Russia Invades Ukraine – What It Means for Markets
After weeks of warnings from the US about Russia’s intentions to invade Ukraine, it appears America’s fear has become reality. Having already declared the independence of separatist regions in Eastern Ukraine, a move largely condemned by the global community, shelling has now been reported in Kyiv and locations throughout the country, with Russian tanks crossing into the state. Russian President Vladimir Putin has offered a range of dubious justifications for the movement, ranging from an attempt to ‘de-Nazify’ the state to allegedly defending victims in the area from an unspecified genocide. To most, however, the move clearly stands as Russia’s latest attempt to reclaim its influence over the region from the West, challenging Ukraine’s independence and adding it back to the Greater Russian Empire that fell with the collapse of the Soviet Union in 1991. For all intents and purposes, Russia and Ukraine are now at war.
Of course, market reactions to the event are secondary to the terrible humanitarian cost this invasion will incur (casualties have already been reported on both sides). Nonetheless, the event will have an impact on economies outside Eastern Europe, and we wanted to provide some insight for clients into why North American markets have reacted negatively to news of this invasion. After all, while most would understand why the Russia Trading System (RTS) Index itself fell ~38% on news of the attack, it might be less clear why European, Asian, and even some North American positions have dropped so dramatically.
It really comes down to three points. For one, there’s the risk that the US and allies may yet be drawn more directly into the conflict. Currently, President Biden has voiced his intention to retaliate through economic sanctions rather than military action, a move that would likely entail cutting Russia off from the US dollar and SWIFT payments, an important money transfer system. Ukraine was also unable to join NATO before the invasion, meaning the US and other powerful allies are not obligated to intervene. Even still, NATO, itself having been formed to fight off Soviet expansion in 1949, has an interest in deterring Russia’s aspirations; nothing is yet off the table.
Secondly, Russia is a major exporter of natural gas and oil, controlling a quarter of the world’s natural gas reserves and supplying ~12% of the world’s crude. Russia’s war will therefore disrupt commodity markets as country’s look to distance themselves from the nation; Germany has already pulled the plug on Nord Stream 2, it’s natural gas pipeline with Russia. This will likely cause prices for these commodities to jump as supply loses a key producer – Brent crude, an international oil price benchmark, has already passed $100 USD a barrel for the first time since 2014. Economists fear that this may lead to further cost-push inflation; given the role natural gas and oil play in energy production, manufacturing and transportation, their higher prices would translate into higher costs for a multitude of other goods across Europe. The continent was already dealing with an energy crisis thanks to the pandemic; Russian sanctions will add salt to the wound.
Finally, market prices are inherently tied to the emotions of its participants – as fear and uncertainty about the conflict in Ukraine spread, market prices can drop as investors adopt a more “risk-off” sentiment. This is why more speculative positions like cryptocurrencies and certain pre-profitable tech positions, which rely on promises of future return, are the hardest hit when investors become more pessimistic about what the future might bring.
All this amalgamates into a scary situation for markets around the world. Even still, there are reasons why investors should not jump ship.
Outside the fact that stock prices already reflect these concerns (selling now will not protect returns from what has already occurred), war has historically had a limited impact on markets. While short-term volatility can be severe, the S&P 500 has historically achieved a positive return within 12 months of most severe international conflicts; even during the second World War, the Dow (a key index at the time) managed to achieve an annual return of roughly 7%. This is not a guarantee that the war in Ukraine won’t be painful for markets – historical conflicts have all occurred in unique economic conditions, with World War II itself being fresh off the heels of the Great Depression, a rock-bottom for the economy. It IS, however, to illustrate that war does not inherently bring with it long-term economic pain, and while the situation is a serious one with severe consequences for Eastern Europe, it is unclear how drastic, or muted, the impact on North American markets will be.
Accordingly, as with most financial events, the best approach is to focus on the long-term and effectively manage risk exposures before markets sentiment changes, not after stocks have already dropped. Time outlives all crises, political or otherwise, and stands as a powerful and reassuring force for long-term investors. Even still, the situation remains a humanitarian tragedy, and our hearts go out to the people of Ukraine, of whom Canada hosts the third largest population.
As always, we are available to address any concerns you may have.