Gill Capital Partners Ukraine Update #2 – Buckle Up
To begin, we are deeply saddened by the unnecessary destruction, loss of life, and developing humanitarian crisis stemming from the Russian attacks on Ukraine. Given the exceptional circumstances, you may be hearing from us a bit more frequently in the coming days and weeks. In addition to more frequent market commentaries, we will be rolling out a special Speaker Series beginning next week. Our goal is to bring globally recognized economists and market thought leaders to you weekly via Zoom. We are doing this with the goal of providing our clients with access to information and views from leaders in the industry during this uncertain time. An invitation will be forthcoming for our first in the series event on Tuesday March 4th with David Lebovitz, Global Market Strategist with JPMorgan.
It is shocking to see a raw, early 20th-century-style land battle play out before our eyes. While the Russian invasion may be reminiscent of a European land battle from decades ago, the battle being fought via financial and economic sanctions is unprecedented. We will get into all of that, along with the potential ramifications for the U.S. and global economies and what many view as the potential range of outcomes. We do not want to sound alarm bells, but we do want to prepare our clients for the possibility of continued volatility in capital markets. We have absolute confidence in our markets and strongly believe that, over time, assets will increase in value as they have always done. However, there are new variables at play that have the potential to rattle markets in the near-term as a result of this crisis.
Coordinated Global Sanctions & Their Impact
Governments and corporations around the world, including the U.S., U.K., Japan, Australia, EU nations, Taiwan, Switzerland (yes, even neutral Switzerland) and others have imposed an unprecedented array of economic and other sanctions on Russia’s government, leadership, corporations, and wealthiest individuals. This extraordinary, coordinated global response is raining down a devastating barrage of financial and economic consequences that is gutting the Russian economy before our eyes. Below is a summary of some of the key sanctions that have been put in place:
Russian Central Bank – The Russian central bank has been banned from effecting transactions with the U.S., EU, U.K., Canada, and many others, and state-owned enterprises may no longer be listed on EU or U.S. exchanges. The Russian state has, in effect, been banned from raising sovereign debt and deploying its estimated $650 billion of international reserves, effectively crippling the state’s ability to raise money and finance its government.
Russian Banks/SWIFT – The majority of Russian banks have been cut off from the SWIFT international payment system, essentially preventing them from operating worldwide and effectively blocking Russian exports and imports.
Individual Sanctions – The foreign assets of the Russian president and other Russian leaders have been frozen in the EU, U.S., U.K., Australia, Japan and New Zealand. Some countries have imposed similar sanctions on all members of the Russian parliament. Additionally, more than a dozen billionaire oligarchs with ties to Putin’s regime are on asset freeze and travel ban lists around the world.
Industry & Transport – Russian airlines and private jets have been banned from EU, U.K., and U.S. airspace. The U.S. and the EU have also introduced bans on exports of aircraft and high-tech goods including semiconductors, computers, telecom devices, etc. This effectively shuts off access to needed technology, which will lead to atrophy of Russia’s crucial infrastructure.
Non-Government Sanctions – Private businesses have also “taken up arms,” in a sense, imposing their own sanctions. Companies like Apple, Google, Fifa, and Formula One have shut off credit card and money exchange methods, cancelled key events, or banned Russian use of their services.
The sanctions being levied are complex and the summary above is by no means exhaustive. However, it paints a picture of the most severe and globally coordinated economic response that we have ever seen. The impact on Russia’s economy has been swift and will continue to bring lasting consequences. Quite immediately, we have seen devastating impacts on Russia’s economy, which include:
Currency – The Russian Ruble has depreciated by nearly 35% in just a matter of days (which is a huge move in the currency world), leading to the type of hyper-inflationary situation we have historically seen in other parts of the world under collapsing economic regimes.
Bank Runs – The fear of banking restrictions and currency depreciation has led to massive bank runs, forcing the outright collapse of Russia’s largest bank Sberbank in just a matter of days. Sberbank stock lost 95% of its value nearly overnight.
Russian Stock Market – The Russian stock market has now been closed for the fifth straight day in an attempt by the Russian Government to stem the waves of selling. Trading of some of these companies listed in the U.K. or other European exchanges have seen billions of dollars of value destroyed nearly overnight as these once significant companies now trade like penny stocks.
While the U.S. and our global allies may not be fighting Russia directly in Ukraine, make no mistake about it, we are waging a devastating war on their economy that has led to immediate and severe economic realities. Unfortunately, these measures will impact innocent Russian citizens who just saw their savings destroyed, their currency devalued, and their once thriving economy shut down. The impacts will not only be felt in Russia, however, as dramatic disruptions within a major global economy and super-power are sure to have far reaching ramifications. Russia’s economy is the 11th largest in the world and Russia is one of the world’s leading exporters of energy, metals, and grains. We would expect higher energy and commodity prices, which we have already seen. Other ramifications may be less obvious from this vantage point, but will undoubtedly be potential sources of uncertainty and global market volatility going forward.
Summary of Potential Outcomes
Many leading strategists, historians, and political scientists have attempted to theorize what may happen next. There are three main scenarios that have been put forth:
The Dirty Compromise – This scenario may involve the Ukrainian military holding off the Russian onslaught long enough for sanctions to force Putin and Ukraine to accept a “dirty compromise.” In this scenario, we may see some of the Eastern parts of Ukraine formally become part of Russia. Ukraine would vow to never join NATO and global sanctions against Russia would be lifted. This scenario seems unlikely at the moment.
Russian Uprising – In an almost “Berlin Wall” fashion, we could see the Oligarchs and the Russian people overthrow the Putin government, leading to the formation of a new government. This is inarguably the best scenario but does not seem the most likely at the moment.
The worst-case scenario – Unless Putin has a sudden change of heart or can be deterred by sanctions, he may continue on the path he is on, looking to pummel Ukraine into submission and wipe out its leadership, irrespective of civilian collateral damage. If he is successful, he will install a puppet pro-Russia government in Ukraine that will likely be under constant attack from within, leading to an ongoing battle ground state. It is unclear whether the rest of the world would allow this to happen.
Unless things reverse course, many believe that we are traveling down the path of the worst-case scenario, as unbelievable as it might be. It makes little sense, as it appears to be a lose-lose situation, but it must be recognized how important it is to Putin to stop the spread of NATO into Eastern Europe. Under that lens, the third scenario becomes increasingly more likely. We hope that cooler heads and rational leadership prevail, but we cannot ignore the possibility that this does not end positively or quickly. It is with in mind that we predict continued, and at times, significant, volatility in capital markets. In the long-term, equity volatility will provide good buying opportunities for more aggressive investors.
Summary & Impacts on the U.S. Markets & The Federal Reserve
Although major global equity markets are down in 2022, they have held in far better than one might expect, given the backdrop. Fixed income has also generated losses, as interest rates have moved higher since the end of the year (remember, interest rates up, bond prices down). Generally, stocks and bonds move inversely from one another as investors rush into safe fixed income investments during times of distress. However, the anticipation that the Federal Reserve will begin raising rates to combat inflation has led to falling bond prices.
Jerome Powell, speaking in front of Congress this week, communicated to markets that the Fed anticipates increasing interest rates by ¼ point at their meeting later this month. He also said they are keenly aware of developments in Ukraine and will continue to assess the situation. This statement assuaged fears that the Federal Reserve will continue to take an aggressive stance irrespective of developments out of Ukraine. We believe that the Federal Reserve will continue to take a softer tone as the Ukraine crisis unfolds, as they have no desire to further aggravate an already unsettled global situation. This softer tone will be supportive for U.S. equities.
On a more positive note, equity valuations have come down dramatically and are now nowhere near the lofty levels that we saw at the end of last year. Corporate earnings have continued to deliver positive results and consumer balance sheets are very strong, which continues to drive spending despite higher prices. And, just this morning, we received a better-than-expected monthly jobs report showing increased hiring. If we are fortunate to see a quick resolution to the Ukraine conflict, we could see a rapid increase in stock prices, likely back to recent highs.
Over the last several days, we have reached out to our investment managers to assess any potential impact on our clients’ portfolios as a result of the crisis in Ukraine. Our client portfolios contain virtually no direct Russian exposure, and we do not expect any direct impact on portfolios. We will continue to watch developments as they unfold. We are not trying to unsettle nerves, but rather provide real information and identify risks as we see them. We are always here to discuss your investments, our views of the global developments, or your favorite T.V. shows.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.