You will of course have seen Russia taking military action in Ukraine with reports in Kiev of explosions. There is a lot of uncertainty surrounding how extensive the attack is or what Putin’s objective is. It may yet be limited to taking the rest of the Donbas region not already controlled by pro-Russian separatists, but it may be a full-scale invasion of Ukraine aimed at imposing a pro-Russian government. The EU, UK and US governments have said there will be harsh sanctions aimed at harming the Russian economy but military involvement by NATO forces has been ruled out so far. It is unlikely that sanctions will have any impact on Putin’s actions over the next few days. He will have been planning this move for a long time and is unlikely to be deterred. While sanctions will impact Russians we will need to see the details to assess the wider impact.
At this point it is not clear how extensive the attack is, or what the objective is. It may yet be limited to strikes on the Ukrainian military or the taking of the rest of the Donbas region, not already controlled by pro-Russian rebels. It may be a full invasion of Ukraine aimed at imposing a pro-Russian government. The initial market reaction has seen a 6% rise in oil prices, with Gold up to 2%. US treasuries have also bounced as a ‘safe haven’ trade, albeit to a lesser degree, given concerns around inflation. On the flip side, most equity markets have opened down 2-3%, with US Futures pointing to another -2% fall, following last night’s drop of -1.8%. The Russian Index (IMOEX) was off -45%, but is down -30% as I write.
In the short term, the direction of markets will largely be determined by the scale and focus of the sanctions and counter sanctions deployed between the West and Russia, and this in turn may well hinge on how far Russia goes in its invasion. President Biden alluded to this (perhaps mistakenly) when he talked about how the level of sanctions will depend on the type of invasion that Russia pursues, and this may well be the case in the coming days. What is clear is that both sides have a lot to lose, and so they will be keen to maximise their aims, with minimal economic damage.
There are longer-term implications for the West’s reaction to the invasion of Ukraine. In particular, China will be looking closely to see how resolute the response is of the West, which may impact their ambitions regarding Taiwan. This is a test of the new leadership in Germany and for Biden’s Presidency ahead of the mid-term elections in particular. With Macron looking to his re-election and Boris Johnson trying to offset his own domestic difficulties, the response may have much to do with domestic politics. Cutting out all oil and gas supplies from Russia would see even higher prices, a policy that would prove to be unpopular. Equally the political leaders will want to look strong.
Trying to trade on any news flow over the coming days will be dangerous, given the unpredictable nature of the situation, and with certain scenarios potentially ‘priced in’ already. In the short term we may see further weakness in equity markets, as short term traders, overleveraged players and hedge funds close out position. However, this will present attractive opportunities for long term investors (such as us), who will be able to pick up high quality companies at depressed levels. This was true in March 2020, December 2018, January 2016, and September 2011 (and so on), and we believe the same will be true today. For now, we wait on the side lines, in the form of cash, US treasuries and absolute return funds, and we will be looking for technical signals (panic selling, high put/call readings etc) to point to an attractive entry point.
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