A shock to markets

The launch of Russian military operations in Ukraine had long been threatened but until today, markets around the world did not believe that it would actually happen. Even the deployment of troops into breakaway regions of Ukraine was met with hope that this would be enough to satisfy Russia’s ambitions.

But that was yesterday. Today, at the time of writing, a full scale invasion of Ukraine appears to be taking place, and markets are now left recalibrating all previous assumptions. And as the world holds its breath in anticipation of President Putin’s next move and President Biden’s promised retaliation, investors are trying to assess the likely end-game.

While it appears almost certain that tough sanctions will be imposed on Russia that will affect its oil supplies to parts of Europe, supply disruptions in the rest of the world is not guaranteed. For example, Asia compared to other markets has a relatively low dependence on Russian energy supplies. About 1.9 million barrels per day (B/D) of Russia’s crude oil transits into the region via northern China. Russia accounts for about 14 percent of China’s crude imports and less than 10 percent for the other Asian countries, Japan is Asia’s largest importer of Russia’s LNG (liquified natural gas), with Russian projects accounting for nine percent of its LNG supply. It is thought that even if sanctions were imposed, any disruption of oil and gas supplies to Asian countries would not be severe.

Rising energy prices

But supply aside, all economies are still subject to the global energy market. Prices were already trending up due to supply disruption concerns, and the imposition of sanctions would add even more upward pressure and further compound inflationary concerns. If the situation does not de-escalate, oil, natural gas and metal prices can be expected to stay uncomfortably high.

For example, Brent has almost reached US$100 per barrel, while aluminum and nickel are at, or close to, their record highs. Such cost-push inflationary pressures, if sustained, would be detrimental to global growth but the Eurozone’s economic growth would be particularly impacted. This could push Europe closer towards a stagflation scenario where both growth and inflation outlooks are adversely impacted.

Regional Impact

We are cognisant that today’s invasion is possibly the greatest security crisis to hit Europe since the Cold War, and markets could be readying themselves for the long haul. The current sell-down in global equities of almost 10 percent since the start of hostilities has exceeded that of previous geopolitical selloffs. For example, the S&P 500 Index typically corrected 6 – 8 percent on average, and quickly re-bounded thereafter.

Asia is also unlikely to be shielded from the events unfolding in Europe. However investors can draw some comfort from the region’s positive fundamentals as it continues its post-Covid recovery. Over the past few months, Asia’s industrial, IT, energy and financial sectors have outperformed their global counterparts and it is hoped that this will help provide some resilience in the months to come.

However, short of the energy and commodity sectors, it is unlikely that any market can escape from the weakness in investment sentiment and increased volatility that looks set to ensue from today’s Russia invasion. If hostilities continue, there is potential for a growth slowdown in Europe that in a worse case scenario, could spread to the rest of the world.

In recent weeks, UOBAM’s risk management monitors have been triggered by rising market volatility. As such, our portfolio managers had started to take actions to de-risk their portfolios. This includes raising the portfolios’ cash holdings, reducing high risk equity and high yield bond exposures, and increasing allocations to alternative assets such as commodities.

Meanwhile we continue to monitor the situation closely and are on the lookout for broader negative spillover impacts into global markets. Conversely, assuming that there is no escalation of the military conflict involving foreign troops, it is possible that the current situation can be contained within Ukraine and its immediate neighbours. In such a case, it is conceivable that global growth will be less impacted and global markets could start stabilise once the dust settles.