Welcome to World War Three. Even if the missiles are yet to fly between NATO and Russia, international sanctions are as much a lever of modern warfare as bullets and bombs and the effects are all-engulfing. This is a global conflict. 

A fast-moving, dynamic environment 

As the world retreats rapidly from anything to do with Russia whether sanctioned or not (what seemed to provoke the most media excitement in the popular business press this week as far as companies were concerned was McDonalds closing all its Russian restaurants), markets began to get to grips with the realities of the knock-on effects of Russia’s near-isolation and all the dislocation which goes with it. The most extreme illustration was the London Metal Exchange suspending all trade in Nickel (Russia is a significant source) as the futures price soared past $100,000 per tonne but without any guarantees of being able to meet physical delivery against payment.

 

As the sanctions noose tightens and the Russian economy is gradually asphyxiated, what still gives it oxygen is oil and gas exports. Having shifted ground perceptibly in less than a week, Biden and Boris announced US and UK sanctions on imported Russian oil. But there are nuances: while the US ban is immediate, the UK’s is to be phased in by the end of the year. The EU was even less fulsome: it will phase out Russian imports by 2030. 

 

Nevertheless the response in crude markets was immediate with the price of Brent oil at one point reaching $145 per barrel, nearly double the price from the beginning of the year. As the US and the UK began negotiations to encourage OPEC to make up the potential shortfall of deliveries to global markets (Russia accounts for 4% of global supplies and is a member of what is known as OPEC+, it itself is not a full member but an affiliate, one of the ‘+’ countries), the world of realpolitik was immediately evident: having been slighted and snubbed by two successive Democrat administrations (and Biden was at the centre of both, including in the Obama government), Saudi Arabia refused to play ball and the UAE is acting as an interlocutor, but it is more than likely that Saudi will make demands of the US in return, to get Biden to show it respect. Venezuela, an economic basket case and close to a pariah state, is the other principal country with sufficient reserves to help fill the shortfall; now in a position to exercise leverage there will be a price to be paid there too. At the time of writing, Brent prices have settled (if ‘settled’ is a word one can use with any confidence in energy markets at the moment) at $113, similar to the beginning of the week.

 

For the EU, gas is even more problematic. An immediate total ban on Russian imports would render swathes of the EU economy, notably Germany, Italy and several of the eastern members such as Romania, at risk of severe compromise. There is simply not the infrastructure to make up 30% of Europe’s and 40% of Germany’s gas requirements in short order by any other means. In reverse, turning off the gas taps to western Europe remains Putin’s one significant economic ace up his sleeve.

A restoration of western unity but divisions remain 

If the West has achieved and restored a significant level of purpose and unity out of the geopolitical rubble of its immense policy failures over years, which cumulatively allowed this situation to develop in the first place and then rapidly to go from flash to bang, there remains great uncertainty as to how far to go militarily to contain it. It is less about how to protect NATO, more about how practically to help Ukraine without directly intervening.

 

But what defines ‘directly’? While many NATO members, even Germany, are now providing arms and ammunition (and in particular state-of-the-art anti-tank and anti-aircraft missile systems which are proving highly successful), the lighting rod has been the confusion over the donation of old Soviet era Polish MiG29 jets to the Ukrainian air force. EU foreign ‘minister’ Josep Borrell suggested just such a move two weeks ago (his plan included Hungarian MiGs too); he was roundly told to sit down, shut up, he didn’t understand, he was embarrassing himself.

 

Yet last weekend, US Secretary of State Antony Blinken revived the idea as practicable. Poland read the smoke signals, offered the aircraft to the US for onward donation to Ukraine via the big US airbase at Ramstein in Germany (Warsaw rightly concluding that supplying the jets directly would be construed as an act of war by Putin, the precept for another invasion). But the idea was immediately shot down by the Pentagon as mad, effectively a declaration of war on Russia by the US. Even in the US, from a military strategy point of view, it suggests that between Washington and the Pentagon, the right hand and the left are not in seamless harmony, and worse, publicly so. Sleepy Joe still needs to get a grip, even with his own people. 

At what point does the balloon go up? 

But the principle of offering jets to Ukraine raises an important question: if air assets are considered too provocative to be able to be sent (and yet compared with the latest generation US Stinger and British Star Streak systems, 30-year old jets are relatively useless in combating the Russian air force, and hand-held Javelin and NLAW anti-tank missiles are inflicting significant damage on Russian armour), at what point does Putin say to the West, “you might not have boots on the ground or planes in the sky in Ukraine but the reality is you’re already committed militarily against us” and declare this a global shooting match? 

Published inflation data still to reflect the new order 

Reflecting largely the conditions existing pre-invasion, this week’s US inflation data saw year-on-year CPI rise to 7.9% in February, up from 7.5% in January. ‘Core’ inflation, the measure used by the Federal Reserve (Fed) in its assessment of interest rates and which in the tidy minds of economists and statisticians removes the inconvenience of food and fuel prices, rose from 5.9% to 6.4%.

 

‘Core’ is a nonsense; back in the real world, the US population still needs to eat, travel to work and heat its homes whatever the volatility in food and fuel prices. Fed Chairman Jerome Powell was forced to concede as much in his renomination speech last November when pitching for a second term in office. His monetary policy committee meets next week, knowing that the February data is already ancient history. As a pointer, US 10 Year government bond yields which stood at 1.75% at the beginning of the week, ended it close to 2%. Fixed income investors are still assuming it is a racing certainty that US interest rates will rise in March, shifting away from zero where they have been for precisely two years and the inception of measures to tackle the pandemic. 

Heads up, eyes and ears open; nobody has all the answers 

It is against this immensely complex and highly dynamic backdrop that markets are trying to make sense of what happens next. “What is priced in?” is a common question – as if markets are all-knowing and totally rational. Markets were entirely wrong-footed by the invasion, as evidenced by the subsequent volatility they have been running to join the dots ever since. The only sensible response is that unless one is President Putin (for he is the one who principally determines what happens next), the answer is largely supposition and guesswork. The least likely outcome of all – unless something extraordinary happens to Putin – is re-setting the button to the status quo ante, before the invasion, with a total restoration of Ukraine as the sovereign nation it was three weeks ago, and we pretend none of this ever happened, it was all just a bad dream, an aberration.

 

While there has been significant volatility, nevertheless the US’s S&P 500 Index is still 8% up on a year ago, the UK’s FTSE 100 Index up 6%; barely reflecting the significant rise in geopolitical heat, as the global proxy for the “risk-free rate of return” the US 10 Year government bond yield is rather less than half a percentage point higher than this time in 2021, and actually lower than it was in mid-2019. Markets seem quite sanguine; whether that proves lazy thinking remains to be seen.

 

December 2019. It seems a lifetime ago. So much has changed in a very short space of time with two exogenous shocks of global proportions. Life seemed so much simpler! However long any of us has been in the markets, none of us has ever experienced the entirety of the current conditions all at the same time, whether economically or geopolitically. It pays to keep an open mind, a cool head, not to assume you have all the answers and to be neither prescriptive nor dogmatic.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

The value of active minds – independent thinking

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