February 25, 2022
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Markets have been bracing for conflict between Russia and Ukraine for much of 2022 and, on Thursday, this conflict became a reality. President Vladimir Putin has stated that Ukraine “is an inalienable part of [Russia’s] history, culture, and spiritual space” and seems intent on restoring what was the U.S.S.R. Equity markets reacted with wild swings, including a near seven hundred basis point trough to peak move by the NASDAQ. The initial “risk off” reaction triggered by news of Russia’s invasion was followed by a sharp rally as investors seemed relieved by sanctions that were less severe than feared and the possibility that the Federal Reserve’s expected rate hikes be muted as it wishes to avoid economic slowdown.
Oil and natural gas prices have been on the rise in 2022 and the conflict between Russia and Ukraine sent them higher. Prices have been driven by the recovery in global demand and the discipline shown by OPEC in sticking to its promise to slash oil production. Further, there has been a low level of investment in hydrocarbon production in recent years as energy companies have instead returned capital to shareholders. Shares of oil and natural gas exploration and production companies, including Marathon Oil, Halliburton, Hess, and Occidental Petroleum, have been propelled by these rising prices and have been the bright spots in small and mid-cap indexes during an otherwise negative 2022. Through Thursday, for example, the Energy sector was up over 19% in the Russell Mid Cap Value index while the benchmark, itself, was down 7%. Similarly, the Energy sector was up over 15% year-to-date in the Russell 2000 Value index and the benchmark was down nearly 7%.
The Case for Quality
Fears over rising inflation, the persistence of COVID, and concerns over the pace of rate hikes by the Federal Reserve were all worries for investors entering 2022. The war between Russia and Ukraine only adds to these, with uncertainty around additional sanctions, the duration of the conflict and added inflationary pressures from energy and agricultural inputs. The resulting volatility is a reminder that risk goes hand in hand with the pursuit of rewards in investing and, in our view, makes the case for long term ownership of quality businesses. Quality businesses, in QSV’s definition, deliver high returns on invested capital supported by durable competitive advantages. These companies share strong balance sheets, lower debt and pricing power, all characteristics that offer stability in volatile times. Businesses like Clorox, Campbell Soup, and McCormick & Company offer essential products and services and possess scale advantages and intangible assets that give them staying power and result in a “smoother ride” for investors in their shares. Equity investing is essential as retirement plans provide benefits to plan participants, foundations strive to fulfill their missions and families build secure futures. Allocations to quality businesses have proven to offer strong long-term results with less volatility in turbulent times.
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