Conflict in Ukraine Update

We have some close friends who live in the United States with family living in Ukraine. We are praying for their safety and the well-being of the entire nation. This is a serious event impacting many families worldwide.

However, from an economic viewpoint, its impact should be relatively contained over the next year or so. The price of oil and natural gas has clearly been driven higher. This affects everyone, especially countries like Germany that are overly reliant on Russian gas. This underscores that good energy policy requires true diversification among nuclear, gas, coal, solar, wind, hydro and other sources produced domestically.

Ukraine is the second-largest country by area in Europe after Russia. They have rich soil and temperate climate to support sizable crops for domestic consumption and export. However, their economic output ranks only 55th in the world, limiting the expected impact on international commerce.

We can draw on prior episodes of armed conflict or more localized violence to examine market reactions as a frame of reference. Below is presented a chart prepared shortly after the 2020 airstrike against the Iranian General Soleimani (source). The events on this list include stock market corrections with past conflicts involving economies of similar or often larger global rankings. However unsettling the events in Ukraine may be, the expected stock market impact should not exceed the more significant entries here. Given an average drawdown of 5%, we believe Baxter portfolios should be well-positioned to weather the anticipated market turbulence and take advantage of opportunities that arise.

The typical US company has little exposure to this conflict. The S&P 500 currently trades around 18 times forward estimates of profit for the next 4 quarters. This ratio is appropriate when interest rates are low. The long run average of the S&P 500 is around 14-16 times depending on the decade and interest rate. It would not surprise us to see the stock market trade in this range over the next few years if interest rates rise meaningfully. The valuation can get there with higher profits this year and next or lower stock prices.

The most important trait of the successful investor is patience and discipline when implementing a long-term plan. Please call us with any updates to your financial situation. Baxter Investment Management is happy to run a plan anytime for your exact needs and risk tolerance. If an investor has demands on capital within 12 months, then adequate funds should always be invested in cash or short-term bonds. Likewise, if you anticipate drawing down funds in 24 to 36 months then these funds should be in 2-3 year bonds of high quality. The remaining funds for long-term should be committed to stocks. If you have extra cash then we should check your plan and consider buying stocks that drop in price as a result of the uncertainty in the geopolitical conflict in Ukraine.

Regards,

 Your Team at Baxter Investment Management