The uncomfortable spectrum of war is emerging from the shadows and finally taking shape. As it grows arms and legs, we recoil, not wanting it to materialise further. But it’s worth stepping back and asking why should the west – the UK, US, Germany and France – (among other nations) support Ukraine? Because we promised to.
While parties are being urged to revive the peace accord set out by the Minsk agreements in 2014/15, we should actually dial back the clock to 1994 when an agreement – the Budapest Memorandum – was struck between Russia, Ukraine, the UK and US, which saw Ukraine give up its position as the world’s third-largest nuclear power. Following that pact, an estimated 5,000 nuclear weapons, more than 170 intercontinental ballistic missiles and several dozen nuclear bombers were passed to Russia to be dismantled. In return, the North Atlantic Treaty Organization (NATO) agreed it would step in if the Ukraine was attacked by Germany or Russia and vice versa.
Just as we previously detailed that China views Taiwan as an extension of itself, the same is true of Russia: it views the Ukraine as an extension of its territory and the west as a very real and present threat. After all, it is not that long ago that the cold war ended – a narrative in which Russia (under the moniker of the Union of Soviet Socialist Republics) was positioned as the ‘loser’.
The current situation
The issue is that although what we are witnessing today may be the scenario envisaged by the signatories, that doesn’t translate into the same level of support today. Even as Putin’s forces are deployed in the new ‘people’s republics’ of Luhansk and Donetsk, economic sanctions may not be as encompassing as have been threatened, let alone other forms of intervention.
The US has said it will respond to both a full and even a limited incursion into the Ukraine by imposing sweeping sanctions on Russia. Indeed, at the date of writing, this has already started, with sanctions targeting financial institutions, the elite in Russia and preventing the state from accessing US capital markets.
Europe’s response is also going to be dependent on the severity of the conflict. Although the German government has said that it is suspending the certification of Nord Stream 2. Europe may well seek to avoid specific sanctions on energy, especially in the case of a limited military incursion in Ukraine.
The initial sequence of Russian attack followed by sanctions announcements will be negative for investment sentiment.
The possible consequences
On the flip side, it could be the start of more global tensions – which in turn could lead to NATO troops on the ground – as well as China deciding to invade Taiwan while attention is focused on Russia. In fact, Russia is likely to strengthen ties further as a trading partner, selling energy to the Chinese instead of Germany.
The consequences for markets
Although the most obvious effect is to be found in Russian markets, where the MOEX Russia Index dropped 14% and the US dollar denominated RTS Index slid by 17% earlier this week (with more falls in store given these were not to the same extent as those during the 2008 Financial Crisis), Russia is a relatively small economy (roughly the same size as Spain).
Global markets have not been immune to this though. It is estimated that tensions over the Ukraine are responsible for around 4.5% of the drop in the S&P 500 this year. In this ’risk off’ environment, the obvious beneficiaries have been US government bonds and gold.
But the big unintended risk is perhaps inflation, which is already headline news. The consequence of this could be a sharp rise in gas and oil prices. Putin could effectively make the inflation shock, which was already causing some turmoil in markets, worse. This could dampen economic growth momentum in a way which has not yet been factored in, especially if oil rises as far as US$140 a barrel, as some predict. According to Capital Economics, this could add up to 2% to inflation in advanced economies. Indeed, the Federal Reserve has already indirectly acknowledged this through its careful citing of risks, turmoil and tensions in its most recent meeting.
Can we learn anything from previous conflicts?
The most useful information I have seen to date is a list of geopolitical events between 1939 and 2017, mostly focused on military action, provided by one of our research partners, which details the financial market falls linked to the event, as well as providing specifics of how long it took for markets to recover to pre-crisis levels.
The oldest event on the list is 15 March 1939, which was when Germany annexed Czechoslovakia, although the market sell-off actually started five days prior due to many investors’ expectations of the events that were about to unfold. It took 22 trading days for the markets to reach their lowest point (for that period at least) and then 108 trading days to spring back.
Given this was at the start of World War II, however, it unsurprisingly isn’t the only ‘event’ linked to that conflict. When Germany started to roll troops through the Low Countries and into France – completely bypassing the Maginot Line – on 9 May 1940, the markets again sold down for 22 trading days, but this time took 745 to recover. Then when Pearl Habor was bombed on 7 December 1941, the market dropped again – this time for 17 days – and took 201 days to recover.
The last event on the list was an airstrike on 7 April 2017 on a Syrian airbase – the last event mentioned in the research to have a significant enough impact – where a sell-off lasted 32 days, but only 16 trading days to return to pre-event form. But while the list is useful even the below summary doesn’t really provide us with a ‘what next’.
Subsequent political events – albeit usually less global in nature – also saw a sell-off. For instance, it took stock markets around two weeks to overcome its shock due to the 2016 Brexit vote.
What is reassuring is that only two events on the list needed more than a year to recover – the invasion of France as above, and the 1973 Israel-Arab war and the subsequent oil embargo, which left markets in negative territory for 1,475 trading days.
What should I do as a result?
Many financial organisations say: do nothing, remain invested and everything will be okay in the end.
To my mind, this is an overly simplistic, predictable answer which I find irritating, even if it is usually right. Take the COVID-19 pandemic as the most recent example of a market shock. Although financial experts said that the fall was an opportunity to buy the dip (which it was), the correction was very sharp, but it was also very dark. It was not a very friendly place to be with only the words “remain invested” for comfort. It felt as though the world was about to cave in.
At Nedbank Private Wealth, we consider the worst case scenario, not just to markets. but for you. What impact would a correction the size of COVID-19, or the 2008 Financial Crisis, have on you and to your wealth goals? We plan for the worst for two reasons:
- First, to ensure we are not exposing you to undue levels of risk, which would have a material impact on your ability to achieve those goals.
- Second, when market shock occurs (as it inevitably will even if not due to Ukraine) you do not find yourself in that dark place with only the words “remain invested” for comfort.
Instead, our clients can be taken through a simulated crash, modelling a sharp correction, and then know that the potential impact has been factored into our recommendations and ongoing reviews, and that your plans or goals are not compromised as a result.
You will know that the key considerations we have factored into our plan for you are: What is your capacity for loss? What rate of return do you need or aspire to? What is your attitude for risk? Practicing these scenarios, even if they remain in theory, means you are less likely in practice to sell your investments at precisely the wrong time.
So we suggest you get in touch. Allow us to review your current situation and, if we have not already done so, work with us to practically demonstrate the effect that a conflict in the Ukraine, or any black swan event in the future, could have on your dreams and aspirations, and so that you can rest easy that you are at the heart of our plan.
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Sources: Bloomberg; Deutsche Bank; FT; and Nedbank Private Wealth.
Investments can go down, as well as up, to the extent that you might get back less than the total you originally invested. Exchange rates also impact the value of your investments. Past performance is no guide to future returns. Any individual investment or security mentioned here may not be suitable, and is included for information only and is not a recommendation. You should always seek professional advice before making any investment decisions.