Rouble to Rubble

  • Western powers are responding to Russia’s increasingly brutal invasion of Ukraine with increasingly punitive sanctions.
  • In the short term at least, the conflict worsens the outlooks for both global inflation and global growth.
  • Western central banks may now be less aggressive in raising interest rates.
  • Financial markets could remain very volatile but prices of commodities have soared.
  • Making major changes to portfolios based on possible outcomes is very risky.
  • Past precedents suggest the best investment strategy is to remain invested.
  • We have negligible exposure to Russia in portfolios.

With Ukraine not being a member of NATO, Western powers have no obligation or appetite to intervene militarily. Instead, financial and economic sanctions are the preferred weapon of response and the West has demonstrated remarkable speed and coordination in their imposition, even though some measures will inflict pain on their own economies.

Almost certainly the most damaging to Russia of the steps taken so far are the sanctioning of Russia’s central bank (“CBR”) and the exclusion of some of Russia’s largest commercial banks from the SWIFT international payments network. The sanctioning of the CBR effectively freezes a large proportion of Russia’s foreign exchange reserves and its ability, therefore, to defend the value of the Russian rouble. On Monday, the day after the CBR was sanctioned, the rouble slumped by more than 20% even though Russian interest rates were more than doubled from 9.5% to 20%. Soaring inflation, caused by the freefall of the rouble, and the huge increase in the cost of borrowing will inflict immense economic hardship on ordinary Russian people and companies. At the same time, the banning of Russian banks from SWIFT makes it much more difficult for Russian companies to conduct international trade, including all-important exports of gas and oil.

Unsurprisingly, the prospect of supply being disrupted has caused commodity prices to spike. The price of natural gas has risen by more than 20% so far in 2022 and this follows a rise of more than 50% in 2021. The price of wheat, of which Russia is the world’s biggest exporter and Ukraine the fourth biggest, has risen by almost 30% and the price of oil is above US$100 per barrel for the first time since 2014. These increases will only exacerbate the cost-of-living squeeze in Western economies. They will also fuel inflation and dampen economic growth, although the latter may make central banks more cautious with regard to the pace of interest rate increases.

We expect global equity markets to remain volatile whilst the conflict rages. Despite the country’s size, both geographically and economically, Russia’s stock market is very small in global terms. More importantly, the exposure to companies listed in Russia or Russian companies listed on other stock markets in the portfolios we manage is negligible.
Making investment decisions and major changes to portfolios against such a volatile and uncertain backdrop is, of course, extremely difficult. As the table and graph below show, however, past precedents, suggest that the best investment strategy is to hold one’s nerve and remain invested, especially in the eye of the storm. We will continue to monitor the situation very closely.  As greater clarity begins to emerge about the medium-term impact on economic growth, inflation, interest rates and corporate profits we will not hesitate to make any appropriate changes to portfolios that we judge to be in the best interests of our clients.

table
Source: LPL Research. Past performance is not a guide to future returns.

Stock Market Reaction to Past Conflicts

Chart 2_1

Source: Bloomberg. Data as at  14th February 2022. Past performance is not a guide to future returns.

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