By Dr Shane Oliver (Head of Investment Strategy and Economics and Chief Economist, AMP). Article used with permission.
The last few days have seen a sharp escalation in the situation between Russia and Ukraine, with Russia recognising the independence of two regions in the Donbas area of eastern Ukraine that have been controlled by Russian separatists since 2014 and ordering Russian “peacekeeping” troops into the regions. At this stage its unclear how big the force will be, whether it will push beyond the areas controlled by the separatists and, if so, how far. Although President Putin continues to deny plans to invade Ukraine, his comments suggest a move into the areas of Donetsk and Luhansk in the Donbas that the rebels do not yet control.
As a result share markets have fallen further, with US and global shares falling just below their January lows and Australian shares under pressure too, albeit so far they have held up a bit better. Bond yields have also fallen due to safe haven demand and oil prices have pushed to new post 2014 highs. The market reaction reflects a combination of uncertainty around how far the conflict will go – with Ukraine being Europe’s second biggest country (after Russia), the threat of further sanctions (so far they have been limited) and uncertainty about how severe their economic impact will be. Although it has said it won’t, there is also the risk Russia cuts off its supply of gas to Europe where prices are already very high, with a potential flow on to oil demand at a time when conflict may threaten supply. In short, investors are worried about a stagflationary shock to Europe and, to a lesser degree, the global economy generally.
Trying to work out which way this goes is not easy and I am not a geopolitical expert. But it still seems there are four scenarios, some of which may overlap:
Given the path Russia has gone down and the stridency of President Putin’s recent comments, Scenario 1 is looking less and less likely, but is still possible if there is a breakthrough in talks. And Scenario 2 looks to be already on the way, with Putin’s ordering of “peacekeeping” troops into the Donbas region. This may be the “military-technical” action that Russia referred to last week. At the other extreme, it’s still hard to see Russia undertaking a full invasion of Ukraine given the huge cost it would incur. And it’s hard to see NATO troops being involved particularly given limited public support for it in Europe and the US. The US has said US forces would not go into Ukraine. However, some combination of scenarios 2 and 3 are possible whereby the crisis escalates further if, say, the Donbas separatists and the Russian “peacekeepers” push into Donbas territory that the separatists do not yet control and beyond.
And, of course, with Russian troops moving into the Donbas region of Ukraine investment markets will worry that we will move on to a wider invasion of Ukraine, until signs appear to the contrary. So, we could still see share markets fall further and oil prices rise further in the short term.
Of course, there is a long history of various crisis events impacting share markets. This includes major events in wars, terrorist attacks, financial crisis, etc. The following table shows major crisis events since World War Two in the first column, the period over which the US share market initially reacts in the second column, the percentage share market fall in the third column and the percentage change from the low over 3, 6 and 12 months in the final three columns.
Based on the Dow Jones Index. Intended as a guide only as other developments also impact shares around the dates shown. Source: Ned Davis Research
The pattern is pretty much the same for most events, with an initial sharp fall in the share market followed by a rebound. Since World War Two the average decline has been 6%, but six months later the share market is up 9% on average and 1 year later its up around 15%.
I don’t have a perfect crystal ball and its even hazier when it comes to events around wars. But from the point of sensible long-term investing, the following points are always worth bearing in mind in times of investment markets uncertainty like the present:
Cornerstone Wealth Group Pty Ltd, trading as Cornerstone Wealth, is an authorised rep of Cornerstone Wealth Solutions Pty Ltd.
Information on this site may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.