Image shows a picture of Lindsey Bell, Ally Invest’s chief markets & money strategist. The title reads “Geopolitics and Market Impact”

Geopolitical risk has returned.

Managing risk is key to a good investing plan, but geopolitical risk is difficult to plan for. The conflict between Russia and Ukraine has investors uncomfortably navigating the daily twists and turns of the market. The devastating situation is something most of us have not experienced in our lifetime. While we can look to history for guidance, it’s never easy living through a geopolitical event.

In times like these, many reconsider owning riskier asset classes like stocks. Yet bonds haven’t provided a whole lot of safety as inflation fears are still around.

When looking at the bigger picture, the U.S. economy is somewhat buffered from tensions in Eastern Europe, and European stock market action has provided some solace. The impact on inflation is uncertain, and the Fed is likely to be less aggressive as they start raising rates in March. Still, it is often better for investors to do nothing in situations like this.

What does “geopolitical” even mean?

With this situation dominating news headlines everywhere you turn, it’s helpful to take a step back and see how similar global events impacted markets. The term “geopolitical” gets tossed around whenever a country — often in the Middle East or Asia — has some kind of upheaval that could impact peace between nations. Natural resource commodities and unstable governments are usually at the heart of this risk type. But geopolitical risks are nothing new.

Stocks take it in stride.

The Russia-Ukraine situation has been escalating since late last year, but it’s just in the last few weeks that it has caused a selloff in the stock market and among some riskier areas of the bond market. Investors are de-risking as tensions escalate and uncertainty builds. Market volatility will likely continue in the near term. The good news is stock market selloffs related to these types of events tend to be short-lived — typically lasting anywhere from one to three months. Go out a year, and returns are solid, as if the market forgot about the turmoil.

Is it different this time?

History can be a useful guide when deciphering financial markets, but what can we glean from the current standoff? For starters, have you noticed that European stocks — which you’d think would be sharply underperforming U.S. equities — have done relatively well in the last few months? Since December 1 of last year, the U.S. stock market is off more than 9%, while European equities have dipped 6%. All the while, Russia’s stock market has cratered. The point: While anything can still happen, we can hope the action in foreign stocks could be a sign the situation will de-escalate sooner rather than later.

Graph titled Foreign Stocks Hold Their Own tracks the iShare All Country World Index ETF, the S&P Europe 350, the S&P 500 and the iShares MSCI Emerging Markets ETF from December 31, 2021 through February 25, 2022. The S&P 500 underperforms the other three. Source: Ally Invest, Yahoo Finance Historical Prices.

Perspective and Economic Impact

Keeping perspective is always important in understanding the market impact. Ukraine’s economy is about the size of Kansas’s at roughly $155 billion. Russia, of course much bigger, amounts to just 0.3% of the total world stock market. Even within the emerging markets niche, Russia represents under 3% of that index. In no way does this downplay the seriousness of the political and military situation between these two troubled nations, but it helps to keep the financial market impact in proper context.

These geopolitical risks are unlikely to have a significant impact on the U.S. economy. However, higher oil and other commodity prices do present the possibility of inflation remaining higher for longer. Since late last year, inflation expectations steadily moved lower before stabilizing within reasonable ranges this year. With the conflict in Eastern Europe driving prices higher for several inputs, inflation expectations in the medium term have begun to rise.

Graph titled Inflation Expectations Perk Up tracks the 5-year breakeven rate from February 2021 through February 2022. The general upward trend suggests rising concerns around high prices as geopolitical risk grows. Source: Ally Invest, St. Louis Federal Reserve

Higher prices are likely to result in lower consumer confidence in the near term. Over the longer term, there is the possibility that slower global growth resulting from the situation in Europe could reduce inflation.

Obviously, inflation is a focus for the Fed as they prepare to raise interest rates. They will be weighing the impact of higher prices and potential for slower growth carefully. It’s a tough position to be in. Looking ahead to the Fed meeting next month, the market now expects just a quarter-point (25 basis points) hike due to the uncertainty. A more aggressive 0.5% (50 basis points) increase is much less likely — the Fed will be watching closely if inflation data accelerates in the next few weeks.

Bottom Line

There’s always something to worry about with the markets. The ongoing Russia-Ukraine geopolitical crisis may be pressuring stocks right now, but history suggests these dips could be good buying opportunities for long-term investors. While there is more than just geopolitical risk to consider in this situation, it’s quite possible that before you know it, the Fed will be back at the top of our wall of worry.

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Expert Take with speech bubble icon

Headshot of Lindsey BellLindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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