Russia’s warlike offensive has met with surprisingly fierce resistance within the Ukraine. The Ukrainian side is also receiving weapons from the West. The situation is in flux.
Advance of the Russian Army
Initial Russian attacks on Thursday on strategic and military facilities were carried out in a very targeted, efficient and effective manner (and were in violation of several international agreements).
Since then, the advance has been limited due to surprisingly fierce resistance within Ukraine. In the two newly Russian-designated People’s Republics of Luhansk and Donetsk, Russia continues to advance and the centre of Kharkiv, Ukraine’s second largest city, has been taken. But the attack on Kiev is faltering.
In addition to strategic targets, civilian facilities have been hit increasingly by missile attacks, giving the lie to Putin’s communicated goal of “protecting the people of Ukraine”. There are casualties on both sides, something which stands to weaken support for the war among Russians.
Apparently, concerns as to impact of Russian casualties on support for the war effort has led Putin to hire and deploy Chechen mercenaries in task forces. One of these task forces has allegedly been crushed by the Ukrainian army.
But Ukrainian resistance also needs weapon support. Over the weekend, several Western countries spoke out in favour of supplying more weapons to the Ukraine. This group includes Germany, in what is seen as an historic departure from previous policy, though Chancellor Schulz stressed at the same time the importance of both sides showing an honest willingness to negotiate.
“Willingness to negotiate”
President Putin has expressed his willingness though how serious he is will be tested in the negotiations. Gomel on the Russian/Belarusian/Ukrainian borders has been chosen as an alternative venue to Minsk. Negotiations support the faint hope for a de-escalation.
Tough sanctions decided – for both sides
The West is acting in a unified manner seldom seen before, with announced measures going well beyond the delivery of more arms to the Ukrainian side. Russian banks will be denied access to credit in the West, future-oriented technologies will no longer be supplied, assets of oligarchs and the central bank will be blocked and the freedom of movement of the political elite will be restricted. Finally, several Russian banks stand to be excluded from the Swift international payments system, a move which prompted China to announce its general opposition to sanctions on Russia.
Sanctions always affect both sides. Europe, and especially Germany, stand to face significantly higher energy costs, something that will boost inflation and hurt living standards.
On Sunday President Putin ratcheted up global tensions with his announcement that he was putting Russia’s “deterrent forces”, meaning her nuclear capability, on “alert”.
Putin’s goals
While Putin’s long term strategic intent still seems unclear, he is pursuing his goals in a manner which is highly destabilizing and fraught with risk. In the current conflict, namely the invasion of Ukraine, the primary goal seems to be the conquest of Kiev, the overthrow of the current government and the establishment of a pro-Russian puppet alternative. Once these objectives have been achieved, hostilities might come to an end (at least temporarily) and the further grab for power in Ukraine could be continued by “political” means.
But the range of possible scenarios includes the conquest of further territories and Russian dominance of far more of the Eurasian continent.
Impact on asset classes
The coming days will continue to be characterised by elevated volatility. With risks now obviously very high, investors will focus on safety and diversification. Given Russia’s increasing isolation, Russian bonds, equities and the rouble look set to remain under massive pressure.
Elsewhere, much depends on the central banks which will have to steer a course taking account of rising inflationary pressures on the one hand and the perception of sharply increased geopolitical risk on the other. Europe looks set to be much more affected by the escalation of sanctions than America or Asia.
Bond markets: Forward interest rates suggest markets do not expect any change in monetary policy due to recent developments. A first interest rate step by the Fed is expected in March and by the ECB in September. Such rate hikes seem credible in view of the rise in inflation. However, interest rates may well now rise less quickly than previously expected. Taking inflation into account, bonds remain unattractive. In a sense, high-yield bonds offer more protection against inflation but are riskier.
Equities: Here, market indices indicate that the dividend yield after deducting inflation is also negative in most countries. Exceptions are the defensive equity markets of Switzerland and Japan. Defensive investments are generally preferable in the current environment. These currently include pharmaceuticals and food, “value stocks”, energy, and commodities in general (including gold mines). In the short term, uncertainty is causing higher “volatility”, with strong movements both up and down. In the medium term, the asset class remains attractive on a relative basis.
Alternative investments: Alternative investments offer diversification and can have a volatility-dampening and performance-stabilising effect given a low or negative correlation to conventional investments. In the current environment, precious metals, commodities, and real estate are likely to remain in demand.
Possible scenarios
It is still difficult to assess how things will develop in the coming weeks. Nevertheless, we outline here some scenarios and assess their probabilities:
Contact: Christoph Sieger, Portfolio Manager
Telephone: +41 58 680 60 56
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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