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Ukraine Update

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Updated March 16, 2022

Yan Arsenault CFA®, CAIA, Chief Investment Officer

On February 24th, the day Russia invaded Ukraine, we published an article which concluded with: “While a material headline event today, we believe the Russia/Ukraine crisis will have limited impact over the long-term. We encourage clients to stay focused on the long-term and stay invested”.

Almost four weeks into the crisis, we stand by that statement.

The war in Ukraine is obviously a humanitarian tragedy. However, we don’t expect it to be an economic tragedy.

Here’s Why

In isolation, Russia and Ukraine represent less than 2% of global GDP in dollar terms, so the direct economic effects of the war on global growth should be very modest, even if Russia and Ukraine suffer a deep recession in 2022. Our thesis has been that as long as the crisis stays within these two countries, the collateral damage should be limited.

We recognize that the global world order has been disrupted, which can also lead to potential indirect effects. In particular, we are closely monitoring the impact on commodity markets (especially oil/natural gas) and the potential involvement of NATO in the conflict (very unlikely in our opinion).

Commodities

Russia is the world’s top exporter of natural gas, the world’s second largest oil producer and an important player in key metals markets, like nickel and palladium. As a result of supply-chain fears and panic buying, prices of these commodities have gone up and are now expensive relative to underlying economic conditions.

Ukraine is a major corn and wheat exporter, and Ukraine, Russia and Belarus combined are major exporters of fertilizers. As countries are putting export controls in place to ensure their own citizens have adequate food supplies, food prices have also gone up.

It is true that rising commodity prices have historically (at times, but not always) preceded recessions, however, in themselves, they do not herald a looming recession. To start with, in the U.S, food and energy spending is about half of what it was in 1980. Secondly, the job market remains too strong to even flash recessionary warning signals.

Having said that, time is of the essence here. The longer the war drags on, the greater the risk to the economy.

What is the Endgame for Putin?

Given the strong resistance of Ukrainians against the invasion and the unity of NATO nations to come together quickly with severe sanctions against Russia, it would appear that Putin should be looking for a compromise sooner rather than later.

If that is the case, for Ukraine, “building your opponent a golden bridge to retreat across,” as described by Sun Tzu in his book The Art of War, may be the solution here as Putin may not be willing to back down unless he can save face at the same time. Under this scenario, a negotiated settlement between Ukraine and Russia could be crafted. Although unlikely to lead to a full removal of sanctions against Russia, the resulting de-escalation of tension would go a long way in calming commodity markets and reducing the possibility of a global escalation involving NATO.   

It is worth pointing out that, almost four weeks into this crisis,  equity markets are essentially back to where they were the day prior to the invasion. In fact, at its worst point after the invasion, the S&P 500 was down only 2.7% (peak to trough) which is more or less in line with how markets have historically performed around geopolitical events.

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Because the US and global economies had positive momentum leading up to the invasion, global earnings estimates have remained resilient in most economies at this point. Because of that, as corporate earnings are the central driver of stock prices over the long-term, markets have been better able to handle the emotionally charged news headlines related to the conflict.

We remain hopeful for a peaceful and swift resolution, but are also prepared for the unexpected. We remain confident that our portfolios are well-positioned to take advantage of broader themes that are built into our portfolios, which should carry us past this conflict.

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Yan Arsenault CFA®, CAIA, Chief Investment Officer