• The Russian intent with respect to Ukraine now appears reasonably clear: to bring the whole country back within the Russian sphere of influence as a satellite state and to replace the current regime with one sympathetic to Russia, in other words a puppet state.

  • The West has been clear throughout the crisis that NATO troops will not defend Ukraine on Ukraine soil, and it is equally clear that the sophisticated arms sent to Ukraine by the US and UK will do little to prevent the might of the Russian armed forces taking control of Ukraine, potentially with a bloody clash but with the ultimate result beyond doubt.

  • This rapid and alarming turn of events has shaken markets, mostly in a predictable pattern. Oil and gas prices have surged, safe haven assets including the US dollar, government bonds and gold have risen, and equity markets have fallen – but perhaps not initially as heavily as some investors might have expected. The steepest falls have been in Russia, where the stock market fell a third yesterday, whereas in developed markets the falls have been relatively modest, with the US holding up better than most and Europe faring worst, understandably given the dependence of the EU on Russian gas, which accounts for around 40% of EU supply.

  • The sharp jolt to markets delivered by the invasion compounds an already uncertain environment due to high inflation and central bank monetary tightening. The duration of the conflict is impossible to predict but critically we believe it will not stray beyond the borders of Ukraine. Should it do so and enter NATO territory the consequences become potentially very much more serious, and the West will be bound to go much further than the sanctions currently being imposed on Russia.

  • On this key assumption, the direct economic impact globally should be limited as Ukraine is a very small economy and while Russia is much larger, it is smaller than, for example, the UK economy, so the aggregate impact of the direct economic hit is likely to be small. Russia has overnight become a pariah state and while the full sanctions imposed by the West have not yet been declared there can be no doubt that they will be far-reaching and long-lasting, and likely to be very damaging to Russia’s economy. For the time being, and maybe much longer, Russia has made itself largely uninvestable for Western investors.

  • As far as stock markets are concerned, Ukraine is immaterial while Russia accounts for approximately 0.3% of the capitalization of the MSCI AC World index, so insignificant. It would therefore be the knock-on impact which will damage markets.

  • That knock-on impact will emanate largely from energy prices and the extraordinary dependence of the EU on Russian gas and oil, with some 40% of EU gas supplies sourced from Russia and 27% of its crude oil imports. (SOURCE Eurostat). The worst-case outcome in this respect would be for these supplies to be suspended, unlikely but by no means impossible, with grave short term consequences for energy prices and likely to knock economic growth in Europe meaningfully. The US is largely but not completely insulated from this risk as it is self-sufficient in energy, although will feel the impact of higher global energy prices.

  • We recognise these risks and believe it is vital to retain a blend of assets in our portfolios, including true safe-haven assets like gold and government bonds. But we do not see this unwelcome turn of events in Eastern Europe as causing a major bear market, but rather a short term shock. Yesterday’s volatility and sharp falls are unlikely to be the end of this crisis, but markets had already discounted some of the fears, and had been falling for several weeks as the US Federal Reserve shifted its policy stance to a much more hawkish approach.

  • The immediate impact of the war would seem to be inflationary, the further rise in energy prices compounding the inflationary impact of strong demand and disrupted supply chains post Covid. However, the greatest period of uncertainty as a result of the invasion of Ukraine is upon us and is unlikely to last long. We will soon know the outcome and the extent of the reaction of the West. Volatility in markets should then subside and as we move into the second half of the year global growth is likely to be slowing significantly, and the impact of materially higher energy prices acting as a brake on spending, in effect a tax on businesses and consumers. Ultimately, this might well prove to be deflationary and contribute to bringing the current imbalance of demand and supply back into balance. Movements so far in bond yields, which have fallen, and longer term inflation expectations, which have risen but not materially, would appear to support this thesis. The more extreme market expectations for Fed tightening this year have been reined in, and the Fed may well have to do no more than it signaled in January, which would take Fed Funds to around 1% by the end of 2022 and 1.75% by the end of 2023.

  • Shocks such as these are deeply worrying for investors, but perspective is required. We do not underestimate the disaster that this brings, but wars always end and this one is likely to be of limited duration and spread. It comes at a time when the global economy and corporate sector are recovering robustly from the pandemic and while there is likely to be some knock to confidence and from higher energy prices, the broader impact is limited. The sharp falls we are seeing in equity markets present opportunities. Rothchild’s famous advice many years ago to ‘buy on the sound of the cannons, sell on the trumpets’ probably remains as true today as it was then. Chasing share prices down in a panic environment is always a bad strategy, much better to ride out the storm and buy into weakness to take advantage of the much better value across markets.

  • Our portfolios are well diversified across asset classes, countries, sectors and styles, and we are currently more defensively positioned than for some time as we have been adding to more defensive assets over the past several months. It is very unlikely therefore that we will make major adjustments to our positioning as a result of the onset of war. It is rarely wise to adjust positions in such an uncertain and fast moving, volatile situation, and much of the damage to share prices is likely to happen very quickly, as we are witnessing. We see this as creating some long term buying opportunities to add to good companies at a time of a shock likely to be relatively short term in nature and with limited long term economic damage.

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