WHAT DOES THE UKRAINE CRISIS MEAN FOR MARKETS?
Key Takeaways
- The conflict between Russia and Ukraine may induce excess short-term volatility.
- Disruption of Russian energy exports could temporarily raise global energy prices, adding inflationary pressures to economies.
- It is important to remain invested and hold a diversified portfolio across different asset classes and geographical regions.
Ukraine Crisis
Tension in Ukraine has been palpable for some time and on Monday night Vladimir Putin recognised the separatist regions of Eastern Ukraine including the major cities of Luhansk and Donetsk as independent states.
In 2014 Ukraine overthrew the government after a tumultuous presidential election in which the previously pro-Russia government was replaced by a pro-European government. Since 2014 there has been an ongoing civil war among Ukrainians. In 2014 Russia annexed the Crimea region and began to fund the separatist fighters in the two Eastern Ukrainian states of Donbas and Luhansk. On Monday, Vladimir Putin made an address to his nation and declared that the two separatist regions are independent states. He signed a Decree essentially allowing himself entitlement to cross the border into Ukraine under the name of peace.
In recent times we have seen the build-up of the Russian military along Ukraine’s Eastern border stretching from the Crimea in the South to Belarus in the North. The latest estimates are 150,000 troops are stationed along the border. Yesterday’s announcement allowed for some of those troops to act as “peacekeepers’’ and enter what is Ukraine’s sovereign territory. This is a direct violation of the Minsk agreement signed in 2014 to help prevent a full-scale conflict in Ukraine.
The reaction to the announcement made on Monday by Putin has been swift from the Western powers with widespread condemnation. The United Nations held an emergency security meeting last night after Russia has been accused of violating International Law with this decree to provide ‘’peace’’ to Ukraine’s Separatist regions.
From here on, the next steps in this conflict are not concrete. While many now view the invasion of Ukraine has begun with the signing of the decree the unofficial line is that there would have to be further Russian troop movement beyond the borders of the separatist states of Luhansk and Donetsk into Eastern Ukraine before a full-scale war between Russia and Ukraine would be declared. The proposed response from the U.S., U.K., and E.U., is one of patience, to unload their full sanctions on Russia if Putin does decide to invade Ukraine.
How the Ukraine crisis could affect the market
As expected, with the rising tensions among countries, we have seen markets react negatively to this news. What can be expected is that the geographical location of each country will define the level of impact that this conflict will cause. Countries in Eastern Europe and Europe could be due to face the largest impact due to reliance on Russia as a trading partner in particular for natural gas and oil. Russia currently produces 10% of the world’s energy supply and contributes to nearly 50% of Europe’s energy via its gas. The control over the supply of energy could have a cascade effect on gas prices, which will have a knock-on effect on inflation in those countries. Additionally, companies like Shell and BP own a significant stake in Rosneft and Gazprom, which are Russia’s largest energy plants.
The Western powers will work hard to impose sanctions on Russia and its partners, putting economic pressure on the country. Tuesday saw the U.K., U.S., E.U., Canada, and Japan all place sanctions on Russia. The sanctions ranged from banning individuals from accessing assets in the respective country, to sanctions against Russian Banks and sanctions against the purchase of Russian Sovereign Debt. Perhaps though the most significant news on Tuesday was Olaf Scholz the German Chancellor ending Nord Stream 2. Nord Stream 2 was to bring natural gas directly to Germany from Northern Russia cutting costs for gas across Germany and the other major European nations. The closure of this gas pipe will be detrimental to Russia as Nord Stream 2 was to see a greater reliance from the major European nations upon Russian Gas for energy.
Amongst the sanctions, we could see moving forward if Russia does invade Ukraine are Russian banks being removed from the Swift banking system, isolating it from the world. Likewise, we could see further sanctions this time targeting the Oil and Gas industry in Russia, which are likely to be more penetrative to the Russian economy.
Additionally, Russia is a big trading partner with countries like China. It is still to be seen on their current stance with Russia invading Ukraine. If they decide to follow suit with the Western nations this could result in the selling of Russian components from emerging market debt indices, posing a liquidity risk in these parts of the world.
To highlight the impact the below table showcases the major global markets performance on Tuesday 22nd February.
| Index | In Local Currency |
| Tuesday 22nd February | |
| The U.K. | |
| FTSE 100 Index | 0.13% |
| The U.S. | |
| Dow Jones | -1.42% |
| S&P 500 Index | -1.01% |
| Europe | |
| Euro Stoxx 50 Index | -0.01% |
| MOEX | -1.58% |
| DAX | -0.26% |
| Asia | |
| Nikkei 225 Index | -1.71% |
| Hang Seng Index | 0.53% |
| MSCI Emerging Markets Index | 0.52% |
Historical effects of military action and incidents on financial markets
The volatility and negative drawdown of a portfolio will also be temporary in the current circumstances. As per the graphs below, we can see how the Dow Jones and MSCI world performed, where data was available, and the impacts that previous conflicts had on these indices.
These graphs show performance one month before the beginning of the conflicts. A common pattern seen across the charts is that the markets tend to dip in the month prior to an attack as tensions escalate between countries. However, In all instances, we also see markets recover in a matter of months with the exception of World War II, where it took three years, but this is an improbable scenario. Further to this, the table below details the S&P 500 reaction to all the major incidents that have occurred over the previous 80 years.
To conclude, it is critical to reiterate the importance of remaining invested. The Ukraine crisis carries a level of uncertainty in terms of how the crisis will unfold over the short term and the long term. Therefore, it is likely we witness excess volatility in the short term. However, as mentioned, remaining invested in the long term is more prosperous than chopping and changing your portfolio in adverse financial markets.
If you would like to speak to one of our advisers regarding the impact it has had on your investment portfolios, contact us today.
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