Welcome to RBC’s Markets in Motion podcast, recorded March 14th, 2022. I’m Lori Calvasina, head of US equity strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we run through a few new thoughts on Russia /Ukraine from a US equity market perspective. Three big things you need to know:
First, the big, obvious risks to our call on the S&P 500 are the possibility that the war will turn into a prolonged conflict involving NATO or the possibility that the US will slip into recession. We took a look at the historical playbook for stocks during WW2 and past recessions as a starting point for how to think about possible downside levels in the index should either of these risks materialize. Second, we are starting to see some shifts in momentum in political polling data back in Biden and the Democrats’ favor, which are worth keeping a close eye on given the mid term elections coming up in November. Third, public company commentary on the Russia/Ukraine crisis has surged and while most companies have said direct exposure is minimal, the broader conversation reflects a significant degree of uncertainty surrounding the impact of the event – reinforcing to us that the stock market either needs more time to digest what’s happening or an outright de-escalation of the conflict in order to stabilize.
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Now, the details.
Takeaway #1: We took a look at the historical playbook for stocks during WW2 and past recessions as a starting point for how to think about possible downside levels in the index should either of these risks materialize.
- Helima Croft, who runs our commodities and geopolitics research team, has warned that a Russian attack on one of the Baltic States is one of the gravest near-term threats, and would pull NATO into the conflict. She’s telling investors to prepare for a worsening of the conflict. On the economic side, while our Head of US economics Tom Porcelli isn’t calling for a recession at this time, he has said that the move in gas prices will pull a point out of growth and that the tail risks are growing fatter.
- So what does the historical playbook tell us about both of these risks for US equities?
- In terms of the broadening out of the conflict, the key stat to keep in mind is that the S&P 500 lost 43% of its value from the time that Germany invaded Poland in September 1939 to its April 1942 trough, sandwiched in between Pearl Harbor, which officially ended US isolation, and the Battle of Midway, which was a major turning point in the war. Flip to slide 3
- In terms of recession risk, dating back to the 1930’s, the S&P 500 falls 32%, on average, peak to trough - remarkably similar to the 34% drop seen in 2020 during the pandemic. The range has been 14% to 57%.
- If the S&P 500 loses 32% of its value from it’s January 2022 high (the average recession drop), the index would fall to the 3,200-3,300 range. If it were to lose 43%, similar to WW2, it would end up around 2,700.
- For now, we continue to operate under the assumption that the current crisis will end up being a growth scare, which takes the stock market down 14-20%, similar to the drawdowns of 2010, 2011, 2015-2016, and late 2018. Fast and furious rebounds were seen on the other sides of those bottoms. What we’ve done today is simply to highlight possible downside scenarios if that framework ends up being too conservative.
Takeaway #2: We are starting to see some shifts in momentum in political polling data back in Biden and the Democrats’ favor, which are worth keeping a close eye on given the mid-term elections coming up in November.
- Looking at the Real Clear Politics data, Biden’s approval rating has started to move up, (Flip to slide 5) while those who say the country is headed in the right direction has also started to improve. Admittedly, both are still quite low, but a positive shift in direction seems to be underway. Flip to slide 6
- Views on Democrats in the generic Congressional ballot have also stabilized, while views on Republicans appear to have peaked in January and have been moving down.
- This is important because it suggests that a risk to the consensus view on the policy backdrop for stocks may be emerging. Most investors we’ve spoken with over the past few months have been assuming the Republicans would do well in the midterm elections this fall.
- Views on Biden and the Democrats have been getting dragged down by inflation (which is likely to remain a problem for a while) and COVID (which is getting better). But the Russian invasion of Ukraine may be managing to do something the pandemic could not – unite Americans. Indeed, a recent Wall Street Journal poll indicated that 79% favored a ban on Russian oil imports even if it caused higher energy prices in the US. We’ve seen similar stats in other polls as well. We’ve seen similar stats in other polls.
Takeaway #3: Public company commentary on the Russia/Ukraine crisis has surged and while most companies have said direct exposure is minimal, the broader conversation reflects a significant degree of uncertainty surrounding the impact of the event – reinforcing to us that the stock market either needs more time to digest what’s happening or an outright de-escalation of the conflict in order to stabilize.
- We’ve read through comments made on Russia and Ukraine by nearly 100 S&P 500 and Russell 3000 companies across all sectors last week in regards to the conflict at investor conferences – both RBC events and other major firms – analyst days, investor days, and earnings calls.
- In most, the conversation amounted to a single question or two – it’s wasn’t the dominate issue in focus.
- Within the Russia/Ukraine conversations, the most common theme was the idea that US companies have minimal direct exposure, along with general disapproval of the invasion and concern for affected employees.
- After that, inflation and supply chain implications, suspended operations and activities in the region, hits to demand/creation of uncertainty in the outlook, and sanctions came up the most. On supply chains, a broad range of issues were highlighted, including keeping an eye on semis and fuel costs, lumber challenges, insurance, and shipping/credit checks.
- Coming in next on the list of topics addressed within the Russia/Ukraine discussions were energy, Europe (where several consumer/TIMT related companies noted weakness in the broader region had already been seen), fundraising/support for refuges and humanitarian efforts, and raw materials/metals.
- In terms of other interesting nuggets that we gleaned from a few companies: several highlighted how they were helping their clients manage through the risk and uncertainty, several emphasized that they would manage through this challenge for their own company just as they did with COVID, and a few Health Care companies noted that some clinical trials would be affected. Several media and financial firms also observed that the appetite / need to understand the crisis was massive, another testament to the knowledge vacuum in place.
- There’s always a quote or two that lingers in my mind after I do a batch of transcript reading. This time one of those came from a consumer and industrial related company, who compared where we are with Russia and Ukraine to how they were thinking about COVID in March of 2020, the last time they attended the conference they were presenting from. They said: “And I was thinking about the last time I was here. The question at that time was COVID. How was COVID going to impact your business? And as I said back then, we really didn't know. Well, it wound up having a significant impact over a long period of time. And I think we're in the same stages with Russia right now. This is so early. It's just hard to tell exactly what it will be.” We share that concern as well.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s industries in Motion, for thoughts on specific sector from RBC’s team of industry analysts.