Staying on course may be the key to investing in wartime

Entire segments of the global economy were thrown into turmoil after the Russian invasion of Ukraine, leaving investors worried about how they should react. Should they buy energy stocks? Shares of defense contractors? What about farming? Is it time to go cash?

Investors had good reason to worry even before Russian President Vladimir Putin’s invasion. Market expectations for the first quarter projected a tepid gain of less than 5 percent for the S&P 500 Index. A report from financial data company FactSet Research indicated that such a slow level of growth would be the lowest since the fourth quarter of 2020.

Instead, the S&P 500 ended lower for the quarter, losing 4.9 percent. Inflation fears led to a significant drop at the end of January, and stock prices remained volatile even before the Russian attacks began in late February. Stock prices plummeted right before the invasion, regained strength, and then fell further in early March. But since February 23, the day before the invasion, the index has risen 7.2 percent for the quarter, indicating that there is more to the war in Ukraine than worrying the market.

“Initially, there was a lot of fear about what could happen, and as is usually the case, most of it didn’t, so people backed out,” said Brad MacMillan, chief investment officer at Commonwealth Financial Network. “Most investors think, ‘This isn’t something I should worry about from a financial perspective,’ and it’s true.”

This does not mean that investors who provide the obvious war plays could not make money from this carnage. The energy sector was already expected to do well in 2022 before war sanctions cut Russia’s oil exports, ending the quarter slightly off 52-week highs. Defense industry ETFs, or ETFs, which can be bought or sold all day like stocks, turn out to be the same, with the iShares US Aerospace & Defense ETF, SPDR S&P Aerospace & Defense ETF, and Invesco Aerospace & Defense ETF all making gains. Additional pressures on an already entangled supply chain, as well as the expected disruption to Ukraine’s massive wheat crop, have pushed commodity money higher as well.

Instead of worrying about Mr. Putin, investors should worry about Jerome H. Powell, chairman of the Federal Reserve. The Federal Reserve raised interest rates by a quarter of a percentage point in March for the first time since 2018 and forecast six more increases this year.

“The market reaction in the past four to six weeks can be attributed roughly to the Fed and how interest rates have moved,” MacMillan added. “There has been little response to events in Ukraine.”

Andy Caprin, chief investment officer at Andy Caprin, said investors did not fully understand what higher interest rates would mean for stocks in the financial sector, especially banks and insurance companies, which have suffered from a prolonged stretch of near-zero interest rates. Regent Atlantic. “The market has not yet determined the benefits that financial stocks will witness from the rise in interest rates,” he said. “Banks in particular can achieve a much higher interest rate margin with higher short-term interest rates.”

One of the funds it tracks is the Invesco S&P 500 Pure Value ETF, which invests in valuable stocks of the S&P 500 index, with about 40 percent of the fund’s holdings coming from the financial services sector.

Caprin said stocks that could suffer higher rates include those of small and emerging software and e-commerce companies and other capital-intensive technology companies that have relied on borrowing heavily at low rates to become profitable.

Simeon Heymann, global investment analyst at ProShares, said individual investors should maintain a long-term horizon even in retirement, which can last for 30 years or more. This means ignoring stock-based temporary disturbances.

“Historically, stock market downturns have been fairly short-lived major geopolitical events,” said Mr. Heymann. “If you look at what happened after 9/11, or the global pandemic or the invasion of Kuwait, the contraction was measured in weeks or two months.”

One interest rate-focused fund is the ProShares Equities for Rising Rate ETF, which is limited to sectors that have historically outperformed the market when prices are rising. About 80 percent of its holdings are in the financial, energy and materials sectors. To get even more defensive, there’s the ProShares S&P 500 Dividend Aristocrats ETF, a stock fund with rising dividends that could offset the effects of inflation and higher rates.

Amy Arnott, portfolio strategist at Morningstar, strongly cautioned investors against dumping stocks and moving into cash. Diminutive returns on bank deposits and money market funds will not necessarily improve with Fed rate increases, and even if they do, they will not beat inflation, resulting in a loss in real dollar terms. Even worse, bailing out stocks raises the more difficult challenge of deciding when to return.

“You can always find a good reason to sell when there is a lot of uncertainty, but the markets are recovering faster than people might expect,” Arnott said.

She said it was important not to lose sight of basic consumer goods and to assume that inflated operating costs would reduce corporate profit margins. The fact is that these companies are able to pass on their increased costs to consumers, as some companies use inflation to hide additional price increases.

“Consumer staples tend to hold up well when there is a lot of volatility in the market,” Arnott said.

Many analysts said investors should also pay more attention to bond funds. Bonds act as an important stabilizing factor in a diversified portfolio, but today’s high interest rates are hurting the value of existing low-interest bonds. This trend will reverse as old bonds mature and are replaced by new, higher rate bonds. Already, yields on five- and 10-year corporate bonds are close to 4 percent.

“There is a lot of talk about, ‘prices have gone up and my bond fund values ​​have gone down,’ but your bond fund can now reinvest your money at a higher return,” said Mr. Macmillan.

One step that doesn’t involve making any drastic changes is a simple one: rebalance your holdings, said Lena Devinny, vice president of Fidelity Investors Center in Framingham, Massachusetts.

“During volatile markets, your asset diversification can change, and rebalancing gives you an opportunity to manage risk and keep your investments in line,” said Ms. Devinney. “We want to buy low and sell high, and rebalancing is a great way to do that.”

She added that how often investors should rebalance their holdings depends on the level of market volatility. The Fidelity management team has already rebalanced the investments six times this year.

For investors still worried about Ukraine, Covid, supply chain shortages, oil prices, and other geopolitical turmoil, the best move is to put together a diversified portfolio that can take global crises a step further without the need for major adjustments. Analysts say investors who have already done so should not make any quick decisions.

“The best advice for investors is to try to resist the urge to make drastic changes to your portfolio,” Ms Arnott said. “As long as your original plan still makes sense, stick with your plan, making sure your portfolio allocation aligns with your goals and rebalancing if necessary.”

If, after all that, investors are still wary, consider this observation from Mr. Macmillan of the Commonwealth Financial Network: “If you look back at the last century and how wartime markets have performed, they actually do better.” As a citizen, am I worried? definitely. As an investor, not so much.”

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