The crisis in the Ukraine is a timely reminder of the genuine existential threats that we are faced with. A reminder that power, left unchecked, will corrupt, and seek more power. In Vladimir Putin, we have the world’s most dire threat since Hitler. It has been remarkable to see how quickly the world’s most powerful nations have mobilised to confront and nullify this threat. For all the political missteps that got us to this point, the world is now fully focused on the threat at hand. I am increasingly confident that the leaders of the western world are acting in the most rationale and pragmatic way possible to address this situation long term.
The invasion of Ukraine will have a far-reaching impact on the global economy. The economic and financial sanctions will have significant consequences, both intended and unintended. As necessary as these sanctions are, it makes for an even more dangerous time for the global economy. You cannot cut off a country the size of Russia and not have significant flow on effects. Obviously, it is essential to manage the crisis and the world will need to adjust, but that doesn’t make it any less risky in the financial sense. There is a risk that the Rouble collapses and potentially the entire Russian economy. The subsequent flow on effects will not be insignificant for the global economy.
Another concern is the potential for contagion in relation to the collapse of Russian companies or non-Russian companies with large exposure to Russia. There will be nations and banks with large exposure to assets and liabilities in Russia. Removing Russian banks from the SWIFT system is a powerful move but relatively untested at that scale. There are always two sides of the transaction to consider. There will be defaults and it will require intervention by international governments to manage this issue.
Energy prices and food commodities are going to go up, probably a lot. Russia controls about 40% of the natural gas supply in Europe. It is the 3rd largest oil producer in the world. Prices may spike creating an energy crisis that cripples the global economy and sparks inflationary pressures to levels even greater than they are currently. I have been surprised by Germany’s willingness to lead the way with sanctions and support given they source over 50% of their natural gas from Russia. It’s possible that Russia retaliates by turning off their supply to European nations dependent on them for energy. Sharp increase in energy prices will not only spur higher inflation, but it will also slow global growth.
There are significant long-term impacts too. Between the previous supply chain shocks from covid, and new ones from the current conflict, many weaknesses and vulnerabilities have been exposed. Countries will be far more strategic in pursuing a more robust and independent supply chain going forward. Increased prices sourcing goods that may not be as cost-effective is a small price to pay to ensure national security going forward.
You’ll see massive increases in military spending, especially from those nations threatened by Russia or China. The recent announcement by Germany to massively increase their defence budget marks a turning point. Since WWII, Germany has been neutral and reticent to be active in military conflict due to its past. But the threat that Putin now presents has been deemed large enough that Chancellor Olaf Scholz has made this adjustment with the full support of the national and international communities.
Importantly, for world peace in the years ahead, Putin has awakened the rest of the world from its slumber. The change in the geopolitical landscape in the past week has been greater than would ordinarily happen over the course of years. We have Sweden and Finland aligning more closely with the west and potentially resulting in their NATO membership and Switzerland breaking from its neutral stance to applying sanctions. While organisations such as the EU and NATO have been revitalised and empowered in the face of the crisis.
Initially, I felt the condemnations and sanctions were the worthless equivalent of ‘thoughts and prayers’ and did nothing to provide genuine assistance to the Ukrainian people. However, as these sanctions and support have been rapidly increased it is clear that the USA, Europe, and their allies are carefully and strategically navigating this situation. Their decisions are co-ordinated and considered. They are mindful that Russia is a nuclear power run by a power-hungry lunatic. They are clearly aware that perhaps the only thing more dangerous than a powerful and aggressive Putin is a weakened and cornered Putin. So far, they appear completely aligned and I believe they are prepared to do whatever needs to be done in response to any escalating threat Putin presents. While Ukraine may soon fall, Putin’s time is now limited.
Overall, the current situation with Russia overlays a significant new layer of risk across financial markets globally. This is over and above the significant existing concerns for inflationary and interest rates. Stock markets appear to be treading water as the situation evolves. It is possible that the current situation will result in a delay in the interest rate increases that were pending. This may be so, but if anything, it will be even more problematic later if inflation escalates and rate increases were delayed.
From a portfolio perspective, Australian stocks remains relatively insulated, while our international exposure is heavily weighted to US stocks and US dollars. We remain very underweight Europe and we avoid China. We retain an overweight cash position and will add to stocks on weakness as long-term buying opportunities emerge.
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