Russia and the markets
Rising tensions over Russia and Ukraine are now the dominant factor driving day to day movements in investment markets.
Yesterday, Russia recognised the breakaway regions of Donetsk and Luhansk in Ukraine’s Donbas region and has plans to send “peacekeeping” forces to the area! I think it’s fair to say that these areas were already controlled by pro-Russia militias, so this could be seen as confirming the status quo. On the other hand, it will be seen as provocative by Ukraine and its allies.
Sanctions will be forthcoming, for instance five banks and three high profile individuals have already been sanctioned by our government, but for the UK, the US and the EU, this is not on the scale threatened if it becomes a full invasion.
This has caused a drop in equity markets and created a rally in US Treasury bonds yesterday afternoon, which continued in the Asian markets overnight. The biggest damage, however, has been to Russia’s own equity market, the MOEX, which was down 17% over yesterday and today (as at 7am GMT). The Ruble has also dropped, meaning the MOEX is down over 20% in Dollar terms. Perhaps this demonstrates that the damage to the Russian economy may be worse than that for the rest of the world, as mentioned in one of my previous newsletters.
An invasion of Ukraine would most likely see oil and gas prices continue to rise and the possibility of stock markets falling further. How far and how deep will depend to some extent on how far this all goes. It seems unlikely that NATO forces will get involved directly in any fighting and Russia may settle for what it did yesterday, recognising these pro-Russia separatist regions by putting Russian troops on the ground in this Russian speaking area. This would be symbolic but would, perhaps, do little more than recognise the status quo.
As you may know, Russia’s main concern has been the expansion of NATO into what it sees as its sphere of influence, but it has also been keen to support ethnic Russians in Ukraine. This may be the excuse for Putin to embark on a full invasion which would be the biggest war in Europe since 1945.
These are dark times and when trying to understand the implications you tend to look for historic comparisons. Perhaps there is nothing that compares directly with what’s happening now, but to try and put this into some historic context, you could look back at the Cuban Missile crisis of 1962 for US/Russia tensions or the Iraq invasion of Kuwait for oil supply disruptions.
Firstly, a de-escalation of the tensions around Ukraine would be best for all parties and diplomacy may yet provide that.
Today’s circumstances are, however, different to the Cuban missile crisis which threatened a direct confrontation between two major nuclear powers and the destruction of life as we know it. President Biden has made it clear that direct fighting between the US and Russia is unthinkable and that US forces will not fight in Ukraine. It would result in sanctions however, which could see Russian oil and gas supplies cut off , making this somewhat comparable to Kuwait which threatened disruption in the oil supply from the gulf.
The Cuban missile crisis took place in October and November 1962 and followed a sustained rally on the US S&P index through the 50s, this peaking in 1961. It then fell by 27% in what was known as the Kennedy slide, bottoming out in June to then recover by 14%. It declined again, but only by 6% in the early days of the Cuban crisis before bouncing back. By September 1963, it had passed its 1961 peak. The market was helped by JFK who agreed to tax cuts and other fiscal stimulus.
The invasion of Kuwait came in August 1990 and over the following weeks the oil price rose by over 80% whilst the S&P fell by 17%. The latter then gradually recovered, only dropping a little ahead of Operation Desert Storm, the success of which saw the oil price fall back and the S&P recover by the end of 1991. At that time, it was 17% above its pre the invasion level. All of this occurred against a backdrop of a recession in the US between July 1990 and March 1991, during which time interest rates were cut from 8% to 4% to help fight this.
Clearly the time to buy was mid-crisis when it looked bleakest. If you had cashed in your investments you would no doubt have congratulated yourself but would probably not have bought back until the market had bounced. As I’ve mentioned in various newsletters over these past two years, trying to guess the markets is nearly always dangerous.
Interest rate cuts on the scale of 1991 are not on the cards this time round, however and despite higher energy and agricultural prices, the US Federal Reserve may be reluctant to raise rates as fast as has been priced into markets. It will also be interesting to see what our own Bank of England Monetary Policy Committee decide when they meet next month.
I think it’s been generally accepted that the European economy will be hardest hit, being dependent on Russian gas, however European markets have, to some extent, already priced in some of this risk. It should also be noted that while the oil price has risen steeply, the futures curve implies that the oil price is still expected to fall back later this and into next year.
We all hope that the Russians see the potential economic damage, particularly for their own countryfolk and that the diplomats can find a way through the present crisis, just as they did in 1962.