Just as the market started to recover from the fears of an inflation drive interest rates spike, the world lapse into a crisis again. This time round, it is a geo-political risk of a potential invasion of Ukraine by Russia.
For those who are unaware of the background of why Russia wanted to invade Ukraine, here is a quick summary: Ever since the annexation of Crimea by Russia, the relationship between Russia and Ukraine took a downturn. The incident galvanized the Ukrainian government to seek a NATO membership in order to deter Russia from encroaching onto their territory as an attack on a NATO member means declaring war on the world's most powerful military states. The Russian see that as a threat to their influence on Ukraine and amass 100k of troops all around Ukraine under the guise of military exercise, trying to use that as a leverage to force NATO into a promise never to admit Ukraine as a member state. That failed and with all sides taking a hard stance on their diplomatic possible, a conflict looms.
Unlike the previous confrontation between Ukraine and Russia, the world is now a much more different place. Due to supply chain disruption, commodity prices have risen to a high. Russia has enormous natural reserves of crude oil and the threat of disruption to the global supply has seen oil prices soar in recent days. Current prices for crude are approaching $100 per barrel, their highest in seven years, and could potentially go higher. The price of Russian oil has major repercussions for energy prices in the West and there is concern that a prolonged stand-off could exacerbate the price increases that have already hit consumers.
With the financial markets already jittery on an already high inflation rate, a sharp rise in energy prices will add to the inflationary pressure and possible faster interest rate increase, and financial markets do not like another abrupt tightening of monetary policy.
On the other hand, if Russia choose to de-escalate the confrontation, the market will probably have a sharp relief rally.
Will Russia Invade?
Predicting which direction a geo-political crisis will go is almost impossible. we can only make an educated guess which way will this turn out. In my opinion, Russia has a lot more to lose if they choose to invade Ukraine. Even though Ukraine's military might is not as strong as Russia, they still have one of the largest standing army in Europe, abide with aging machines and corruption in the military ranks. Other than a sizeable army, they have a large land mass which allows the Ukrainian army to give up some land in exchange for time, to engage in a long draining war with Russia, while supported by the economic resource of the NATO alliance while Russia is being squeezed by harsh sanction. The Russia economy will severely drained by both a prolonged war and economic sanctions if they choose to invade.
On the other hand, if they choose to de-escalate, it will be a loss of face and political prestige for President Putin, and risking a NATO backed nation at their door step, which will dent Putin's ambition to incorporate Ukraine back as part of the old Soviet bloc.
Logically, there is too much to lose for Russia if they choose to invade, but things become unpredictable when dealing with a nation whose entire military might rest on the actions of a elite few.
Portfolio Strategy
As much as I am optimistic that the conflict can be resolved diplomatically, I have no illusion that a conflict may still happen. Should we pull out to cash now, we will definitely lose out on any relief rally in the case the conflict do de-escalate as seen in a sharp rally in the financial markets base on news that Russia has withdrawn some troops, which later turn out to be a feint from the Russian side. Moving our cash and bond into equities to take advantage of the current weak market also doesn't make sense as there may be another 10-20% downside should a real invasion materialize and I prefer to keep some powder for such an incident. The best strategy for now, is to stay put, and perhaps to move away from European and Emerging Market equities to US equities, where it will probably be more resilient to the market shock base on the chart below where US equities fell the least when the incident started a few weeks back. The US will probably also be the first to recover once the war falls into a prolonged stalemate as they are the major economic power least affected by a European Crisis.
An actual Russian invasion will definitely send the market tumbling, and that may be a great opportunity to invest, as that will bring the market valuation to an extremely attractive level and the market will recover, once the disruption from the war is priced into the market.
So, let's hope for the best that the conflict will de-escalate as a war will be a lose-lose situation to all the parties involved along with a tragic loss of lives due to death, and the world can move on to continue their battle against COVID and recover from the loss of life from an already dreadful pandemic.
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