After the past few weeks of speculation, on Thursday (February 24th), Russia launched a full-scale invasion of Ukraine. Russian attacks have included ground troops, missiles, tanks, and aircraft. Russian troops attacked Ukraine from several directions targeting major cities and military sites, including missile strikes on Ukraine’s capital city, Kyiv. The attacks provoked condemnations from the US and many EU member countries, as “a flagrant violation of international law.” The situation is shrouded in uncertainty as it is the first attack of its kind on European soil in several decades.
The US and the EU look to deter Russian aggression with potentially devastating economic consequences. President Joe Biden imposed economic sanctions on Russia’s sovereign debt earlier in the week in response to the imminent Russian attack. These sanctions disallow Russia and its oligarchs from raising money in the West and from trading on new debt in US and European markets. The US is also working with Germany to halt certification of the Nord Stream 2 pipeline which would provide natural gas from Russian state-owned Gazprom, whose sales support that government’s budget.
Additional sanctions were announced over the weekend by leaders of the US, EU, UK, and Canada. The most significant of these is the banning of Russian banks from SWIFT, the dominant system for global financial transactions, and the freezing of hard currency assets of the Central Bank of Russia (CBR). These sanctions will most likely send the Russian economy into a deep recession and cause the value of Russia’s currency to plummet. While it appears the Western allies will attempt to design the sanctions in a manor where Russian oil and gas exports would continue to flow, it is unknown whether the energy payments will be able to be excluded in the framework of the SWIFT restrictions. Russia could also decide to retaliate by cutting off energy exports in kind.
It is unclear how these events will impact the US and world economies which are still attempting to recover from Covid lockdowns. Geopolitical events are often destabilizing for markets, and economic sanctions impeding Russia’s oil and gas exportation tightens the global supply. Russia supplies more than a third of the EU’s natural gas and more than a quarter of its oil, but that is a double-edged sword as oil and gas exports represent a third of Russia’s economy. The EU has long been seeking to diversify amongst renewable energy sources and could now be more motivated than ever to pursue energy independence. Ending European reliance on Russia for energy may turn out to be a long-term positive for the economies in the West. It is also unclear how these events will impact China’s relationship with the US, the EU and Russia. China is aligned with Russia on political philosophies and can provide assistance when dealing with US and EU sanctions. However, China must consider how any assistance will negatively impact its relationship with the US and the EU.
Will these events have a long-term economic impact on the US? History has shown that markets react to these moments in the short-term, but those effects are not necessarily enduring. The current Russian-Ukraine crisis comes at a period of pandemic-induced supply chain issues and high inflation. If energy costs increase substantially, these pre-existing challenges may be exacerbated. It is impossible to know if the current predicament will worsen. Destabilization could also have the opposite effect of dampening consumer sentiment and spending to the point that inflation slows down on its own.
The S&P 500 is down about 10% from its highs in late December, largely due to inflation concerns; Crude oil is approaching $100 a barrel, up almost 30% for the year. This spells bad news for consumers, as soaring oil prices couple with inflation at 40-year highs. Investors have been eyeing the Federal Reserve’s next meeting in March, where it is expected that the central bank will begin lifting interest rates to quell said inflation. Whether the Russia-Ukraine conflict influences the Fed’s decision making remains to be seen.
Historically, markets have taken geopolitical conflict in stride and weathered the storm in the long-term. This includes the last time Russia invaded Ukraine and annexed the Crimean Peninsula in 2014. A study from Glenview Trust, which examined 29 different geopolitical crises since World War II, showed that after Russia seized Crimea, the S&P was positive days later after an initial plunge. Similarly, the S&P was up 1-year after all the following geopolitical events: Pearl Harbor, the Cuban Missile Crisis, the Russian invasion of Afghanistan in 1979, the Persian-Gulf War, and the start of the Iraq War. However, the S&P remained negative one year after the attacks on 9/11.
Eagle Ridge has no direct exposure to Russia; i.e., owns no companies domiciled in Russia (or Eastern Europe) in clients’ portfolios. Given the global nature of almost all large-cap public companies, Eagle Ridge investments may sell into Russia or rely on Russia for raw materials, including as a source of energy. However, Russia is not the driver of revenue growth for the company or a key supplier.
Taking all this into consideration, how should an investor handle geopolitical risks in their portfolio? History tells us that it is more likely that any major market movements will be short-lived, so investors should sit tight. Eagle Ridge will continue to monitor this situation and the economic ramifications as they develop but does not recommend allocation changes based on the events thus far.