The Russia / Ukraine conflict is evolving at a rapid pace with plenty of propaganda and misinformation doing the rounds along with vested interests and important historical contexts missing.
Putting that aside, any war / conflict / invasion is a terrible thing to see, and our thoughts and prayers are with those affected by the conflict.
What we know so far, in what is a very fluid situation, is that Russian troops have moved into Ukraine from the north, east, and south. It also appears that there's been no official use of NATO or allied troops yet.
Source: Geopolitical Futures
What we still don't know are the exact motives for doing so, what the Russians hope to achieve, and how long they plan to remain in Ukraine. We can guess or speculate, but that won't help the situation, and we can confirm that many are guessing and speculating.
What we can and have been focusing on is the economic and financial market implications of the conflict. These include:
2. risk sentiment
3. inflation and central banks
Before we get into the details on some of these, it's worth noting that geopolitical events rarely have a lasting impact on markets. For example, if you look at the US equity market (S&P 500) returns and geopolitical events since 1970, the average returns are as follows:
1 week - up 0.1%
1 month - up 0.2%
1 quarter - up 3.6%
1 year - up 9.6%
Coming back to areas of focus, Russia has been hit with plenty of actual and proposed sanctions from the West, which is to be expected. These sanctions have the ultimate aim of trying to stop further conflict by:
1. crippling Russia economically
2. causing politically pressure / instability to weaken or topple Putin
There's a strategy of sorts behind how and when you apply sanctions. Go too hard early and you embolden the aggressor to act more aggressively; go too soft early and you let your aggressor know that you're not serious or that you don't want to harm yourself in the process (e.g., oil and gas). Sanctions thus far have been weak to reasonable, so there's plenty of room to ramp these up if needed.
Risk sentiment is clearly negative at present with investors looking for safety in assets like cash, government bonds, quality equities, gold, and safe-haven currencies such as the Japanese Yen, Swiss Franc, and the US dollar. However, this negative sentiment is polluted by the negative sentiment that already existed before the conflict owing to concerns regarding high inflation and how central banks are likely to fight inflation. That is, we don't know how much of the current negative sentiment is due to the conflict versus the concerns about central bank rate rises. Right now, we'd say that the conflict is responsible for the negative sentiment at the surface, but the underlying driver of the negative sentiment remains inflation.
Following on from that, and perversely so, the conflict has given central banks the breathing room they so desperately needed to slow and calm market sentiment regarding the amount of rate rises that were likely this year. In stark contrast to that, the conflict could actually exacerbate already high levels of inflation through higher oil and gas prices and further supply shortages, thus exerting additional pressure on central banks.
One thing we are watching closely is oil and gas prices, along with oil and gas demand and supply, and how that might impact consumption, business investment and earnings, and political manoeuvring especially in the lead up to elections where energy security is likely to be a hot topic.
Key takeout’s are as follows:
1. our thoughts and prayers go out to the people caught up in the conflict
2. geopolitical tensions rarely have a lasting impact on markets, since they rarely have a lasting impact on the business cycle
3. we think a resolution to the conflict is likely, but have no guidance on the timeframe
4. our base case remains that central banks don't need to raise rates aggressively from here, but that rates should be higher than they are currently
5. the negative sentiment since the beginning of the year is more an opportunity than it is a risk
As such, we don't believe significant portfolio changes are required given the fluidity of the situation and given portfolios remain well positioned. But we remain very watchful of the prevailing news, data, and market conditions. Dollar cost averaging and portfolio rebalancing might be worth exploring further at this juncture.
Chris Lioutas, Director, Insight Investment Consultants
Chris holds the position of asset consultant for Maxim Advisors and is a current sitting member of Maxim's investment committee.
With permission of the author, this article is presented by Maxim Private Clients Pty Ltd ASFL No. 511972
Maxim Private Clients Pty Ltd ABN 47 611 614 398 AFSL No. 511972
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