Global perspectives: Investment implications of Putin’s invasion
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A spirited and valiant defence spanning the military, political and media spheres has so far both held up the advance of Putin’s forces in Ukraine and created a strong international response deploring the invasion. As a result, the Russian ruble has fallen by 25% and international investors have had to quickly distance themselves from Russian investments; notably, BP has stated that it will divest its 19% stake in Russia’s Rosneft. The situation on the ground in Ukraine will depend on Putin’s military choices, but from an international perspective the world has changed. We believe investors should assume the severe sanctions regime currently in place is likely to persist for an extended period. Direct investments in Russian equities will be off-limits for many investors as even if not specifically prohibited, the potential risk of sanction for any Russian investment will be high.
Putin’s miscalculation on the strength of Ukrainian opposition to his invading forces has eliminated any chance of what we believe was his original goal of a quick strike for regime change in Kyiv, presenting a tempting ‘fait accompli’ to Western nations with little appetite to engage with Russia in Eastern Europe. This would have allowed him to maintain the status quo with a co-dependent Europe reliant on Russian energy supplies, while enabling further advances in political objectives over time.
As a result of the determined Ukrainian resistance, European nations, which had previously been quite obstructive in dealing firmly with Russia’s breaking of 21st century taboos of political influence campaigns in Western states and the annexation of Crimea, have now turned 180 degrees in terms of policy towards Russia, finally acknowledging the threat Russian expansionism represents.
European nations have now backed firm action in response to the invasion of Ukraine. Importantly, this includes Germany, which has finally backed SWIFT (the international banking messaging system) based sanctions, will be sending military equipment to Ukraine and has increased its spending on defence to more than 2% of GDP. Separately, and for the first time in its history, the EU will also send weapons to a country at war.
While the absence of widespread political opposition to Russia’s invasion of Ukraine in 2014 might one day be regarded as the policy failure that led directly to outright war in Europe in 2022, the introduction of these sanctions is unlikely to be of concern to Putin – or change the course of the battle for Kyiv in the short term.
Despite the remarkably effective repulsion of Putin’s tanks by both Ukrainian forces and the civilian population, Russia will have prepared carefully for the scenario of an economic siege and has ample foreign exchange reserves, assuming it has access to them. Also, there will no doubt be efforts within Russia to focus the impact of sanctions on the Russian population onto the need for a strong leader rather than a new one.
We believe investors should continue to act for the long term and avoid attempting to run portfolios from twitter or other social media sources where the risk of misinformation is high. Western governments have already given a clear steer to investors that this invasion of Ukraine is not another Crimea and will not be tolerated. The divestment of BP’s stake in Rosneft and the placing of Chelsea FC under Trustee administration signal that those operating at the highest political levels believe the conflict has created a permanent change in relations between Russia and the rest of the world.
Economic sanctions are therefore likely to be in place for some time, in the absence of capitulation by Putin. Unfortunately for all sides a mere tactical retreat from Russia is at this point unlikely to change the direction of travel on sanction policies and in particular, energy supply diversification in central Europe. Furthermore, with the stakes so high for Putin personally, we view any capitulation in the short term as an unlikely scenario.
We believe investors should first focus on the energy sector where significant disruption is being priced into short-term oil and gas prices as the full implications of the new sanctions regime unfold. However, while helpful for short-term profitability, oil prices over US$100 per barrel are also unlikely to be sustainable for the medium term. History suggests significant demand destruction is likely to occur in oil consuming nations if these price levels are maintained for any length of time. We believe investors should also remain on watch for any supply issues for Russian gas in coming months given the potential impact on European industry. We note that spot prices have surged by over 25% in the past week.
Defence stocks may have surged higher in a knee-jerk reaction to the outbreak of hostilities but are likely to remain well-supported from an initially favourable valuation level as the focus of Western nations turns to resolving any weaknesses in military supply chains and increasing preparedness for hostilities as a demonstration of effective and credible deterrence.
We cannot be sure of Putin’s next step. There will be hopes that by holding back Russia’s heaviest artillery in the initial assault, this could suggest that a tactical retreat is a possibility having avoided catastrophic civilian casualties. In such a scenario the international community would no doubt be pragmatic in obtaining a peaceful outcome, which would save face for Putin. Nevertheless, the pariah status of Russia in terms of investment would be likely to persist in the medium term as international trust is likely to be difficult to rekindle, absent a new Russian administration that can develop Russia’s people, society and resources in harmony with the international community.
The use of weaponry on a neighbouring population, of such intensity that it effectively represents the use of weapons of mass destruction, is a Rubicon which even Putin may hesitate to cross. Putin may assess that while the international community is united now, only a few months may elapse before populations become weary of war. As a result, there will be increasing pressure on democratic leaders for a ceasefire on terms allowing Russia to consolidate its grip on Ukrainian territory and political influence, as early as April or May. Nevertheless, we believe this could be a miscalculation at this stage and means that hostilities could be prolonged as Putin’s hoped-for negotiating leverage may never arise. In any case, the international community is likely to continue to isolate Russia and diversify away from Russian energy in this scenario.
We believe a significant discount for Russian assets will persist even if hostilities cease. The invasion of Ukraine has finally shifted the international consensus on the dangers of Russia’s assertiveness, a trend that has been more than a decade in the making. Long term, there are likely to be opportunities in Europe’s new energy infrastructure and defence capability. Investors should also not allow the events in Ukraine to dominate their thinking as financial markets are still contending with an ongoing normalisation of monetary policy and valuations are still relatively high. Finally, even if central banks look through short-term surges in the price of energy, the scope for an oil shock to crimp economic activity cannot be excluded.