War in Ukraine, and Investors Are Buying. Should They Be?

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This is not going to be one of those geopolitical crises that just gets handled in a short period of time and provides an immediate buying opportunity. I think we are in the hands right now of Vladimir Putin. Much will depend on, uh, what his goals are and how long it takes him to achieve those goals and what the reaction of the West will be.

Welcome to the Barron's Streetwise Podcast. I'm Jack Howe. The voice you just heard is Ed Yardeni. He's the president of Yardeni Research, an investment strategy service, and he's talking, of course, about the Russian invasion of Ukraine. In a moment, we'll hear from Ed about what that grim news means for inflation and economic growth and whether investors should buy the dip in stocks. He says hold off for now. We'll also talk with Ryan Dietrich. He's the chief market strategist at LPL Financial, and he says it's time to buy. Listening in is our audio producer Jackson. Hi, Jackson.

Hi, Jack.

It was a grim news week, but investors aren't panicking. In the U.S., the Nasdaq Composite plunged more than 3% early Thursday and then reversed and ended the day more than 3% higher. We haven't seen a swing like that since 2008, and investors kept buying on Friday, sending broad indexes higher for the week. The stock market has a history of coming back quickly, even after dark events but it doesn't always come back quite this quickly. So I wonder if investors have developed buy-the-dip-itis, an over-eagerness to buy stocks right away after any sell-off. They've had 13 years of near-zero interest rates and mostly soaring stock prices. I heard investors say to buy the dip in early January when stocks were down less than 5%. This past week at their low point, they were down closer to 15%, but we've had much worse declines than that. Also, as we've discussed in recent weeks, the Fed is expected to raise interest rates aggressively over the coming year to combat high inflation. Rising interest rates could be a headwind for stocks if they offer investors better yields on safe short-term bonds or deposit accounts, and those investors decide to take profits in stocks. Also, earnings growth is expected to downshift sharply this year from last year, now that easy year-over-year comparisons created by pandemic lockdowns have passed. So is now the right time to buy the dip, or should investors wait for a better opportunity? I'm not much of a market timer myself, but for the benefit of investors who are sitting on plenty of cash and looking for that opportunity, I asked around, starting with Ed Yardeni. He's the president of Yardeni Research, which provides market analysis to investment firms. And Ed does not sound super duper bullish over the near term.

Geopolitical crises have a tendency to be buying opportunities unless they become very long-lasting and impact an enormous number of people. And that's the problem with this particular geopolitical crisis. It's very disturbing to see a country like Russia and invade its neighbor without any provocation whatsoever.

Ed notes that the price of crude oil briefly went over $100 a barrel this past week. If it continues climbing, that could add to inflation or worse.

Suddenly we have to seriously consider the possibility that this will lead to a recession. We have seen in the past that many recessions were caused by credit crunches when the Fed tightened monetary policy. But one of the consequences of what we're seeing here is the Fed might actually be forced to hold off, or to moderate its tightening. Instead, uh, what we face is the risk of an energy spike, and energy spikes also have a history of being associated with recessions.

A recession is when economic activity declines. It's often defined as 2 or more consecutive quarters of falling gross domestic product, or GDP. The consensus view doesn't call for a recession this year, but GDP lately has been all over the place. 2 years ago, the beginning of the pandemic caused the steepest but also shortest recession in U.S. history. We ended that year with a 3.4% decline in GDP. Then last year we had a 5.7% increase, and growth was even faster than that during the fourth quarter. But much of that was due to companies rebuilding their inventories. So growth was expected to slow sharply this year. There's a measure called GDPNow tracked by the Federal Reserve Bank of Atlanta, which tries to predict GDP growth in real time. Its latest reading for the first quarter is 0.6% annualized. At the end of last month, Goldman Sachs slashed its first quarter estimate for GDP growth from 2% annualized to just 0.5%. For now, it expects growth to strengthen later in the year, but in a note to investors, it said that each $10 rise in the price of oil would cut a tenth of a percentage point off of GDP growth, and that the hit to growth, quote, could be somewhat larger if geopolitical risk tightens financial conditions materially and increases uncertainty for businesses. So recession might look unlikely, but it's by no means out of the question. Much could depend, as Ed says, on what Vladimir Putin does next. Ed has another concern.

Once you have a correction, you start to worry about the potential for a bear market. And this does have the potential for turning into a bear market, which would be a 20% drop as a result of oil prices soaring, as a result of sanctions being placed on Russia, which will affect global trade, including very likely the amount of gas and oil that the West takes from Russia. We're in a dangerous geopolitical situation. It's going to, I think, continue to clearly weigh on the market. The one offset is prior to the invasion, the biggest concern the market seemed to have was about Fed tightening monetary policy. And now clearly all the talk about multiple increases in the Fed funds rate are going to give way to how much will the Fed moderate its policy tightening as a result of this crisis.

This is where things get complicated in a hurry, and it's what makes predicting the short-term direction of the stock market so difficult. Russia invading Ukraine— that's clearly bad if you're a fan of peace and democracy, but it's also potentially bad for growth, and it might be bad for inflation. But what if all that gloom makes the Fed less likely to raise interest rates as aggressively as it otherwise would have. Then it might not be so bad for stocks. On Wall Street, sometimes bad news is good news for stocks because investors come to expect policymakers to keep conditions favorable for stocks. Goldman, by the way, expects the Fed to stick with its plan to steadily raise interest rates starting in March. But it says the odds have fallen that the Fed will start with a half-point hike in rates as opposed to a less aggressive quarter-point hike. There's one other complicating factor that I won't get too far into, which is that stocks can track growth, but they can also create growth if rising share prices cause a wealth effect that makes investors more likely to spend. But that can also slip into reverse during big stock market declines. So a further decline in stock prices might not be great for growth. How about some good news? We'll hear plenty of it from our next strategist, but for now, Ed has a ray of sunshine for you. It's that we're all pretty glum, trending toward downcast, bordering on Eeyore-ish. Jackson, you think the folks know what I mean by Eeyore-ish?

Nobody listens to me anyway.

Exactly. We're talking, of course, about the donkey from Winnie the Pooh.

Not much of a house, just right for not much of a donkey.

Thank you, Eeyore. Excessive gloom can be a positive for stocks because it suggests that investor worries are already priced in.

The only real positive in the real short term here is sentiment. Sentiment was very bearish early this week, and now I think it's obviously going to be even more bearish as we see the disturbing pictures and videos of what's going on in Ukraine. So I think investors, it may be too late to panic in terms of getting out of stocks. There's certainly lots of opportunities to buy cheaper stocks. This geopolitical crisis will at some point pass, but it's not necessarily a short-term buying opportunity. I think you have to wait it out and see how it all unfolds.

Thanks, Ed. Time to hear from a bull. And a look at what history says about stock returns following geopolitical scares. That's next after this quick break.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.

Welcome back. Time to hear from our bull. Hey, Ryan, thanks for making a few minutes to speak with me.

Absolutely. I'm honored to be here.

That's Ryan Dietrich. He's the chief market strategist at LPL Financial, which is a giant broker-dealer that serves financial advisors.

We are a chip shot away from 20,000 advisors. You add up all the assets, uh, it's over $1.2 trillion. So I'm in the research department. I work with really smart portfolio managers and other analysts, and we manage a lot of money for our advisors as well.

When Ryan says chip shot, he's using a golf metaphor. That's when your ball lands close to the green and all you have to do is tap it on, let it roll up close to the hole. So a chip shot means something easy. Although for me, chip shots are no layup. But layups are a slam dunk, and dunking—

I think I know where this is going.

That's no chip shot. Now then, should we buy the dip? Here's Ryan.

We found, you know, 37 major geopolitical and historical events, and sure enough, if the economy avoids a recession, a year later stocks are up double digits. If you are in a recession or that event caused a recession, think like 9/11, Stocks are down double digits a year later. So it's a real simplistic way, I think you could say, to look at it if the economy's okay. But the truth is, in our opinion, the economy is pretty strong here. It's devastating what's happening, the impact it's going to have on so many people. But from a purely investments point of view, what did we know coming into this year? Well, we knew, you know, the average year sees a 14% correction. We know your average midterm year sees a 17% correction. Yes, there's geopolitical concerns, and honestly, the Fed turning a little more hawkish than we thought 3, 4 months ago is a surprise. But is volatility a surprise when we only had a 5% correction all last year? We'd say no.

I asked Ryan if he thought investors might have buy-the-dip-itis. He says, for the most part, no.

If you're in energy stocks and financials, you're feeling just fine. If you're in technology, you're feeling like a bear market. If you're in a lot of those Cathie Ark high flyers, you're almost in the Great Depression, you feel like, with some of those returns. So you look at the AAII sentiment poll just came out Thursday. You know, one of the highest number of bears we've seen in a long time, lowest number of bulls. Not surprising. I think a lot of those people are in those names. So there could be some of the buy the dip mentality. But I'll tell you, it really does feel like people get pretty fearful and flushed out and sell. And that's kind of how, you know, what old Churchill said, if everybody's thinking like somebody isn't thinking. You know, this morning it sure had a lot of feeling like this is— I hate to say it— the end of the world. It kind of felt that way. And that's kind of when those opportunities arise.

When Ryan says Kathy ARK, he's using a shorthand for Cathie Wood. She's the founder of ARK Investment Management, and she was on this podcast a few weeks ago talking about some of her growth stocks, which are down a lot. Ryan says there's only been one bear market over the past 50 years that didn't occur during a recession, and that was the 1987 stock crash which was short-lived. He counts 87 bear markets that occurred during recessions, although there have also been some close calls that occurred outside of recessions. Ryan tracks a lot of historical facts like that. He points out that in 2014, after Russia invaded Crimea, the U.S. stock market reaction was short-lived. There was a bigger direct effect on American economic interests when Iraq invaded Kuwait back in 1990, and that led to a U.S. stock drawdown of 17%, and the duration of the drawdown and recovery period was about 6 months. That's longer than the recovery period for many geopolitical events. The Cuban Missile Crisis, 18 days. The Kennedy assassination, 1 day. The September 11, 2001 terrorist attacks, 31 days. The Boston Marathon bombing, 15 days. One of the longest was the attack on Pearl Harbor. That led to a 20% decline for stocks, but the downturn lasted less than a year—307 days, to be exact. So stocks can clearly shake off the bad news in Ukraine, provided there's no recession. They could even do well from here. Ryan's analysis of corrections since 1980 of between 10%, and 15%, like the recent one so far, shows that the average return over the following year was 22% from the low point. Here's Ryan.

Now the big thing is, well, nobody knows when the lows happen, right? You only know that after the fact. But again, if you think you're fairly close— and again, we think this one's fairly close, you know, just some of the put-to-call ratios we've seen, the volume we've seen, the fear, and rightfully so, headlines are scary— uh, we do think we're, you know, in more of a process of forming a low. Just look at the VIX, right? Everybody's favorite volatility index. It was close to 40 this morning. That historically, outside of a 100-year pandemic, when you get up around 40, has marked some fairly major lows in equities. And we wouldn't be surprised, we look back on a month from now, we might have been pretty close to one this morning as well.

You heard Ryan say put-call ratio. He's referring to options activity and what it says about bearishness. He also mentioned the VIX. That's a measure of expected volatility. So Ryan thinks measures like those have been showing a lot of fear, suggesting stocks are close to their lows. I asked him about a key investor concern now, rising interest rates. Ryan says that many investors expect 7 or 8 quarter-point rate hikes, but that he thinks there'll be 4 or 5, and that rising rates aren't necessarily a bad sign.

When the Fed starts hiking rates, normally that's more mid-cycle, right? It's like taking the training wheels off. I mean, you look at the last 7 cycles, stocks are up a year later, 6 of those times after the Fed starts hiking rates. Oh, and by the way, markets usually don't peak for about 3 years after that first Fed rate hike. So every time is different. Yes, but it's because they're hiking. Don't run away and hide under your bed.

What about earnings growth? The consensus estimate for this year has earnings growing at 8%. That's a big downshift from last year, and earnings estimates often start the year too high. But Ryan thinks that this year's earnings growth could come in a little above the consensus, and he sees other promising signs.

We think we can maybe hit double-digit earnings growth, which isn't spectacular, but when you come from where we were last year, that's pretty good. And again, who's one of the better indicators of what the economy is going to do? Be honest, it's not necessarily the economists. It is actually what small businesses are saying and what corporate America is saying. Small businesses are worried to death about inflation and higher wages. Absolutely. But if you look at the sentiment polls, small businesses are still pretty optimistic about this economy going forward. So we'd rather follow them. And again, maybe a little more upside. And let's be honest, you know, everybody's been stuck at home for a long time with everything we've been through. We think we're on the other side of this, the pandemic at least. We think animal spirits are going to take over and there's going to be a consumer who spent a lot of money, who will continue to spend money and help this economic recovery continue, in our view.

Thank you, Ryan and Ed, and thank all of you for listening. If you'd like to ask a question on the podcast and have us take a crack at answering it, just tape it on your phone, use the voice memo app, and send it to jack.hough@barons.com. Jackson Cantrell is our producer. Subscribe to the podcast, write us a review on Apple, and to achieve full nirvana, You can follow me on Twitter. That's @JackHough, H-O-U-G-H. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.