What does the Ukraine crisis mean for markets?

Key takeaways

• The Ukraine conflict may contribute to increased short-term market volatility.
• Disruption of Russian energy exports as a result of the conflict could temporarily contribute to rises in global energy and food prices.
• While Europe's economy is likely to suffer, the US is relatively insulated.
• Professional management may help US investors better manage long-term international stock investing while managing the risks.

While tensions between Russia and Ukraine have been rising for years, the current military action is raising the risks of a protracted conflict within Ukraine and creating concerns about the potential impact on financial markets and the global economy. Fortunately, however, history shows that while geopolitical crises such as the one between Russia and Ukraine can temporarily roil markets, they don't typically have long-term consequences for investors.

As Dirk Hofschire of Fidelity's Asset Allocation Research Team says, "In general, these types of crises tend to only have a significant and lasting impact on global financial markets if they have a sustained macroeconomic impact on major economies." While Russia's economy ranks as the world's 11th largest, according to the International Monetary Fund, at only 1/20th the size of the US and 1/15th the size of China, it is likely not big enough by itself to affect global markets or economic growth, even if it suffers significant economic damage as a result of sanctions against it by the US and Europe.

Still, because Russia is also the source of 10% of the world's energy—and nearly 50% of the energy consumed in Europe—the conflict does pose risks beyond the 2 countries' borders including higher energy prices and increased financial market volatility.

More geopolitical uncertainty, more market volatility

While markets reacted with restraint to the invasion of Ukraine, Fidelity's geopolitical risk analyst, David Bridges, says investors shouldn’t rule out higher volatility in the days and weeks to come. “This is the start of a new cold war. The conflict could take a variety of forms and isn’t likely to be resolved soon. Over time, it will also become more difficult to get information about what’s happening in Ukraine, which will add to uncertainty,” he says.

Another factor that will likely influence the impact of the situation on the economy and markets is how Russia responds to western sanctions against its financial interests, as well as restrictions on exports of technologies used by the Russian military.

Inflation rising, but US economy still growing

Besides raising the likelihood of market volatility, the invasion is likely to add to inflationary pressures by disrupting exports of oil, natural gas, and wheat from Russia and Ukraine and raising prices.

The impacts of the conflict are likely to vary depending on geography. Europe—and particularly countries such as the Baltic states and Poland—are likely to experience more difficulties than countries that depend less on Russia for energy. Russian gas is a major source of winter heating in Europe and already spiking prices have hurt European households and businesses. Western Europe, particularly Germany, also has no easy alternative source of energy to replace Russian natural gas.

Hofschire says that the Russia-Ukraine conflict adds uncertainty about the strength of the economic expansion in Europe. While that injects some uncertainty into the global outlook, he says, the US economy appears relatively insulated from the conflict. For individual investors and consumers in the US, the effects will most likely take the form of additional inflationary pressures due to higher energy prices.

North American energy companies could benefit

From an investment standpoint, the biggest impact is on Russian stocks, bonds, and currency. Higher oil and gas prices could further benefit North American energy companies, whose stocks have been among the best performers over the past year.

An increase in short-term stock market volatility is also likely. Hofschire says, "The Russian military action likely adds to general market nervousness. Recent stock market volatility reflects a variety of investor concerns, so another source of uncertainty and disruption doesn't help." However, he says additional inflation pressures and higher volatility by themselves won't cause a recession in the US.

Despite geopolitical risks, US investors should not lose sight of the long-term opportunities that international stocks may offer. Indeed, Hofschire's team expects international stocks to outperform US stocks over the next 20 years. Those expectations partly reflect the fact that US stocks have risen more than those of other countries over the past 2 years and US stock valuations are now high by historical standards.

Diversification and professional management can help manage short-term risks while pursuing long-term rewards. As Naveen Malwal, institutional portfolio manager with Fidelity's Strategic Advisers LLC, explains, "We hold stocks and bonds across many different regions, countries, sectors, and industries. One result of our diversified approach is that our clients generally have very little direct exposure to investments in Russia, and even less exposure to investments in Ukraine. That level of diversification can give investors some peace of mind in the face of geopolitical events." Or as Bridges puts it, "My view, as the old geopolitical guy, is to take the long view. Just stay focused and don't be afraid."

This article will be updated.