Russia and Ukraine: How Do I Manage My Portfolio? History Says, "Don't Panic!"

by Arden Trust

A Special Insights Report by Donald Deyo, EVP, Chief Investment Officer, Arden Trust Company

The ongoing incursions Russia is levying on Ukraine have created a global firestorm of reaction--mostly in opposition to the crossing of the border and encroachment on the sovereignty of Ukraine, an independent, democratic nation once a satellite territory under the umbrella of the former USSR. Not since 1939 has there been a border crossing, a challenge to power by one nation over another in Europe.

The lessons learned from WW II were supposed to prevent such a repeat offensive; however, President Putin is a product of the former USSR and has long believed the arcane alliance can be reestablished. He was a member of the KGB, former Soviet military arm. He has also been in near-absolute power in Russia for over twenty years and as his power has grown so, too, has his isolation and likely his grip on the reality of global response to his aggression. He has never recognized Ukraine as a sovereign nation (often referring to it as Russia’s little brother).

With the ascendence of President Zelenskyy in 2014 as Ukraine’s democratically elected leader (deposing the pro-Russian predecessor) and the nation’s embracing of democracy, the paranoia of Putin has escalated. He now fears an expanding NATO and democracy on his doorstep. He believes he can walk across borders without opposition, remove Zelenskyy, install a Russian puppet government and reassert Russian control.

The reality has been markedly different. The Ukrainian people have stood to defend themselves against a superior Russian force and to confront Putin with their faces not their backs. The NATO Alliance has put forces in place to protect those NATO nations from expanded Russian aggression and has supplied Ukraine with means of defending itself, without committing troops.

NATO has stood strong in implementing economic sanctions where possible, including Germany’s shutdown of the Nord Stream 2 pipeline project between the two nations. And most recently, certain Russian banks’ access to SWIFT (Society for Worldwide Interbank Financial Telecommunication) has been suspended which has been thought of as the nuclear option hobbling Russia’s financial transactions. SWIFT encompasses 200 countries, 42 million daily messages and 11,000 finance firms. It stops all payments within financial systems to or from the impacted Russian banks.

With this as the backdrop, what actions should investors consider to protect their wealth?

In Europe, stock markets have dropped sharply while commodity prices have soared. Russia’s stock market plunged 50% and the Ruble fell to record lows against the US Dollar. Russia is a small economy comparatively and is not a significant trading partner with the U.S. As a result, direct economic effects have been somewhat muted on the US Economy due to the nominal trade links between the two countries.

The European Union, however, imports approximately 27% of Russian exports and China about half that percentage. There is a much more direct impact in the EU, particularly in the energy sector. A sustained incursion could have more prolonged repercussions, which is why the German shutdown of Nord Stream 2 pipeline was notable. It will result in immediate upward energy pricing for German consumers. Germany believes the move is in its best long-term interest because of the geopolitical message it sends to Moscow. It is committed to the mission of NATO.

As Russia sees its economy threatened, one of its options (although unappealing) would be to turn more closely to China who, at best, regards Russia as a diplomatic sidekick and a source of cheap commodities. Sidling up to China could weaken Putin’s power as such dependence would further emphasize Russia’s weakness globally. While energy may suffer some supply chain issues, the U.S. remains the number one producer of both oil and gas and could fill the commodity gap.

There are commodity concerns to be considered in the equation as well. Russia and Ukraine represent between 20-25% of the world’s exports of wheat and corn and the war’s impact on these exports will have direct impact on all markets. Also, Russia is the world’s largest exporter of Palladium, which will increase supply chain concerns for the Auto industry. Gold prices have also spiked recently, reaching a new high of $1909.01 per ounce.

Financial Markets do not like uncertainty, and it is normal to see demand increase for hard goods as a storehouse of value. The unanswered effects of Russia’s aggression are found in the continued escalation of Putin’s gamble. Is the end goal to occupy Ukraine or to topple its democratic regime?

The scale of fighting and the effects of sanctions are critical elements which could result in stagflation globally and increased supply chain pressures. In contrast, the 2014 Russian annexation of the Crimea had little to no economic impact on US investors. It did, however, result in a new class of Russians, the seviliki, whose power and interests may be underestimated by Mr. Putin.

The seviliki represent a new economic consumer group among the Russian government elite. Russians had begun to enjoy the consumerism of a post-glasnost era. They are the sixth largest spenders on international tourism, enjoying imported luxury goods in an increasingly cosmopolitan Moscow. They have been active purchasers of second homes in Europe, have grown accustomed to an open internet. They have an unfiltered view of the world no longer fully controlled by State communication messaging. They increasingly desire what is good for them, rather than what is bad for the West. As sanctions take hold, the seviliki could be a source of discontent and could demand resolution.

The move on Ukraine has not been popular with average Russian citizens, since many Russians have family members and friends in Ukraine. The U.S. and its allies have imposed a number of sanctions, including personal sanctions on those people in Putin’s inner circle and on Putin himself. Both Sweden and Finland have openly voiced opposition to Putin’s move into Ukraine and even China has had a muted reaction.

It is hard to say how affected Putin will be personally. Estimates of his wealth span $7 to $20 Billion and may be hard to identify. But the messaging will be clear when Russians, whose per capita income exceeds just over $10,000 annually, are made aware of the vast wealth gap.

While the immediate reaction has been volatile in US Equity Markets, history has shown that immediate reaction is usually the most dramatic and equity markets have recovered quickly, usually within 1-3 months. Both the S&P 500 and the Dow Jones Industrial Average are officially in correction, down more than 10% off their highs. The technology sector- heavy NASDAQ - is in bear territory, off over 20% from its highs.

While there is tactical exposure in the near-term, long-term investors with a defined strategic investment are likely to be rewarded for their patience in staying the course. These four historical events and the associated 3-month, 6-month, 1-year returns on the S&P 500 Index are good examples:

• Pearl Harbor, 12/7/1941 (-11.0%, -6.5%, +4.3%)
• Cuban Missile Crisis, 10/16/1962 (+14.1%, +20.7%, +27.8%)
• 1987 Stock Market Crash, 10/19/1987 (+10.9%, +14.7%, +22.9%)
• Iraq War starts, 2/20/2003 (+13.6%, +18.7%, +26.7%)

There is likely to be short-term Inflationary pressure in food and energy pricing and it is expected that the Fed will go forward with a planned .25% increase in interest rates in March to stem consumer demand.

That said, selling into volatile markets rarely produces a desired result. The adage “buy low, sell high” is still as relevant as ever. Don’t panic. Remain calm. A diversified portfolio with a clear goal is the best equation. And, as always, it is prudent to contact one’s financial advisory team before making rash and irreversible trading decisions. The current crisis has both economic and geopolitical concerns and it is important to consider both when making individual investment decisions.

The foregoing general information is not intended as investment advice. You should consult a financial professional before making any investments, which have a risk of loss. Arden Trust Company does not provide legal or tax advice. Please consult a legal or tax professional for advice specific to your circumstances.