Weekly investment strategy
Review the latest Weekly Headings by CIO Larry Adam.
Key Takeaways
- Putin wants to cement his legacy and Russia’s influence
- Russia & Ukraine both have essential exports
- Prior geopolitical events reveal an equity market pattern
With headlines, political rhetoric, and the financial markets bracing for an “imminent” attack for weeks, President Putin already had the world’s attention before his decision to invade Ukraine this week. His demands had been made clear: 1) NATO must be restored to 1997 conditions, 2) NATO must not expand further, and 3) NATO must not conduct military drills in Ukraine and eastern Europe without permission. With the US and its allies unwilling to concede to his proposal, Putin made his first advances at demilitarizing the Ukraine. While he stated his intent was not to harm civilians, dozens were killed in the multi-pronged attack across the country. Below discusses how and why the tensions escalated to this point, what the next steps may be moving forward, and the potential ramifications for the markets.
- What Is Putin’s Objective? | It is important to understand the historical context for the tensions as investors question Putin’s rationale for igniting this conflict. While Russia is the largest country by landmass (it extends 11 time zones), its population—which is less than half that of the US—is quickly declining. From a population density perspective, the majority of Russia’s population live in the most western part of the country. With NATO expanding its influence since 1997 to many countries at the doorstep of Russia—such as the Baltic region, Poland, Hungary and Romania—Putin fears Russia’s influence could erode. Given that he dubbed the dissolution of the Soviet Union as “the greatest geopolitical catastrophe of the century,” it is unsurprising that he is seeking to cement his legacy and return Russia’s borders and influence to what it once was.
- What May Putin Do Next? | Sadly, this is not the first time that Russia has embarked on an invasion as it entered Georgia in 2008 and the Ukraine (via the annexation of Crimea) in 2014. Thus far, the playbook for this incursion parallels the other two. Similar to the aforementioned crises, this current Ukrainian crisis has involved (in the same order) disinformation campaigns, significant military mobilization in the months prior, false signs of de-escalation, a focus on separatist territories and the Russian government’s acknowledgement of the independence of the region (in this case, the Donbas region). The next two steps—a ceasefire and the establishment of pro-Russia influence or leaders—will determine the longevity of the crisis. History suggests that the conflict/fighting could continue for days (Georgia) to several weeks/months (Crimea).
- How Does This Impact The Global Economy? | Russia and Ukraine have essential exports for the global economy. Whether it be agricultural staples such as wheat (the two combine for nearly one third of the world’s total production) or precious and industrial metals such as palladium or aluminum, the concerns that prolonged tensions will adversely affect the already constrained supply chains are well-founded. And it is hard to ignore Russia’s role in the energy market as WTI and Brent oil spiked above $100 per barrel for the first time since 2014. Given that it produces 10 million barrels per day and that more than a dozen European countries rely on it for more than 20% of their oil imports, investors are fearful that already high prices at the pump will rise even further. While higher oil prices would be detrimental to the US consumer, the pain could arguably be worse for European nations where gas prices are well-above those seen in the US (e.g., Germany $7.59). While none of the sanctions announced thus far target Russia’s energy exports specifically, the halt of the Nord Stream 2 pipeline is an attempt to prevent further reliance upon Russia’s supply and to accelerate a shift away from fossil fuels towards renewables. Even though Europe installed a record amount of wind power last year, it will still take years before for its Russia-energy dependence to wane.
- Will The Equity Market Weakness Persist? | The S&P 500 closed in correction territory (a decline of 10%+) for the first time in nearly two years this week as geopolitical tensions intensified. As we analyze the market declines associated with previous geopolitical conflicts, the typical pattern is a short-term pullback followed by a recovery and higher markets six and twelve months later. However, some geopolitical events are clouded by external factors that include the bursting of the dot.com bubble and recessions—two dynamics we do not foresee unfolding over the next year. First, equity valuations remain attractive given a robust earnings outlook. Second, despite this crisis, we see limited risk for a US recession over the next 12 months as economic fundamentals (such as a robust labor market, the re-opening of the economy as COVID fades and elevated capex) remain strong. Given that corrections can be uncomfortable, we reiterate that the equity market should recover to higher levels by year end and encourage long-term investors to remain patient during these volatile times.
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