Ask Forstrong:
Putin’s War
The Week A Decade Happened
March 2022
What impact will the war have on Forstrong’s investment themes?
Key Takeaways:
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What happens in Russia, will not stay in Russia. Expect ongoing reverberations around the world, with mounting inflationary pressures.
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The Ukraine crisis has revealed the durability of new investment leadership. The less glamorous, out-of-favour international value stocks have trounced technology and growth stocks.
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Markets are now experiencing a panic moment similar to the onset of the pandemic. Indiscriminate selling has led to several opportunities.
While it may not be the right time to say it, Russian literature spoils the world with talent. The lively prose of Tolstoy, Chekov, and Dostoevsky is studded with crisp sentences and arresting metaphors. But it was Vladimir Lenin, the first and founding head of the Soviet Union, who delivered the most memorable and deadly one-liner: “There are decades when nothing happens and there are weeks when decades happen.”
Over the last few weeks, a decade has indeed happened. What has been simmering at the wilder edges of post-Soviet Russia is now at full boil, spilling over into all corners of the world. To be sure, Russian history is a whirlwind of war and tyranny. And the past is never far apart from the present. The country has a lengthy track record of failed wars. Regime changes always follow. The drawn-out war in Afghanistan contributed to the collapse of the Soviet Union in 1991. Defeat in WWI led to the Russian Revolution in 1917. The list swells as one looks back further in history.
Putin missed this in his calculus. And, while the sudden and brutal invasion shocked nearly everyone, the Western response has been equally astonishing. Sanctions have sunk Russia’s economy into an immediate depression. Hard-won freedoms and connections to the outside world have disappeared. International flights have been cancelled. A torrent of Western companies have cut off the Russian market. Even FIFA barred Russia’s national team from the World Cup.
All of this is tragic. Before February 24th, Russia’s urban middle class had become accustomed to a world complete with Starbucks, iPhones and holidays in Spain. That existence is now over. Putin has again successfully imprisoned Russian citizens behind an iron curtain, amounting to a financial, commercial, and cultural excision of the world’s 11th-largest nation.
Investing During Wartime
In the world of investing, the consequences are already breathtaking. The Russian ruble has collapsed, while the central bank has doubled its key interest rate to 20 percent. Sovereign default looks almost certain. Contracts and promises between nations, banks, companies, and individuals are now being torn apart.
But what happens in Russia will not stay in Russia. Before the invasion, the country was an integrated member of the global economy. Russia reliably supplied oil, gas and base metals to most of Europe and agricultural products to the Middle East and Africa. The country alone supplies 25% of the world’s copper production. Now, as the war constrains Ukraine and cripples Russia, effects are being felt across the world, including food shortages and skyrocketing commodity prices. In a dangerously globalized world, investors are witnessing a masterclass in economic interdependence.
This is just the beginning. Yes, a variety of scenarios could yet unfold: a diplomatic solution (with French President Emmanuel Macron as the Kremlin-whisperer or even Xi Jinping brokering a deal), a disastrous quagmire or, at worst, a chaotic spiral into World War III. No one knows. What’s more, the world’s unprecedented and collective boycott of Russia has many unknowns. Unintended consequences are the norm in these situations.
But the economic battle lines have already been drawn. Energy and food independence, enlarged military budgets and a quickening pace of decarbonization are now firmly entrenched as top global policies. In fact, the war extends and catalyzes several investment themes that had been building prior to the invasion.
Recent Forstrong publications have tracked this ongoing regime shift: away from the low inflation, slow growth malaise of the post-2008 period to a higher inflation, higher growth and, yes, higher volatility period. With changing macro conditions, investment leadership will also change. Consider that the 2010s had a very specific topology — a chronically strong dollar, rising bond prices and an outperforming America. This has been in reverse for some time, even before coming out of the lockdown coma. Increasingly, leadership can be found in the less glamorous, out-of-favour international value stocks, at the expense of growth and technology stocks.
The Ukraine crisis has revealed the durability of these new trends. Covid winners have turned to losers. The US dollar, typically a haven during crisis, has provided scant relief for portfolios. Western bonds have been horrible hedges, declining in tandem with stocks. Conversely, early winners in this war have been nations with a similar economic makeup as Russia. For example, Chile’s stock market, loaded with copper companies, is up 17% year-to-date in US dollar terms (a sharp contrast to the technology-heavy Nasdaq, which has fallen nearly 20%). We have been invested in these countries and view them as hedges against further Russian aggression.
A new Europe has also emerged from the tragedy of Ukraine. The significance of the sanctions campaign goes well beyond straight economics. Rather, the coordinated response points toward a move away from a meandering European Union toward a strongly unified one — a collective rally around a common set of ideals and principles.
The EU’s three-decade complacency is now over. France has a powerful ally in Germany. Together, they will no doubt seize the opportunity to push an agenda to build a new energy system which will be enormously capital intensive, even comparable to the post-war reconstruction boom, as infrastructure, transportation networks and technologies require vast amounts of fixed investment. In fact, geopolitical rivalries always act as spurs for massive investment in infrastructure, technology and other innovations. Growth will surprise on the upside, providing several areas of investment opportunity.
Investment Implications
Markets are now experiencing a panic moment similar to the onset of the pandemic. Public sentiment is at a negative extreme. Even Wall Street’s mood has turned apocalyptic. Bank of America’s widely followed fund manager survey shows global growth optimism crashing to lowest since July 2008 (two months before Lehman collapsed).
As the sense of Orwellian gloom descends on the world and the public’s collective doom-scrolling continues, some perspective is in order: risks are now far lower than prior to the Russian invasion. Severe markets declines and indiscriminate panic selling have already happened. Risks associated with the war are now known risks and volatility is moderating.
But a key blind spot for many investors is that major bear markets almost always unfold alongside a global recession. That probability is low right now. In America, the labour market is booming and household net worth has soared. With a real Fed funds rate of negative 7%, the central bank is nowhere close to short-circuiting the recovery. Also, quietly, China’s fiscal and monetary policymakers, now critical for the direction of the global economy, have turned stimulative. Macro numbers released this week show a widespread improvement in growth.
At times like these, investors need to strike the right balance between defense and offense. Today, that means sticking with an ongoing equity-bias in portfolios, but also including non-traditional hedges like commodities and the currencies of resource-exporting nations. If another decade happens next week, portfolios will still be well-insulated against market shocks.