Isaac Asimov — ‘Violence is the last refuge of the incompetent.’
As we moved from 2021 into 2022 there was a slight glimpse of a future that looked something like we had seen prior to 2020 and the onset of COVID 19. Whilst Omicron was still dominating the news cycles, we were, here in Australia (and to a certain extent most western countries) seeing the positive impact of mass vaccination of the population. Whilst Infection rates were still at uncomfortable levels, importantly hospitalisation rates and death caused by CIVID 19 were no longer at the numbers we had experienced through 2020 and 2021.
From a financial perspective, we were looking at the world opening up with the re-emergence of global trade putting a wind behind equity markets as a return to normality was priced in. There were the first signs of rising inflation. Whilst predominantly an American issue, future decisions by the worlds central banks on interest rates and the impact this could have on share markets was leading to some nervousness.
On 24 February 2022, Russia began an open military invasion of Ukraine, in a major escalation of the Russo-Ukrainian conflict that had begun in 2014 with the Russian annexation of Crimea.
Explanation of the conflict
The early weeks of 2022 saw Russia increasing their military presence on the border of Ukraine. A general ramping up of vocal threats led to a full-scaled invasion into Ukraine, an outcome few saw as the likely reality given the human, political and economic costs of war. This invasion into Ukraine is predicated on Russia’s unwillingness to let Ukraine become a member of NATO (North Atlantic Treaty Organisation) and the strategic advantages that Russia perceived this would create against them. Remember, NATO was the enemy of the Soviet Union during last century’s Cold War. The Russian narrative was simple, if NATO were to accept Ukraine into the alliance, NATO forces would be allowed to militarise along their border.
This in no way gives any nation the justification to impede on another’s sovereignty. Self-determination is a sacred rule that is being broken.
Since the initial invasion, the success of the Russian advance has not been in line with expectations. This appears to be leading to frustration on the behalf of Russia’s leaders and the use of more deadly weapons with an increasingly indiscriminate nature in major cities of Ukraine. The one truth to this conflict is that like all wars, innocents are suffering.
Markets turn volatile
Markets had a volatile start to the year as rising inflation and expectations of higher interest rates had put a lot of pressure on asset prices. Now, investors are trying to work out how to price in the war occurring in Ukraine. This is understandably causing concern. Markets fell significantly on the initial news of the invasion and safe-haven assets like gold rose sharply. Since the initial shock, there has been higher volatility in commodities and equity markets as there is no clear understanding of what this war’s actual impacts on the global economy will be. The level of unpredictability and risk remains high.
The fact remains that this is an isolated war in a country that has had war present between Russian Separatists and the Ukrainian Army since 2014. It appears unlikely that a World War III scenario is playing out. Countries not directly involved in the conflict are not sending troops but rather turning this into an economic war. As an example, French Minister of the Economy, Finance, and the Recovery Bruno Le Maire declared an “all-out economic and financial war” against Russia. Western nations have actively moved to sanction Russian banks and individuals connected to the Russian State.
The most significant recent reaction to the Russian invasion is the agreement of the European Union, UK, US and other allied nations to remove some Russian banks from the Swift payment system. This is likely to have significant impact on the Russian economy. In 2012, Iran was banned from this payment system. They proceeded to lose half of their oil export revenues and 30% of foreign trade. It is expected that a similar financial impact will happen to Russia as their banks become unable to send money overseas with ease. Whilst the US has announced a ban on the import of Russian energy (Oil, gas and coal), Europe because of their heavy reliance on Russia for their energy needs have not initiated similar sanctions at this point.
There is a high probability that energy and other commodities will be impacted by this conflict as production is disrupted. As an example, Ukraine and Russia also account for one-third of global wheat production which has since gone mostly offline in Ukraine or unable to get to port. Wheat prices have since moved much higher as a result. Watch this reflected in the price of bread over coming days and weeks.
This does not appear to be heading into a world war environment. The West appears to be willing to let Ukraine fight their own battle aiding only with military equipment and financial sanctions. The outcome of all of this is currently unknown in its entirety as the situation evolves constantly. Shocks to commodity markets may further elevate already rising prices and keep inflation fears elevated. These flow-on effects from war may cause further downside in markets. If there are any talks between the two nations that consist of concessions and aspects of de-escalation or a sign of the war ending, markets would likely stabilise. This is yet to be seen as the Russian war effort increases in intensity.
The Russian economy (144 million people) has a Gross Domestic Product (GDP) roughly the same size as Australia (26 million people). Sanctions and the removal of Russian banks from the SWIFT payment system will further deteriorate the economic situation in Russia. The Russian Ruble has already fallen roughly 30% relative to the USD since the initial invasion bringing the value of 1 Ruble to less than one US cent.
With trade on the Moscow exchange suspended, a proxy for the value of Russian shares is reflected in the below chart of the Dow Jones Russia GDR index. The value of Russian shares is all but wiped out and with it the wealth of many Russians. The longer this war goes on, the more the people of Russia will suffer as a product of the sanctions with further unrest predicted to occur domestically.
Impact on your portfolio
A statement frequently seen in financial news reports, particularly at the moment, is that ‘markets hate uncertainty‘. In reality, uncertainty never goes away. The forecast may say ‘no rain today’, but you still keep an umbrella handy, just in case.
The truth is that any investment with an expected return above cash involves trading off certainty for a potentially increased return. What you can do is have a portfolio you can live with, accept there will be anxious periods, and stick to the agreed plan. If you wish to discuss this further please reach out, as always we are here if you need us. In the meantime, we will continue to monitor the situation and if we feel that action is necessary we will be in touch.