Ukraine, Europe, and you

Key takeaways

• The Ukraine conflict remains a potential source of increased short-term market volatility.
• Disruption of Russian energy exports as a result of the conflict has raised global energy and food prices.
• While the US economy is relatively insulated from the war and sanctions, Europe's economy is suffering and that may affect US investors, too.
• Professional management may help US investors better manage long-term international stock investing while managing the risks.

Since the war between Russia and Ukraine began in February, financial markets have reacted to the conflict with relative equanimity. US stocks rose during the early days of the war and though markets have turned volatile since the Russian military entered Ukraine, that volatility more reflects uncertainty about US monetary policy rather than Russian military policy. So far, the markets' reaction to the war is consistent with what history shows which is that geopolitical crises don't typically have long-term consequences for investors. However, new signs are appearing that suggest the economic fallout from the conflict and resulting sanctions may be increasing.

Dirk Hofschire of Fidelity's Asset Allocation Research Team explains that, "Geopolitical crises don't tend to have significant and lasting impacts on global financial markets unless they have a sustained macroeconomic impact on major economies." 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, so while Russia has been battered by sanctions against it by the US and Europe intended to punish it for its actions in Ukraine, it is likely not big enough by itself to affect global markets or economic growth.

But because Russia is also the source of nearly 50% of the energy consumed in Europe—the policy responses from the US and Europe that have disrupted energy and other commodity supplies are raising risks beyond the 2 countries' borders. The issue is particularly significant in Europe. Analyst Cait Dourney says that while Europe's economy is still growing, the outlook for the near future now shows a rising risk of recession. "We see higher risk in our recession probability models, especially for the biggest European countries like Germany and Italy. This is due in part to Europe's reliance on Russian oil and natural gas, which is squeezing the consumer sector and in some cases causing production bottlenecks. Some of this may be offset by increased spending on services by consumers and tourists. Overall we'd characterize Europe as being in a late stage expansion with rising recession risks. The speed and magnitude of the slowdown will be determined by political developments with regard to the Ukraine war. Even though no one knows exactly how the war will play out, we can assess the recession risk as higher for Europe than for the US."

What it means for you

Because of its huge domestic economy and its ability to meet its energy needs without imports, the US is more insulated than Europe is from the effects of the Ukraine war. However, the globalized nature of financial markets could mean that US investors will see more volatility in the months ahead, even if the US avoids recession while Europe doesn't. The European Union's economy is larger than that of the US and many US-listed companies rely on European consumers for a significant part of their earnings. If those consumers spend less out of fear of losing their jobs in a recession, company earnings and prices of stocks in US investors' portfolios could also decline. Fidelity's geopolitical risk analyst, David Bridges, says investors shouldn’t rule out the possibility that the conflict may fuel higher volatility in the months 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.

Beyond the military situation, uncertainty is also likely to be heightened by the prospect of unintended consequences resulting from western sanctions against Russia and the risks that policymakers will entangle the US in a conflict that the US could otherwise largely avoid the effects of.

Inflation rising, but US economy still growing

Besides raising the likelihood of market volatility, the war and sanctions are adding to inflationary pressures by disrupting exports of oil, natural gas, and wheat from Russia and Ukraine.

The impacts of the conflict will likely 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. Western Europe, particularly Germany, also has no easy alternative source of energy to replace Russian natural gas.

A human tragedy

While volatile markets can be unnerving for investors, and recessions can mean lost jobs it's important to remember that the situation in Ukraine is a human tragedy of many lives lost and many more profoundly disrupted. Relief agency World Relief was founded after world war II to help displaced people in Europe and is one of many groups working with Ukraine refugees. They point out that the refugees are part of a worldwide crisis in which 1 in 95 people worldwide has been displaced by war and other forms of political violence. Here are some more ways to help people displaced by war.

Keeping perspective

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.