Group, who sees inflationary parallels to the Yom Kippur war in 1973.

When U.S. stocks rose late last week despite the war in Ukraine, investors seemed to embrace the adage, "you buy at the sound of cannons," Papic said in a phone interview. But he worries that Russia's invasion of Ukraine risks pressuring the S&P 500 index for longer than the market might expect, partly because of its location.

Ukraine is a large country on the border of Europe, situated close to members of the North Atlantic Treaty Organization, said Papic.Any complicated military operations close to NATO member states run the risk of sparking a broader conflict, he said.

What happens if, say, a Russian military plane veers into Poland's airspace and is shot down? speculated Papic. "We could have a lot of events that are very, very volatile."

Also, Russia's attack on Ukraine risks "meaningfully" adding inflation to the surge in the cost of living that the Federal Reserve already was aiming to tame in the U.S., through rate hikes expected to start as soon as this month, he said. The conflict in some ways is similar to the Yom Kippur war in 1973, an event that stands out for creating "sustainable downside risk to U.S. equities," according to Papic.

Parallels between the two geopolitical crises include the addition of inflation to an already inflationary environment, he said. Papic pointed to the Organization of the Petroleum Exporting Countries retaliating against the U.S. for its support of Israel after it was attacked by Arab states by imposing an oil embargo in 1973-1974. The shock sent oil prices soaring.

"That adds inflation at the worst time," said Papic.

Oil prices surged to more than $110 a barrel in futures trading Wednesday, amid concern about the potential for supply disruptions tied to Russia's intensifying attack on Ukraine.

Russia's invasion of Ukraine could add inflation in some other "pretty complicated ways," according to Papic, who said he is focused on palladium, potash and wheat as Russia is a significant producer of all three. Ukraine also is a large wheat producer, he said.

The price of a bushel of wheat jumped on Wednesday to levels not seen in more than a decade, amid shipping disruptions stemming from the Russian invasion of Ukraine as it pressed into its seventh day.

Papic says he worries that Russia could curtail its export of potash, which he said is a fertilizer farmers use to sew fields. Russia produces around 16% of the world's potash, while its ally Belarus also is a large global supplier of the fertilizer, he said. "If they banned the export of potash," Papic said that costs could go "through the roof" and countries that can't pay could potentially face "a food crisis."

As for metals, Russia provides about 43% of the world's palladium production, which is important for catalytic converters in cars, according to Papic. Should Russia start "messing with the metals," by curtailing exports of palladium , aluminum or nickel, "this just adds inflation at a point where all of us thought it was kind of peaking."

To fight high U.S. inflation that has spiked during the pandemic, Fed Chair Jerome Powell signaled Wednesday that the central bank intends to raise its benchmark interest rate by a quarter-percentage point following the end of its two-day meeting on March 16.

"With inflation well above 2 percent and a strong labor market, we expect it will be appropriate to raise the target range for the federal funds rate at our meeting later this month," Powell said in prepared remarks for his testimony Wednesday before the Committee on Financial Services. U.S. inflation rose in January to 7.5% on a 12-month basis, the highest since February 1982.

The stock market already was jittery before Russia's invasion of Ukraine, as the Fed was pivoting away from its highly accommodative stance and investors expected that the central bank would this year begin raising its benchmark rate from near zero to combat the surging cost of living. Some investors have been anxious about how aggressive the Fed might be, with concern that rising rates too much too fast could hurt the economic recovery.

"The Fed has to now deal with a really complicated situation," said Papic. "That should be unsettling to the market."

The S&P 500 dropped 5.3% in January and fell 3.1% in February, according to FactSet data. Major U.S. stock indexes, including the S&P 500, Dow Jones Industrial Average and Nasdaq Composite , were trading up Wednesday afternoon, after closing sharply lower Tuesday as Russia said it would begin attacks on Ukraine's capital Kyiv.

"Eventually this could be a buy-the-dip kind of thing," Papic said of the geopolitical tensions surrounding Ukraine. "We're not there yet."

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Comments

  • JeremyKok
    2022-03-05
    JeremyKok
    Has the market really fallen to the levels when the pandemic started? Valuation still on the high side and market is very volatile lately. Do your own due diligence before you invest.
  • KSHoSG
    2022-03-04
    KSHoSG
    [Thinking] 
  • Adenphua
    2022-03-03
    Adenphua
    GG
  • AOOH
    2022-03-03
    AOOH
    Thanks for the information 
  • KCKHOO
    2022-03-03
    KCKHOO
    Ok
  • TeikLeong
    2022-03-03
    TeikLeong
    Like
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