Last week, we wrote that even a worst-case scenario between Russia and Ukraine (a full-scale invasion) was unlikely to have a major negative impact on the global economy, and as such investors should be cautious about reducing risk in response.
On Thursday, sadly, our outlook was put to the test. Russia launched a full-scale invasion of Ukraine. The unfolding situation will have a disastrous impact on the lives of many in the region. It may also have significant political ramifications for Europe.
But, while European equity markets initially reacted negatively to the news, we closed Thursday in the US with the S&P 500 up +1.5% and Nasdaq up +3.3%… in other words, it was a strong day for stocks. At the time of writing (the morning of Friday 25th February) European equities have opened positively.
Why were equity markets initially weak, but eventually reacted positively to the news from Ukraine?
Markets hate uncertainty, but once a risk crystalises, markets can get to grips with the real implications for the global economy and price stocks accordingly. In the case of Ukraine, the build-up to conflict and wide range of potential outcomes weighed on market sentiment for months. Now markets know the outcome there is a pricing in of reality. If that reality is not so bad for the global economy then stocks respond in kind.
The Western response of more sanctions against Russia, which (being generous) is a mid-sized economy, and the flow of energy from Russia to Europe continuing, the outcome is one with little immediate harm to global economic demand or supply.
There is still room for escalation with the West. Some countries are lobbying for Russia to be removed from the SWIFT system of international payments, effectively cutting Russia off from being able to pay for imports or receive money for exports. Russia would likely respond with escalated cyber-attacks and restricted energy supplies to Europe. This would be more economically disruptive, but even then, no catastrophe for anyone other than the average Russian citizen.
As we said before the conflict turned hot last week, investors have bigger fish to fry in 2022.
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