The effects of the Russia-Ukraine conflict on the financial markets

It’s fair to say that the global political and economic landscape has shifted in recent weeks due to the war between Russia and Ukraine. Since last month’s ‘special military operation’ first took hold – perhaps marking the largest land war since 1940 – it would be fair to assume that the financial markets would have been heavily impacted by the conflict.

In reality, it is not always possible to predict how war will impact the world, let alone the stock markets. If we look back at other moments of conflict in recent history, examples show that the markets remain relatively composed in response to geopolitical events.

The Syria conflict and the N.Korean missile crisis are two recent events that had minimal impact on the financial markets. On a much grander scale, the Dow was up by 50% throughout World War II – a further reminder, that that the stock markets can be merciless as the catastrophe of war unfolds. So, how have the markets reacted to this specific conflict?

What is the relationship between sanctions and volatility?

For Russia, the consequences of war have been catastrophic, due to the unprecedented sanctions imposed by the West. From oligarchs to oil companies, the economy has been strangled at 104 Roubles to the dollar and the Russian stock markets remain closed to date.

But the economic impact stretches far beyond Russia’s borders. With the conflict threatening key commodities like oil and wheat, prices continue to sky rocket and European stocks linger on the edge of correction territory, while the UK also mulls a cost-of-living crisis. One thing we can be certain of, is that moving forward, a long war can only mean fresh volatility.

Another unusual development is the fact that many corporations and conglomerates in the West have pulled out of the country for what seem to be moral reasons, adding more fuel to the fire to the wider debate about the shift to ethical investments.

Of course, the rise of ESG funds and investments in clean energy have increased in recent years, with HYCM’s research finding that 31% of investors see ESG investing as a vital aspect of their strategy, but we cannot be certain that this shift in trends will be permanent.

What is the impact on stocks?

The peace talks between the two sides have yet to make progress. As such, the likelihood of a longer conflict and the threat of wider-scale conflict grows by the day – although, whether this takes place on the traditional battlefield or in the cyber world remains to be seen.

Answering Pres. Zelenskyy’s calls for help, the German gov’t has pledged ground-to-air missiles to Ukraine, whilst the EU and the U.S. have moved to increase their defence budgets.

These pledges of support from the West have led to a rise in defence and cybersecurity stocks, with Raytheon Technologies and Global X Cybersecurity exchange-traded fund (ETF) in rising by 10% and 3.6% respectively. The longer that peace talks take to de-escalate the conflict, the more investors should expect interest in the defence arena to continue.

Even though some corporations such as McDonalds and Starbucks have continued to pay their employees, it is estimated that a staggering 450 companies have ceased to operate in Russia. Even the likes of oil giants, BP and Shell, have divested major assets in the Russian.

In terms of what this means for companies who opt to continue operations in Russia – in short, these firms can expect to see major kickback from consumers who denounce the war, with experts suggesting that this could result in boycotts of their products and services.

With this in mind, traders and investors should be conscious of how continued operations in Russia could affect company stock valuations as the conflict continues.

What is the impact of sanctions in the energy markets?

Given that Russian oil and gas make up 40% of the federal budget and 4.9% of total GDP, sanctions on this part of the Russian economy presents perhaps the most effective means of starving Putin’s war chest without direct military intervention from other Western countries.

As the U.S. and the United Kingdom have been able to limit imports of Russian oil and gas, due to the fact that Russian imports only make up 8% and 3% of their respective fuel imports, the European Union has however found this to be a much more difficult task.

For the EU, this number is closer to 40% and accounts for more than half of Russia’s daily total crude oil exports. Consequently, any disruption to their supply could cause fuel prices to inch even higher, which could be the cause of significant unrest for European economies.

The shift away from Russian oil initially, to other oil suppliers in the Middle East, increased the global benchmark for oil to its highest level since June 2014 at $113 a barrel. As an energy price crisis had already been brewing, this has been exacerbated further by sanctions.

The UK Chancellor Rishi Sunak has attempted to reduce the effect of increased prices on consumers by cutting fuel duty costs, but such measures are unlikely to make any difference.

Indeed, prolonged uncertainty in the energy markets will no doubt stoke inflation figures even further – and this should not be quickly dismissed, given that figures are touted to reach almost 9% in the UK by the end of the year. So, what can investors and traders expect?

There are two modes of thought in this situation. On the one hand, ESG funds and clean energy investments could see an uptick as traders look away from fossil fuel investments.

In this scenario, stocks involved with nuclear energy, biogas and low-carbon hydrogen could rise in value in the medium to long-term. On the other hand, greater investments fossil fuels and ‘dirtier’ energy are likely to dominate short term investment plans, contradicting the net-zero commitments many Western governments promised to set in motion at COP26.

How will Russia’s kinship with China affect the markets?

Traders and investors would also do well to look to international relations for hints showing where the markets may head – namely, Russia’s ‘strategic partnership’ with China.

Since the annexation of Crimea in 2014, trade between the two powers has increased by around 50% – in 2021 alone, trade increased between the two nations by 35.9% as President Xi proclaimed that the alliance was ‘without limits’.

However, as the world’s biggest importer of oil, market fluctuations and deviations of Western market trends can be particularly challenging to the Chinese economy. With Pres. Biden threatening to impose sanctions on China if they supply Russia’s army with weaponry, it is likely that there are in fact some ‘limits’ on Beijing’s relationship with Moscow.

The threat to diminished trade with the West is likely to cause China to withhold support to Russia – at least publicly – so it would be wise to monitor these relationships going forward.

To conclude, it’s unlikely that investors’ portfolios will be at the forefront of their minds. It is however vital that traders maintain a clear strategy. It perhaps goes without saying that it would be sensible to avoid over-exposure Russia-linked investments for the time being, as the risk of a wider conflict and greater uncertainty in the Russian economy is too high.

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Giles Coghlan is Chief Currency Analyst, HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders.