After one week of attacks, Russia has taken control of a nuclear power station in Ukraine, one of the biggest in Europe, after it was hit by shelling. If at the beginning of the week the media was informing of the start of the negotiations, which did not stop Russia from keep attacking Ukraine, it seems like those negotiations might be far away from reaching an agreement. The EU, UK, US and Canada have started to imposed sanctions on Russia, which include the removal of some of the Russian banks from the SWIFT, as well as freeze Russian assets in the EU and stop access of Russian banks to the European financial market. Asset managers around the world have also started to leave Russia, the last one being the Asian Infrastructure Investment Bank (AIIB), which has announced they will be putting all activities relating to Russia and Belarus on hold.
Timeline of the events
Ursula von der Leyen, President of the European Commission and Charles Michel, President of the European Council were the first among the leaders in condemn the attack on the 24th of February, on a statement they said that “Russian forces invaded Ukraine, a free and sovereign country. We condemn this barbaric attack, and the cynical arguments used to justify it.”
On the 25th of February, that same Friday, they announced the first package of targeted sanctions, which targeted strategic sectors of Russia’s economy including freeze Russian assets in the EU and stop access of Russian banks to the European financial market with the objective of stopping the Kremlin from being able to finance war.
Somo of the other Financial sanctions included, targeting 70% of the Russian banking market and key state owned companies, including in defence. Energy sector, a key economic area which especially benefits the Russian state. Their export ban will hit the oil sector by making it impossible for Russia to upgrade its refineries. Sale of aircrafts and equipment to Russian airlines. They are limiting Russia’s access to crucial technology, such as semiconductors or cutting-edge software. Visas. Diplomats and related groups and business people will no longer have privileged access to the European Union.
On the 26th of February, after hours of meetings and negotiations, they announced, in coordination with the US, UK, Germany, France and Canada governments a second package of sanctions which included, as mentioned above, their commitment to ensuring that a certain number of Russian banks were removed from SWIFT in order to affect Russian exports and imports, as well as the Paralysation of the assets of Russia’s central bank, another sanction they imposes was the prohibition of Russian oligarchs from using their financial assets on European, UK, US and Canadian markets.
The impact of the Russia-Ukraine conflict in the markets
01/03/2022 Market updates and reactions
Nachu Chockalingam, Senior Credit Portfolio Manager, at the international business of Federated Hermes
How much of the Euro credit markets are exposed to Russia and Ukraine?
The left-hand side of the chart below looks at the IG universe and the right-hand side, the HY universe. The most represented sector is, unsurprisingly, Energy, accounting for 4.2% of the Euro IG market and 8.4% of the Euro HY market. Ukrainian issuers only feature in the HY universe, accounting for c. a third of the Energy sector and all of the Basic Industry and Utility sectors.
Source: FHI, Bloomberg
As with previous episodes of extreme Russian stress (2010 and 2014), the initial reaction to the invasion last Thursday was extreme with the bonds most exposed to the two countries falling multiple points. So much uncertainty remains and we are braced for more volatility. The experience of 2014 when Russia annexed Crimea suggests that these names can keep underperforming.
Jane Shoemake, Investment Director, Global Equity Income at Henderson Global Investors
Events in Ukraine are unfolding quickly and the impact on the European and global economy is as yet unclear although the sharp rise in oil and agricultural commodities will further add to existing global inflationary pressures that were in place prior to the escalation in the crisis.
A period of increased equity market volatility can be expected as the ramifications of the conflict become clearer but ultimately the scale and sustainability of inflation and the response from central banks will go a long way in determining whether economies enter a period of stagflation or simply an economic cycle with higher inflation than recently.
The interplay between higher energy prices, inflation, economic growth and central bank policy will be very closely watched in the coming months. With regard dividends, the impact of the crisis will vary according to the sector / company with some being more impacted than others by sanctions and rising input prices. However, Russia is not a significant contributor to global dividends. The biggest impact will be in Emerging Markets, which accounted for 13% of global dividends in 2021, with the contribution from Russian banks and oil companies likely to be severely impacted. We will be updating our global dividend forecast for 2022 when the next quarterly JHGDI report is released.
Michele Morganti, Head of Insurance & AM Research, Senior Equity Strategist, Generali Investments
As the Ukraine crisis took a turn for the worse, markets are down by 10% from the November peak. The situation remains fluid (SWIFT ban and sanctions on CBR mark a clear escalation). Short term, excluding big drawdowns (GFC and Covid in 2020) and looking to past spikes in the risk premium (ERP, at 7.5% for MSCI EMU and 4.5% for S&P500) we conclude there is scope for another 5% downside or more.
Historically those ERP spikes were generally short-lived and represented buying opportunities. We find the same order of magnitude when looking at past relevant discounts to our Fair Value indicator. This approach implies a further downside of c. 5% to reach the discount registered in periods of high-risk aversion.
We suggest a minimal equity OW and see mid-single digit positive returns over the coming year. Markets remain event-dependent, and we would refrain from aggressively buying current dips: tactical indicators are neutral, not yet stressed. We reduce the Value OW (but stay long energy) while adding defensive and quality names. US weight is aligned to EMU (from OW) during high volatility and risks to growth, while we maintain an OW on UK and selected EM. Longer term, higher credit spreads and real yields as well as higher-for-longer energy prices and inflation could hurt growth, an additional risk to the earnings outlook.
28/02/2022 4 days after the war started, the EU, US and Canada announced sanctions on Russia and the markets are starting to suffer it
Christopher Rossbach J. Stern & Co CIO
Ukraine crisis: policymakers will view a recession as the greater risk Previous geopolitical events suggest a time-limited downturn in markets, but markets have entered a new phase of risk and volatility. It is important to keep a perspective and understand that markets discount events over time. Clearly, the impact of the Ukraine crisis is going to be severe because of the unprecedented actions that are being taken.
But if you look at the impact on markets such as the S&P500 or the MSCI World, it has been moderate so far. Oil is a global commodity, and the price is at $100 but it has been as high as $80 in the past and not collapsed the global economy. Gas is more of a regional problem because of transport issues. US gas is only at the higher end of a long-term range. Gas, however, is a problem for Europe where spikes in prices stem from the potential threat of Putin cutting off gas supplies. The impact short term may be significant, but over the medium-to-long term, the markets are keeping perspective.
Fears over the Ukraine crisis have added to market fears around inflation and continued monetary tightening. After a 29% rise in 2021, the S&P 500 fell 10% in the first few weeks of January, and after a brief rally, closed on Friday down around 9% year to date. This is a correction, but a manageable one.
The greatest economic pressure to come out of the Ukraine situation is likely to be a broader inflationary pressure which will include energy, materials and agri-commodities. The question will be how central banks respond to inflation that is up to 2% higher than previous estimates. Will the Fed, the ECB and Bank of England lift rates further and faster than current expectations, raising the risk of choking the economic recovery? Or do they fear a potential recession more than inflation and adopt a more measured approach?
We believe that policymakers will see recession as the greater current risk given the geopolitical situation, the still uncertain recovery from the pandemic and the potential for polarised political outcomes in domestic elections in many countries this year, in particular, the US mid-term elections and the French presidential elections.
Garrett Melson Portfolio Strategist at Natixis Investment Managers
In terms of the market impact from the conflict in Ukraine, we believe we may have seen the bulk of the selling pressure play out already. Historically incursions and military escalations have proven to be a case of sell the build-up, buy the invasion. In other words, your classic sell the rumor and buy the news playbook where investors take risk down as the rumors and uncertainty abound only to buy shortly before or after the actual escalation.
These events generally have very little fundamental impact on broader economies, unless they are at a much larger global scale.
As such, beyond the knee-jerk selloff markets tend to refocus on the economic backdrop, which currently remains very constructive. The conflict poses the greatest risk for net energy importers and thus has the potential to weigh on European demand should energy prices continue to remain firm and grind higher. The US, however, remains a net exporter of crude and is relatively insulated from the global economy from a broader export perspective. As such, the conflict will likely have little impact to the US economy as well as US multinationals.
The other factor that continues to be supportive of US equities is investor sentiment. Retail sentiment has now moved below the lows seen at the peak of the COVID selloff in 2020 to nearly 10-year lows and other investors bases have followed suit similarly. Sentiment is most reliable as a contrarian indicator at extremes, which current measures certainly suggest we are. While we continue to expect inflation and the path of policy rates to be the key driver of markets contributing to volatility in the first half of the year, it’s hard to be too bearish after we’ve already endured so much multiple rerating and sentiment as depressed as it is.
Finally, there’s a lot of talk about the Fed not wanting to be too aggressive as a result of the conflict in Ukraine. We believe at the moment it has very little impact on Fed decision makers. If anything, it likely puts to rest for good expectations for a 50 basis point hike in March, but unless the conflict contributes to a significant deterioration in inflation prints outside of energy prices it’s unlikely to materially impact policy decision making moving forward.
24/02/2022 Russia attacks Ukraine
Hours after the attack Russian MOEX plunged a 45%, the major one day drop in ages. Asset managers around the globe, start commenting on the attack and its effects in the markets.
Generali Investments Partners’ research team
Russia’s invasion of Ukraine has been a surprise, given the substantial economic costs for Russia. We look at potential scenarios and suspect that a rapid de-escalation is unlikely. President Putin may try to take advantage from a peculiar political environment on both sides of the Atlantic. Social stress emanating from the energy transition and inflation is giving more leverage to Russia, especially on energy-dependent countries like Germany and Italy. Both the US and France face elections this year.
We discuss the potential range of sanctions. Their direct impact on the global economy is manageable; yet the main risk lies in a continued surge of energy prices, potentially precipitating an economic slowdown. All eyes on the consumer’s purchasing power.
The crisis has increased the stagflation risks. Already we had reduced our pro-risk bias in the face of high inflation and upcoming monetary policy tightening. While geopolitical stress often creates buying opportunities, we see no rush to buy the dips. Further reduce the cyclicality of portfolios for now, waiting for more stability in both the geopolitical and energy complexes. Temporarily increase cash, reduce cyclical stocks, and to a lower extent the Value bias – especially financials, while keeping Energy exposure. Stay overweight Credit but more in IG than HY. Sovereign balance sheets look more exposed than private ones.
Ashok Bhatia, CFA, Deputy Chief Investment Officer—Fixed Income, Neuberger Berman
We could see new inflationary pressures and modestly lower growth, with impacts on central bank policy and risk asset volatility. The security and geopolitical ramifications of Russia’s invasion of Ukraine will take months and quarters to play out. In the near term, we see three key fixed income investment implications from the overnight events.
First, the peak of central bank tightening expectations has likely passed. So far in 2022, the central banks and markets have been acutely focused on inflation and the policy response, which has resulted in expectations for significant tightening over the next 12 months. We expect growth concerns to now enter the central bank calculus. Whether from commodity prices, tighter financial conditions or general risk appetite, we believe the modestly rising uncertainty about growth will allow the central banks to be slower on hikes. Near term, we expect the markets to move toward four hikes from the Federal Reserve in 2022 and an unchanged ECB, which has been our base case for the year.
Second, our base case moving forward is that major economies will continue to experience positive growth, given underlying domestic growth trends, continued fiscal stimulus and a lack of major private sector imbalances. However, we don’t discount the possibility that markets will price toward a more negative growth outcome, or stagflationary outcome, in the near term. And regional growth differences will likely increase, with more pressure on European growth rates. German industrial production, in particular, may be affected given its linkage with the east.
What does this all mean for credit markets? Volatility will remain, but spread-widening toward “recessionary” pricing will likely represent a significant investment opportunity. Spreads in U.S. investment grade at 150 bps and U.S. high yield at approximately 450 bps or higher should be attractive entry points.
Third, the biggest sectoral impacts will likely be in commodity markets. While energy remains the headline risk, it’s important to note that Russia is a key supplier of industrial metals such as palladium, platinum and aluminum. The impacts from higher prices and/or lower supply will reverberate not just through mining companies but into a range of sectors that depend upon these supplies. And, obviously, impacts on crude and natural gas will be in focus, and likely create elevated inflation rates for longer.
Volatility will remain high for a while, and the long-term impacts will take time to sort out. But net-net, the growth outlook is likely modestly lower, with implications for lower central bank hiking and continued volatility in risk assets.
Michel Salden, Head of Commodities, Vontobel
Russia has invaded Ukraine pushing commodity prices to new record highs as equities tumble in a risk-off move by markets. While disruptions to oil and gas supply are looming, markets are anticipating a softening of major central bank policies.
Already in the run-up to the crisis, commodities were pricing in a geopolitical risk premium which received another bump by Russia’s decision to invade. The Bloomberg Commodity Index (BCOM) is up 20% year-to-date, WTI oil is up 8% today and Brent is trading above 100 USD, the highest level since 2014. Gas shortages in Europe have been exacerbated as Germany already blocked the opening of the Nordstream 2 gas pipeline on Monday, which makes further issues in highly needed gas deliveries likely. As a result, gas traded in the Netherlands has rallied by 50% since Monday.
However, the crisis reverberates beyond energy supply with inventories of all major commodities already dropping to their lowest levels in 20 years. Ukraine is responsible for 12% and 16% of global wheat and corn exports respectively, and it remains to be seen to what extent Ukrainian ports and shipping infrastructure will be damaged by the military conflict. In addition, Ukraine and Russia are one of the biggest fertilizer exporters which introduces risks around global food security. Meanwhile, all US grains are already trading at their maximum daily gains of 6% triggering major trading disruptions, and French wheat is up 17% today. The picture in metals markets marked by Russian dominance is similar with aluminium up 4%, nickel up 5%, and palladium up 7% based on intraday data.
Sanctions will introduce further premiums across all these markets. However, given Europe’s dependence on Russian gas, industrial metals and fertilizer, sanctions might prove less viable options than hoped for. Furthermore, Russia signed a 150-billion-euro energy deal with China in a bid to reduce the country’s entanglement with the West which further undermines the power of sanctions imposed.
The full-fledged military conflict has increased the risks of oil and gas disruptions significantly, but it can be assumed that Russia will honor its long-term energy delivery contracts as they did in the past. However, it is unlikely that Russia will send any extra gas to replenish the European inventories in summer which are now 20% below their 5-year averages. This could prove to be a major issue next winter. Also, the much debated sanction of excluding Russia from the SWIFT payment system will be a tricky one. If Russia is unable to receive payments for their oil and gas deliveries, they will restrict or even stop supply. To alleviate the situation, Europe and US could resort to striking an immediate agreement on a new Iranian oil deal. Whilst such a deal would help to bring new oil barrels to the market – up to one million barrels per day in six months – it would create new geopolitical risks in the Middle East.
Central banks expected to shift towards maintaining growth
As the crisis could affect US and in particular European growth, major central banks could turn away from fighting inflation fighting to restoring growth and smooth functioning of capital markets – depending on how long the crisis lasts. In fact, markets are already revising the likelihood of the Fed’s envisaged interest rate hiking path in an anticipation of dovish moves as the long end of the US Treasury curve is exhibiting large drops in real yields.
Stefan Kreuzkamp, Chief Investment Officer DWS
We expect markets to remain very volatile for some more days until there will be clarity about the scope of Western’s sanctions and a better understanding of whether Putin will stop at the Ukrainian borders to other post-Soviet states. Central banks will reconsider their policy and remain flexible. The risks of a recession in Europe have increased, thus our strategic forecasts are under review.
Already now, we believe that Europe has to prepare for a bigger influx of refugees. In the absence of any meaningful de-escalation, Europe might also have to prepare for unprecedented cyber-attacks from Russia. While these two points could already weigh on the European economy, the biggest impact might well come from energy imports, mainly natural gas. A significant gas price shock, or even a cut in gas deliveries could easily lead to a recession in Europe (leave alone of higher inflation).
Consequences for the economy and markets
After a first state of shock, markets are waiting for more clarity about the scope of Western sanctions as well as possible counter measures by Russia. Market dynamics to the downside might intensify if certain risk limits would be triggered with institutional investors, or if retail investors start panicking. At the same time, historical experience tells us that such days are not a good time to sell either. For Russia the biggest impact will be in the financial sector, including security trading. The West, most of all Europe, is most vulnerable when it comes to commodity imports. We believe that energy will carry a risk premium for a prolonged time. This in turn makes central bank’s reaction more difficult to predict. While they will be tempted to stimulate the economy if needed, or at least not tighten financial conditions too fast, they might be confronted with potentially higher inflation rates for a longer period than anticipated.
With Europe’s economy being much more dependent on energy supply from Russia, we would expect more pressure on European yields compared to the United States. For treasuries we expect a flattening at the longer end of the curve (10y to 30y). We have also become more cautious on European corporate bonds.
For equities as well, European assets at the core of the storm. Safe havens (US equities, Japan, Swiss market, Health Care, Consumer Staples) and oil sensitives (UK, energy sector) are likely to outperform, while cyclical sectors and Europe ex-UK are likely to face a more difficult environment. Eurozone financials could be hurt by delayed ECB hikes and disentanglement of relations with the Russian financial system. Investors will adapt their risk premium for single stocks depending on their direct or indirect exposure to Russia and Ukraine either as an end market or as a source of supply. Russian stocks are down by more than a third, however they represent less than 0.5% of the MSCI AC World and less than 3% of the MSCI Emerging Market.
William Davies, Global Chief Investment Officer Columbia Threadneedle
As the situation in Ukraine unfolds, we remain focused on our investment process: being active, long-term investors in companies with strong balance sheets and solid fundamentals, employing our research intensity capabilities. As with other major geopolitical situations we anticipate there will be volatility in markets and while we invest with conviction we do not ignore the impact of globally-driven events on the companies and industries in which we invest, in addition to the impact on economies more broadly.
Furthermore, we incorporate these considerations as part of our responsible investment approach, providing stewardship of assets which support the welfare of society.
We are already seeing a risk off sentiment across emerging markets, as the possibility of imposed sanctions increases, although Russia and Ukraine together comprise around 3.5% of the Emerging Market Debt hard currency index. Our Global Emerging Market equities portfolios have c.4.5% investment in Russian companies1 with minimal exposure to Ruble-denominated names. From a credit perspective, most Russian companies are at the lower end of Investment Grade ratings and could be downgraded to High Yield as a result of sanction risks. We expect to see an increase in energy prices and grain prices across emerging markets which is likely to have an impact on commodities globally. We will continue to monitor the situation and ensure that we actively manage our portfolios responsibly and maintain a global perspective.
Benjamin Melman, Global CIO Edmond at Rothschild Asset Management
Russia’s overnight invasion of Ukraine is the worst case scenario for the Ukrainian population and a massive jolt to the global, geopolitical picture. It is also a shock to investors who were slow to consider this eventuality as a stark probability. Lots of questions are still unanswered, starting with Vladimir Putin’s intentions.
Is he looking for a guarantee that NATO will not admit Ukraine and for recognition that Crimea is now officially part of Russia? Is he trying to impose buffer zones for countries that are at Russia’s mercy? Does he want to turn Ukraine into another Belarus or simply annex it? Do his ambitions go beyond Ukrainian territory?
It will take time before we have a clearer view and the situation looks like remaining highly uncertain.
Energy prices in question
Russia and Ukraine count among Europe’s relatively modest trading partners but Germany and Italy import close to half of their gas from Russia. Energy prices had already surged even before the risk of a conflict emerged so the threat to trading between Europe and Russia is bad news for prices. Gas inventories are now generally low in Europe but the mild winter and the approach of spring should limit the risk of shortages in the near term. The problem will be rebuilding inventories ahead of next winter as Europe depends on Russia ; deliveries had already been reduced in 2020. A move to liquid gas could only be limited as there are not enough liquefaction and regasification terminals, leaving supply out of kilter with demand. We will have to find other energy sources and that presents another problem, especially if we are talking about coal. We would also have to consider energy saving measures.
“Buy when the war starts”??
At the time of writing, market reactions to the invasion are moderate. European markets were down around 3% and futures indicated a 2% drop for the S&P 500 and a reasonable widening in credit spreads. Historically, geopolitical crises are a good buying opportunity.
After all, we say “Buy when the war starts”. But for a buying opportunity to arise, markets need to overreact and this is not yet the case. With inflation still rising amid an energy crisis and now this shock to investor confidence, we need to evaluate this crisis fully before gauging its impact on the outlook for growth. And we are still unsure if Europe will be able to secure energy supplies at the end of 2022. It is interesting to see the first indications from the ECB that it is monitoring the situation but the chances of central banks going back to reinjecting liquidity to shore up economies and markets are still remote.
We chose not to be overweight European markets pending better visibility on the Ukrainian situation, preferring Japan instead. Recent events have not provided any clarification on Russia’s intentions or Europe’s ability to ensure reasonable energy supplies. Nor have investor reactions been excessive. As a result, we have left our asset allocation unchanged but will continue to keep a close eye on developments.
Greg Hirt, Global CIO Multi Asset de Allianz Global Investors
As Russian begins a full-scale invasion of Ukraine, already vigilant investors should adopt an even more cautious position in risky assets. While the full course of the conflict is yet to be known, the implications will be wide-ranging for markets, as rising energy prices push up already high inflation.
Early on Thursday, the S&P future was sharply down (-2.5%) and the Euro Stoxx future tumbled by more than 4%, while oil and gold were among the key safe havens bought by investors. Gas price futures are also spiking. This will likely hit the lower middle classes in most European countries hardest, leading to weaker growth, while potential blackouts could lead to production slowdown, also negatively impacting growth. Of course, this would also lead to higher inflation rates, as gas and gasoline prices continue rising and chemicals become more expensive.
The ECB will be in a difficult situation. Inflation numbers are already at record levels, which had led markets to speculate on interest rate hikes this year. Nevertheless, an increase in commodity prices is, in effect, a “tax” on production and consumption that would negatively impact growth. So, while inflation rates could continue to rise, the ECB may adopt a more bearish stance for the time being. Overall, rising commodity prices are set to result in weaker global growth and Europe would likely be the most affected region.
What does this mean for asset allocation?
Our Multi Asset Fundamental Investment Committee had already recommended increasing the allocations to safe havens such as US Treasuries and gold. Wednesday’s rather muted market reaction puzzled us, and so we think an even more cautious position in risky assets would be appropriate for the time being. We hold to our positive view on commodities, even though the market reaction could lead to some production support from OPEC.
Importantly, we are also watching for potential disruption to market liquidity, especially in Russian or Russian-related securities as these will be impacted – increasingly – by EU and US sanctions. The EU will prohibit the buying or selling directly or indirectly of any financial instrument issued on or after 9 March by the Russian government, its central bank, government agencies, or any person acting on their behalf. This means that Russia is now excluded from issuing new debt or refinancing its debt. Substantial outflows from any related Russian instruments could ensue, and there could be knock-on effects for widely used instruments such as ETFs and derivatives.
All in all, after a few years of solid performance for equities and other risky assets, this crisis may spur market participants to reduce their exposures over the coming weeks. We therefore continue to favour a cautious stance.
Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at Schroders
How the Ukrainians and the Western powers will react remains the major unknown for those trying to assess the tragic situation that is unfolding. We’re all shocked and saddened by events in Ukraine. Although we are talking here about the impact on markets, we acknowledge first and foremost that this is a human crisis with potentially awful consequences for millions of people.
However, at times like this our clients expect us to stay level headed, which is what we’re trying to do in assessing the market implications. Previous crises have shown us that what markets hate most is uncertainty. The worst phase for the market is when uncertainty is at its peak.
Now Russia has invaded Ukraine we have moved a step closer to peak uncertainty and into the realm of actual bad news. This is easier for investors to price, even if the consequences are negative. The one major source of uncertainty is how the Ukrainians and the Western powers will react. The assumption is that the response will be ever tougher sanctions. But there is also the question of whether at some point the West will be willing to intervene militarily.
So I don’t think we have reached “peak uncertainty” just yet. At this stage I wouldn’t advocate attempting to time the bottom of the market – let’s at least get through the weekend first. All the while we’re assessing the consequences, stock by stock, bond by bond and have the flexibility to respond if and when buying opportunities appear.
In terms of regions, some people are treating this as an emerging markets issue, but it is broader than that. Europe in particular is arguably the most exposed to the impact of what is going on.
Looking beyond the impact of geopolitical risk on risk premiums, the main economic transmission mechanism is via energy prices. This poses particular challenges for Europe given its reliance on Russian energy.
This has detrimental implications for growth and complicates the picture for the European Central Bank.
Evli Fund Management
Russia invades Ukraine. The crisis has escalated and it’s difficult to predict future outcomes. What we do know is that the West is not prepared to intervene militarily, which limits the potential severity of the crisis. The West will announce stricter sanctions.
Markets fall and volatility rises. Risk assets, especially European shares and equities directly related to Russia are falling whilst safe haven assets such as government bonds, Swiss franc, and gold are rising. Oil, gas and commodity prices are rising as Russia is a major exporter in the commodity complex.
We advise caution regarding investment decisions. Historically geopolitical shocks do not result in bear markets. The reasoning is that geopolitical shocks do not have major earnings effects for global equity markets. Markets may fall swiftly and aggressively, but generally recover relatively quickly as the crisis subsides. The macroeconomic risk of higher energy inflation, however, is a very real threat.
The conflict is likely to be contained, which means limited market reaction. The West in unwilling to deploy military force, which means fighting will be limited to that between Ukrainian and Russian forces.
22/02/2022 Russian President Vladimir Putin’s recognition of self-declared Donetsk and Luhansk People’s Republics
Filippo Casagrande, Head of Insurance Investment Solutions of Generali Asset & Wealth Management
The scenario is reminiscent of what happened in Georgia in the summer of 2008, when Russia intervened in support of the separatists in the regions of South Ossetia and Abkhazia; on that occasion the Georgian government responded militarily, but was quickly defeated by Russian forces, resulting in Russia’s recognition of the two separatist republics.
The current situation is undoubtedly more complex, given the size and strategic role of Ukraine for the Western countries. The United States and the United Kingdom are pushing for heavy sanctions against Russia, while the European Union’s response is more uncertain.
Economic sanctions would affect energy supplies, at a time of already severe tension in oil and gas prices, and while diplomats remain at work, it is undeniable that tensions over Ukraine represent an additional element of volatility and downside risk for the economy and financial markets.
It should be noted, however, that the financial markets have already been in a situation of tension and increased volatility for weeks. This is due to the sharp rise in expectations regarding the course of monetary policies by the major central banks, above all the Fed and the ECB.
In fact, inflation continued to surprise on the upside due to a combination of rising energy prices, problems in supply chains, but also increasingly due to rising wage pressures linked to the sharp fall in unemployment, which had returned to practically pre-Covid levels in the US.
The run-up in inflation, coupled with less expansive monetary policies and geopolitical tensions are inevitably weighing on growth estimates, which remain, however – and it is worth remembering this – well above potential levels.
In the US, the consensus now sees growth of 3.7% during 2022, while Eurozone estimates have been revised from 4.4% to 4.0%, mainly due to the slowdown in Germany (from 4.5% to 3.7%).
The Bundesbank recently stated that the German economy could contract in the first quarter of 2022, which would lead to a technical recession, given the decline in GDP in the last quarter of 2021.
Inflation estimates for this year, on the other hand, continue to rise, reaching 5.0% in the US (up from +3.0% in September, when the Fed started talking about tapering) and 3.7% in the eurozone (up from 1.5% in September).
Looking ahead to 2022, we reiterate the central role of the central banks’ normalisation process, and the Fed in particular, in the evolution of financial markets.
Steve Clayton, HL Select Fund Manager
Russian troops have not massed along the Ukrainian border in order to hold a cake sale. However this unfolds, tensions and uncertainties are likely to run hot for some time to come. The market will not like any escalation, nor will it trust any settlement between the parties unless accompanied by a rapid demobilisation of Russian forces around Ukraine.
Whenever international tensions flare, money tends to rush toward safe havens and the greatest of these has long been the US Dollar. The Yen could also benefit. Japan has stayed well away from this argument. Cautious money tends to head to the least risky assets, so it looks likely that US Treasuries and JGBs could benefit.
Defence stocks, like Bae Systems could provide safe havens; European politicians are unlikely to urge for lower defence spending whilst the Russian bear is growling angrily.
Banking shares could come under pressure. Effective sanctions will impact on economic activity and banks will be where it is felt in the West. Lending volumes would be hit too, if tensions really rocket, because cautious consumers and businesses will refrain from borrowing until they feel more confident.
Travel and leisure stocks are always going to react warily to rising international tensions. Wizz Air, with its large flight network across Central and Eastern Europe stands out here, but other airlines and tour operators like easyJet and Tui will also be impacted.
Times of tension are when defensiveness can pay off. People still have to eat, take medicines and get operated upon. Food retailers and drug companies like Sainsbury and AstraZeneca could be interesting, but Tesco’s exposure to Central Europe will not help.
Stocks with Russian exposure include BP, where exposure comes via an 19.75% shareholding in Rosneft, which is notionally worth around $12bn, having just plummeted by around 25% in recent days. Hyve Group was built around an exhibitions business in Russia and is still substantially exposed to the Russian economy, but a recent deal to acquire Ascential’s portfolio of shows has at least diluted the exposure.
But perhaps the real message for investors is that in the long run, it rarely pays to worry about the headlines. If it looks as though share prices are coming under pressure, go look for bargains.
Kelly Chung, Senior Fund Manager at Value Partners
While we view that Russia will not wage war with Ukraine, we expect that tensions may further escalate, which could exacerbate inflationary pressures. With both Russia and Ukraine being major exporters of oil and other commodity products, the tensions may cause more bottlenecks in the supply chain and push up energy and food prices.
In addition, any response from western economies, especially the US, would likely be trade sanctions, which should also impact oil and food prices.
We expect that tensions between the two countries will prolong longer, and the market is still yet to price in this geopolitical uncertainty. However, we view that the market impact will not last too long (historically direct market impact from geopolitical tension last from three weeks to three months). As more important market drivers associated with the tensions are inflation-related, investors will eventually focus back on the Fed, particularly on having a clearer picture of its balance sheet normalization. Ten-year US Treasury yields have risen since yesterday as investors are buying back long duration treasuries as a flight to safety in response to the ongoing tensions. On the other hand, we are seeing less movement in the short-end, causing the yield curve to further flatten, which also arise from the concern of economic slowdown.
In the equities market, the market has been rotating from growth to value stocks amid the faster-than-expected hikes of the Fed. We view that the rotation will last at least up until the end of the first half. While the growth-value valuation gap has started to narrow, it is still above the historical average.
While markets globally have been impacted by the geopolitical tensions and ongoing inflationary concerns in the US, we view that our China- and Asia-focused portfolios should be in a better position.
We also believe that the Russia-Ukraine tensions will have relatively less impact on the region compared to the west. While the tensions may further drive up inflation, this should benefit resource- and export-heavy Asia, especially Malaysia and Indonesia.
12/02/2022 Macron Meets with Putin. Putin gives no indication he is preparing invasion
Hugo Bain, gestor de Pictet-Russian Equities
Russia: a large amount of geopolitical risks already priced in
The return of geopolitical risks at the end of 2021 have triggered a part reversal in the strong performance of the Russian equity market in 2021. The energy and materials sectors have remained the most resilient, while financials and domestics have been more significantly impacted.
Whilst markets are pricing in a potential escalation of the Russia/Ukraine situation, Ukraine’s defence minister still retains the view that the likelihood of a Russian invasion is “low”. However fears over sanction implementation and the scale and severity of these sanctions, still loom large.
Now, Russia is one of a few major countries with a budget surplus, which protects it from needing external financing. Its structural current account surplus may remain high given the oil price, low public debt and high foreign exchange reserves, as well as the credibility of its central bank. Prudent fiscal and monetary fiscal policies have been a hallmark of its central bank policy in recent years, having recently stopped converting cash from oil sales into foreign currency to protect the ruble. Even though, inflation is high and may rise further if the ruble depreciates further.
Even though, Russian deposit rates have encouraged a return of domestic investors and the local initial public offering market, a trend that is set to continue in 2022. Also, valuations appear extremely cheap across multiple sectors. Aside from that, Russian firms remain cash generative, having considerably deleveraged, with 9.7% dividend yield. We believe the sustainability of these pay-outs is underappreciated. So, fundamentals on Russian equities look attractive.
Over the short term, we expect the market to remain volatile as geopolitical risks remain. Stopping gas flows or oil exports is a lose-lose situation for the West, especially given the already fragile global energy markets. An accommodating outcome on both sides would of course be the best situation and in case of a de-escalation or should a peaceful conclusion be found, there is a significant upside potential for Russian equities.
Thomas Smith, Fund Manager of the Liontrust Russia Fund
Russian equities fell by a third from their October high to the January low, erasing all of last year’s gains. This is despite the oil price surging to $90/bbl and, combined with a weaker currency, reaching record highs of RUB 7000.
This compares with an average of RUB 3700/bbl over the past ten years. European gas prices remain very high with storage across the region at depressed levels. Prices are expected to remain unseasonably high through the summer as storage is replenished. The reason for the stock market weakness is due to the rising geopolitical tensions between Russia and the West.
The sell-off reflects the market pricing in the likelihood of new financial sanctions against Russia. The West is united in that a full invasion of Ukraine by Russia would trigger widespread sanctions, although it remains unclear what other actions could also lead to fresh sanctions. These sanctions range from restrictions on international investors holding Russian sovereign debt to excluding Russia or its state owned banks from the international payments system. While a military invasion of Ukraine, and therefore radical new sanctions, cannot be completely ruled out, it appears unlikely because of the political and economic costs involved (to Russia and the global economy), the fact that both sides are determined to avoid this outcome and that they are now in regular talks. While Russia has made huge strides in recent years to improve its macroeconomic resiliency and ability to withstand external shocks, financial sanctions could still be very damaging. However, in this scenario the West must also be willing to accept a severe economic shock as surging commodity prices would fuel inflationary pressures and a stagflationary environment would be very negative for global equities.
Following the written responses from the US and NATO to Russia’s security demands, diplomatic channels remain open and further meetings will take place in the coming weeks. While Russia’s primary demands over NATO’s expansion policy and its military presence in Eastern Europe have been rejected, discussions over arms control and military transparency to address Russia’s concerns on the eastward expansion of NATO can now take place. While the future path of this crisis remains highly uncertain, we mustn’t forget that a diplomatic solution to the benefit of both sides remains very possible. Given the strength in earnings of Russian companies benefitting from high commodity prices, combined with the recent weakness in prices, Russian equities are now trading at less than six times forward earnings and more than 50% discount to broader emerging markets. There is clearly a significant geopolitical risk premium embedded in valuations. There would no doubt be further downside if the conflict in Ukraine saw material escalation, but as both sides are incentivised to avoid escalation and are now talking more frequently, there is potential for de-escalation in the months ahead.