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Uncertainty builds for investors after Russia invades: Editor’s Note

Emma Rapaport  |  26 Feb 2022Text size  Decrease  Increase  |  
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With reporting from Dow Jones.

The unthinkable happened. After a months-long impasse, we watched in horror this week as Russian missiles and airstrikes hit the Ukrainian capital, Kyiv, and more than a dozen other cities across the country. Hundreds of thousands of civilians fled the war zone, clogging roads leading west. Others sought refuge in bomb shelters and subway stations as sirens rang out across the city. At the time of writing, Russian forces were closing in on the capital as defenders geared up for urban combat.

It’s uncomfortable to think about money as a humanitarian crisis unfolds, but the biggest land war in Europe since World War II is expected to reverberate across economies and financial markets. It adds to the list of uncertainties facing investors – inflation, interest rates and economic slowdown, to name a few. At Morningstar, we were hoping to close out the month talking about the wide implications of the MCB-AGL takeover bid and continuing our coverage of reporting season. But our attention quickly turned to important questions investors are asking: What’s going to happen to my portfolio? How can I protect my assets? What’s the best way to navigate the markets? And truthfully, where are the opportunities?

Let’s start with what we know. Things are moving quickly but on Thursday European time, the shockwave triggered by Russia’s invasion of Ukraine spread across global financial markets, inflicting heavy losses on European stocks and dramatically shifting investor sentiment. The pan-European Stoxx 600 fell 3.3% while in London, the FTSE 100 dropped 3.8%. Russian miners Polymetal International PLC and Evraz PLC were the index's biggest fallers, both plunging more than 30%.

The impact on the ASX and US markets was more mixed. The ASX fell 3% following the news of invasion but spent most of Friday in the green, led by a rebound in technology stocks. After suffering early losses, US markets whipsawed in response to President Biden’s announcement of new sanctions targeting Russian oligarchs, lawmakers and financial institutions. Financials and consumer-defensive stocks maintained losses, while cybersecurity stocks like Palto Alto, Crowdstock and Okta rallied on fears of Russian attacks on security systems. As oil prices briefly topped $100, shares of renewable energy companies also jumped, with the invasion strengthening the argument to build renewable energy capacity. Gold prices rose, as did oil and agricultural prices.

What comes next?

As investors, this adds to the considerable uncertainty we are already facing in 2022. For the last few months, whether you’ve wanted to read about it or not we’ve been banging on about a new phase in financial markets as investors confront record-high inflation, the very real prospects of rising interest rates and the end to easy money. Despite being on the other side of the world, the economic consequences could send shockwaves through global markets, ramping up uncertainty yes but also adding to inflationary pressures led by higher food and gas prices.

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Short-term, David Sekera, Morningstar’s chief US market strategist says the volatility is unlikely to let up. “The next step for the markets will be to evaluate the potential impact of the sanctions that the US and its allies will impose against Russia and gauge for any signs of further escalation or de-escalation,” he told my colleagues Tom Lauricella and Sandy Ward. He does say however that US stocks are relatively insulated as large businesses don’t have significant exposure to either Ukraine or Russia. The same could be said of Australia as a small trading partner with the region. In emerging market indexes, Russian stocks account for just 3% of the basket.

Ukrainian flag

A prolonged conflict could also have broad-reaching macroeconomic effects. Morningstar senior equity analyst Michael Field says three key issues are rising to the top: food, oil and gas and supply chains, which could drive up prices at a time when much of the world is experiencing rapid inflation and anticipating interest rate hikes.

“In terms of food costs, Russia and Ukraine combined export one-quarter of the global wheat supply, so any disruption here could prove material, with large supermarkets and retailers’ business models not set up to pass through rapid and large price increases,” he says.

“On the energy front, Russia exports more than 180 billion cubic meters of gas annually to Europe, more than 40% of the EU’s external supply. While this is a concern, we view the likelihood of material gas delivery disruptions to be low given the importance of energy revenue to the Russian government (oil revenue about one-third of total revenue).

“From a supply chain perspective, Russia and Ukraine are not key cogs in the global system. But at the same time, with global supply chains already heavily stretched, the introduction of measures such as no-fly zones through the region will certainly not help the situation.”

Additionally, Russia is the largest producer of ammonium nitrate and is a large exporter of palladium, platinum, and aluminium. Palladium is needed for catalytic converters in automobiles.

With the US Federal Reserve poised to raise rates in March, the invasion certainly complicates the outlook for investors. On the one hand, in an environment of rising global inflation, this increases the pressure on central banks globally to tighten monetary policy. However, on the other, the situation could weigh on economic growth if nervous consumers tighten their purse strings. Additionally, the initial wave of Western sanctions has exempted Russian energy and agriculture exports. Overnight, the events in Ukraine have for now cooled expectations for an aggressive interest rate increase by the Federal Reserve in March.

Acting in troubled times

So, what can investors do? At times like these, you won’t be surprised to hear Morningstar say this isn’t a time to upend well-laid plans. Analysts believe it is important in situations such as this to keep one’s bearings and not lose a long-term perspective. “Unsettling headlines can lead to fear, which in turn can lead to sub-optimal decisions, which in turn can undermine long-term return objectives,” says Morningstar Investment Management’s head of research, Americas Tyler Dann.

This is not to say to ignore the risks or switch off completely. Dann says it’s important to be "alert and prepared during periods of uncertainty, acknowledging that short-term fluctuations are likely and can be times of significant investment opportunity". Upcoming events for your calendar include the RBA’s meeting on Tuesday and fresh US inflation figures (announced overnight). Also watch for announcements affecting commodity prices including the possible coordinated release of additional oil from strategic reserves in the US and Europe.

While every time is different, Dann notes the historical track record of the equity market during wars and conflicts is mixed, with some conflicts such as the Crimea invasion in 2014 leaving equity markets barely changed. As difficult as it can be to navigate the usual economic forces that buffet markets, geopolitical risks are even more opaque. While I know you’ve heard this before, and will hear it again and again, those with a long-time horizon will likely be well placed staying invested, historically speaking. I’ll leave the final word to Morningstar’s Christine Benz:

“No investment is risk-free, and that includes cash, especially in an era of rising inflation. If you don’t take risks in your portfolio, you’ll face the biggest of all risks, falling short. The best you can do is to understand the risks of each asset type and then create a portfolio of investments that aren’t all risky in the same way. And once you’ve done that, the only course is to press on regardless.”

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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