Over the past few days, traders have focused on the situation in Russia and Ukraine. It seems that every jump in indices and exchange-traded funds (ETFs) such as the SPDR S&P 500 ETF (NYSEARC:TO SPY) stock is related to Putin’s latest military moves.
And, of course, what ends up happening with this geopolitical situation is of crucial importance. Here are seven stocks with exposure to Russia and Ukraine to avoid as long as the crisis persists. However, it is not the actual key issue that carries the most weight on the interim outlook for SPY stocks and other major US equity indices. On the contrary, the crux of the problem is interest rates.
Interest rates are a major issue
Interest rates have been climbing for a while now. And I would argue that’s precisely why certain sectors of the market such as speculative growth stocks, meme names and Cathie Wood ARK Innovation ETF (NYSEARC:ARKK) fare particularly poorly. As capital begins to flow out of the system, less fundamental assets tend to suffer the most.
Why would that be? Because tech stocks have inherently become a bet on lower interest rates. Over the past few years, investors have embraced the idea that with interest rates at zero, they should buy as much duration as possible. Duration, in this sense, meaning future cash flows as opposed to current earnings or dividends.
As rates rise, short-term fundamentals matter again
In a world of zero interest rates, the value of a future dollar earned by Datadog (NASDAQ:DDOG), Snowflake (NYSE:SNOW), Where Shopify (NYSE:STORE) in 2035 is not too much less than one dollar earned by Chevron (NYSE:CLC) today. People are willing to pay exponentially more for a growth stock when interest rates are close to zero.
If you are running a financial model on a stock, the discount rate is an important factor in the fair value of a security. Until not too long ago, we typically used a 10% discount rate, which meant that future cash flows were depreciated by 10% per year as you projected into the future. A business with no current profits or cash flow isn’t worth much in this type of scenario, because by the time it (hopefully) starts generating profits, the future value of those profits is minimal.
However, in a world of zero interest rates, people have cut their discount rates dramatically. After all, if capital is free, you just want to own the biggest, fastest growing tech companies at any valuation. And that was reflected in valuations until around November 2021.
The rate rally turns into a frenzy
However, this spike has turned into overdrive over the past few weeks. Moreover, and this is of paramount importance, the peak is in short-term interest rates. Long-term interest rates move more slowly, which can give you a false sense of security.
But no, we’re seeing some wild moves – think five standard deviation types – over the past two weeks.
It all started with the Federal Reserve’s most recent interest rate decision. They chose not to raise rates. However, the post-decision press conference left the door open for a surprise rate hike of 50 basis points, instead of the expected 25 basis points, in March.
This is why the market first rallied and then sold off strongly after the Fed’s decision. Since then, Fed members such as James Bullard have added fuel to the fire, suggesting that the bank will act aggressively and imminently to stamp out inflation.
And the interest rate drama was just beginning. Europe added to the panic. The British raised interest rates, despite mixed underlying economic conditions. Analysts pointed to out-of-control inflation due to Britain’s power crisis forcing their hand.
Following this, Christine Lagarde of the European Central Bank did a terrific job of communicating with the public. While the ECB did not raise rates immediately, Lagarde awkwardly signaled much more hawkish policy going forward. This caught the market off guard and caused the biggest rise in European short-term interest rates in the past decade.
Volatility is near for SPY stocks
US credit markets are now pricing in about seven rate hikes over the next two years. It seems unlikely that the stock market will be able to withstand this kind of bold rate hike campaign without substantial collateral damage. The sheer removal of new stimulus over the past few months helped trigger a sharp sell-off in the tech sector.
It should also be remembered that credit markets are significantly larger than stock markets in terms of the total amount of assets. When you start to see wild activity in bonds, watch out, because volatility is surely on the way. When the credit markets burst in 2007, for example, we all know what happened to the stock market soon after.
Conclusion on SPY stocks
Will the Fed drive the economy straight into a recession and cause the market to fall sharply? Unintentional. But remember that Mr. Powell imposed a controversial rate hike at the end of 2018 that helped cause the S&P 500 to fall 20% before finally stopping this rate hike cycle.
As at the end of 2018, the Fed could push too far and only let go after the dramatic fall in stock indices. For now, traders of SPY stocks and other ETFs in the market should pay close attention to the bond markets. Until they stabilize, stocks are likely to fall suddenly.
As of the date of publication, Ian Bezek had (neither directly nor indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.
Ian Bezek has written over 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a junior analyst for Kerrisdale Capital, a major New York-based hedge fund. You can reach him on Twitter at @irbezek.