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Early Thoughts on Russia-Ukraine Conflict

With Russia’s invasion of Ukraine yesterday (24 February 2022), investors are understandably feeling uneasy. Not surprisingly, the Ukraine invasion roiled Asian and European markets yesterday, layering additional losses on top of a tough start to 2022. Numerous equity market indices are now in correction territory—meaning a drop of 10% since highs reached in late 2021.

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What’s happened?

In recent weeks, the potential threat of Russia invading Ukraine has been widely documented in the media. Reports of an increasing number of troops amassing on the Ukrainian border made headlines, with U.S. President Biden stating that he believes, after receiving information from U.S. intelligence, that Vladimir Putin was planning an attack on Ukraine. Despite this, President Putin’s intentions remained unclear, with “mixed signals” from the Kremlin.

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The Turning Point

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On Tuesday, Russian President Putin surprised the world, by making an about turn on diplomatic negotiations and signed a Russian presidential decree, recognising the independence of two separatist regions in eastern Ukraine –severely ratcheting up tensions with the West amid fears of a Russian invasion. At the time, he denied any planned attack on its neighbour, but threatened unspecified “military-technical” action unless it receives sweeping security guarantees, including a promise that Ukraine will never join NATO.

Over the past 24 hours, things have escalated significantly, with reports of Russian troops conducting “military drills” in Ukraine and reports of bombings in Ukraine. Moscow has confirmed that it is targeting military facilities in the Ukraine.

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What is the conflict about?

President Putin has frequently accused Ukraine of being taken over by extremists, ever since its pro-Russian president, Viktor Yanukovych, was ousted in 2014 after months of protests against his rule. Russia then retaliated by seizing the southern region of Crimea and triggering a rebellion in the east, backing separatists.

Russia has long resisted Ukraine’s move towards the European Union and the West’s defensive military alliance NATO. President Putin is unhappy about North Atlantic Treaty Organisation (NATO) forces encroaching on Russia’s western border, with Ukraine applying to become a NATO member and Ukraine representing the last major buffer between NATO members and Russia.

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What comes next

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Information remains fluid with volatility likely to persist in the coming days. The G7 and European leaders met on Thursday morning, mapping out more severe measures against Russia including punitive sanctions against Russia as a first move.

Germany has also placed a freeze on issuing the Nord Stream 2 pipeline with an operating licence. The Nord Stream 2 is a 1,200km pipeline under the Baltic Sea, which will deliver gas from Russia to Germany. Understandably, oil surged above $105 a barrel for the first time since 2014 and natural gas prices in Europe jumped as much as 41%.

In the context of investor portfolios, these decisions will need to be assessed against economic growth forecasts, global inflation, and central bank interest rate expectations. Supply-demand dynamics in commodity markets is also of equal importance.

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Should investors panic

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The market volatility that we are experiencing is never comfortable, we however strongly encourage our clients to remain calm and focused on their long-term investment goals. 2022 has got off to a tough start for most investors, with higher inflation expectations (higher interest rate hikes) and now amplified by Russian-Ukrainian geopolitical tensions.

Whilst the actions of Russia are significant, and an exact parallel cannot be drawn with prior geopolitical events, history does give us some comfort that equity markets tend to favour a positive outcome (75% of events result in a positive return for the S&P 500 12 months later).

Similarly, whilst many equity markets are flirting with correction territory, this is not unfamiliar to markets with the S&P 500 experiencing a drawdown of 5-10% on average every 10 months. If there’s anything reassuring to consider, it’s that stocks still had double-digit gains over the subsequent years. Moreover, these kind of market declines are more commonplace than expected. The table below highlights calendar returns for the S&P 500 over the past 40 years including each year’s lowest intra-year loss.

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Drawdowns are common, even in a bull market…

The below chart illustrates maximum intra-year drawdowns and actual calendar year returns (S&P 500)

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What we are thinking

We take the responsibility of managing our client’s wealth very seriously. Whilst we always strive to achieve the best returns for our clients, we are ultimately managers of risk and take tremendous care in this aspect of our investment process.

We anticipate that 2022 will continue to remain volatile, however we remain focused on investing in high quality investment managers, with proven long-term track records headed by experienced investment teams who have managed assets through various market events. In the short-term this may mean some increased volatility, however long-term, this has always proved to be a sensible investment approach. Equally trying to “time the market” as when to go out and back into investments has proved to be a statistically poor investment strategy.

We are not rushed to make portfolio adjustments at this stage as we anticipate ongoing bouts of market swings and will look to make necessary strategic calls at opportune times. We are monitoring our exposure to asset classes, regions, sectors and styles and portfolio adjustments will be driven by these considerations. Rest assured that we are closely monitoring the fluid situation in Ukraine.

Our thoughts and prayers are with the victims of this aggression. As always, we appreciate your support and value your trust in LNKD Investment Managers.

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