After living through one inconceivable event with worldwide repercussions (the COVID-19 pandemic), we now find ourselves facing another that was certainly on no one’s radar prior to 2022. How will Russia’s invasion of Ukraine impact the spending power of our dollars as well as the value of our savings in the capital markets?

I had written about inflation last summer when it reared its head for the first time in years. At that time I explained that there were several causes: (1) increased demand from over $7 billion of government stimulus and (2) supply constraints due to COVID-induced labor shortages, the combination of which caused prices to rise fairly rapidly. My expectation at the time was that inflation was likely to peak sometime in early to mid-2022 and then decline back to pre-2020 levels as COVID-19 evolves from a pandemic to an endemic. Unfortunately we now have another unforeseen global event that complicates the picture quite a bit.

Russia is a supplier of numerous commodities to world markets including oil & gas, metals such as aluminum, nickel, and palladium, and wheat. Ukraine additionally exports numerous foodstuffs such as corn and barley. The curtailment of these supplies will inevitably add to the inflation we are already experiencing. Exactly when inflation will subside back to pre-pandemic levels, if ever, will be determined largely by (1) the length and scope of the Russian war together with the speed of economic readjustment in its aftermath and (2) the degree to which the U.S. government attempts to control prices. During World War II they did exactly that in order to counter the inflationary impact of the reduced supply of consumer durable goods due to the reallocation of resources to military production. And from all appearances the effort was largely successful. From 1942 through 1946 the U.S. inflation rate was held to just 3.5%. Unfortunately it soared to 28% when restrictions were lifted after the war ended. The lesson for today is that inflation could be with us for some time and could even ramp up significantly depending on the outcome of the current war.

What about asset prices? Following the same example the U.S. stock market did not collapse during World War II. In 1942 the S&P 500 lost only about 12%. In 1943 the index gained 20% and subsequently experienced annual double digit growth throughout the war years of 1944 and 1945. Why? Because not all companies experience profitability declines during wartimes. Defense, cybersecurity, and various commodity suppliers today are likely to generate outsized profits as a result of Russia’s invasion of Ukraine. But does that mean you should shift all your money into just those sectors of the capital markets? Remember that current company performance is only one factor driving stock prices. Investor sentiment (or what some might call the market’s forward-looking thinking) is responsible for much of the volatility we’re seeing right now. If investors don’t believe a highly-profitable company today will remain so for long, or believe its share price is too high relative to the profit it is generating, they can quickly drive its price down.

Current market prices rapidly incorporate expectations about the effects of wars, pandemics, and pretty much any event on economies and companies. The most effective way to mitigate the market risk of any unexpected event, including inflation, is through broad diversification, not by trying to outguess the market.