Over the weekend escalating conflict between Russia and Ukraine led to some unprecedented economic sanctions taken by Western countries in retaliation to Russia’s invasion of the Ukraine.
What I am paying attention to and closely tracking are two measures in particular. The first one is the banning of Russia from SWIFT, which is a transnational system used to facilitate payments in global commerce. The second, and in my opinion this is the most shocking measure—Western nations have frozen the currency reserves of the Russian Central Bank.
Ostensibly, booting Russia out of SWIFT has the impact of being very disruptive to global trade, which has seen supply chains in many industries yet to recover from the pandemic halt. Notably, with Russia being a huge exporter of energy, particularly natural gas into Europe, the potential for knock-on effects that will cause market dislocations in numerous industries is significant. For example, we should recall that oil is denominated in USD, what will be the impact on oil supplies of Russia is shut out of SWIFT?? We have already a little bit of visibility into this answer…while the headlines show that Russia was kicked out of SWIFT, in reality the implementation of the sanctions show that only certain banks have been excluded while other Russian banks are still being allowed to transact. If the conflict continues to escalate and/or if it is prolonged; will the SWIFT sanctions also be escalated and how damaging Will it be to commodity prices and very fragile global supply chains? As an investor, large companies in particular like Apple (given the amount of international revenue as well as manufacturing that is done offshore) seem to be vulnerable given current valuations. I also think about commodity prices and the impact that will have on capital investment, commercial and residential construction which, both in the US and globally, moves a lot of economies, may be significantly impacted.
In general one of the big risks with elevated asset prices across the board is that the future is priced-to-perfection and, rather, not taking into account a prolonged, sustained conflict in the developing world. Whether someone is an investor in stocks, bonds, or real estate you will discover that once the future seems highly uncertain, or drastically revised, asset prices often quickly attempt to price it in. In an elevated market that means asset prices will fall. The problem we currently have is that most assets are priced to perfection.
At the same time…the volatility in asset prices will present significant dislocations which can present, sometimes, opportunities to achieve outsized returns (more on that below). Or if you are a company with a strong balance sheet, opportunities to gain market share, engage in strategic M&A, and/or undertake sudden business transformation may arise—the question of course is: is your board and management team agile enough to do so?
Not withstanding my thoughts on the above, The bigger event that transpired this past weekend in my opinion, and one that may have far-reaching unintended consequences is the freezing of the foreign currency reserves of the Russian Central Bank. Once again, ostensibly, this may seem like a necessary and critical move to cripple an adversary that may well escalate its current campaign. It also may also help achieve other objectives that are beyond the scope of what I understand as an investor/financier and/or manager. But what I do know is that there is a stable order to the global economic community that depends on bank solvency of which, a foundational component to is coordinated and cooperative central bank action. As stated in the Wall Street Journal over the weekend, “there is a tradition of respecting the sovereign immunity of central banks.” Even if, politically, countries may not be in agreement, over the last 50 years global trade has skyrocketed, therefore the functioning of the global economy—ranging from properly working supply chains to smoothly functioning capital markets—is necessary to ensure regular commerce in ALL industries which in turn optimizes global security. However freezing the reserves of a central bank enters into unchartered territory for the global economy because of the implications that it has for the plumbing of global monetary systems worldwide. From my perspective, I struggle to define how wide range the possible outcomes that may stem from the unintended consequences of this action. There is potential to unwind a lot of the modern progress in human economic activity that has been achieved since Bretton Woods. Already, in the last few hours, the Russian bank immediately responded by increasing their interest rates to 20%. This kind of move, of course, creates the type of dislocations that will then lead to other moves in the capital markets.
In my view, the big risk right now, after a wild, unprecedented weekend of geopolitical and economic blow-by-blow actions, is the increasing risk of global economic contagion. Things are developing very quickly and for both companies and investors. For example, as a result of the turmoil over the weekend the capital flows into safe haven assets, namely the USD (although the price of gold is also rising). In general, my view is that it is a good time to have strong balance sheets as the weeks ahead and start preparing from what may be a vastly different economic environment in the coming quarters.