(Bloomberg) — Stock markets have concluded that a Russian invasion of Ukraine could have long-term consequences for the global economy.
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European stocks tumbled at the end of the week to their lowest level in a year as the massive crackdown on Russia disrupts trade with one of the world’s major suppliers of key commodities, especially energy.
US stocks also declined, albeit to a much lesser extent, reflecting a more limited exposure to Russia.
The latest moves mark a turnaround from an early reaction to the attack on Ukraine. The initial decline in equities since the start of the war has been followed by a rally, fueled by a “buy the dip” mentality and speculation that central banks will back off from raising interest rates. Strategists at JPMorgan Chase & Co. and Citigroup Inc. promoted the idea of short-lived pain, and history pointed to the emergence of buying opportunities.
The contrast between encouraging markets and policy messages has been stark, but any optimism is eroding as Russian attacks intensify.
Far from being temporary sanctions, they are more likely to be maintained and possibly tightened, further putting pressure on countries already struggling to contain seemingly unstoppable inflation.
“Interestingly, the market didn’t believe the war would start a month ago, we didn’t believe it would escalate beyond Donetsk and Luhansk back then, so it’s a bit of a negative trade,” says Maria Veitmane, senior strategist at State Street Global Markets.
The European Stoxx 600 fell 3.6% on Friday, ending the worst week since the early days of the pandemic in 2020. The S&P 500 fell 0.8%, its fourth drop in five days.
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The shock of the war — Russia has repeatedly denied it would invade despite its troop buildup — has catapulted commodity prices from gas and oil to wheat and aluminum to new records.
This increases the burden on companies and households, which negatively impacts investment, spending and growth. The threat, especially for Europe, is so great that the specter of stagflation has resurfaced.
“Apart from energy, there is a risk of turmoil for other commodities given the global connectivity for all types of chemicals being introduced,” said Matt Peron, director of research at Janus Henderson Investors. “However, so far, these problems remain contained and are likely to be resolved if the conflict and resulting production problems are short-lived. If it stretches, the ripple effects will be significant.”
In addition, the conflict may signal the beginning of a fundamental disconnect between Russia, one of the world’s largest producers of energy and raw materials, and Europe and the United States.
Diplomats and European Union officials in Brussels say that even if the military operations in Ukraine end and Vladimir Putin’s army prevails, this will only increase sanctions against the Russian central bank, as well as against its creditors and industrialists. Sanctions will only be eased if Putin reaches an agreed compromise with the Ukrainian government, a scenario that seemed unlikely as of Friday.
For Dimitris Valatas, chief economist at Greenmantle, the best historical analogy is the rise in oil prices, the surge in inflation, and the fall in demand that followed the collapse of Iranian manufacturing in the late 1970s.
“With wholesale gas prices almost 10 times higher than a year ago and crude oil prices almost doubling, European household incomes will be hit hard,” he said. “This will lead to a wider reduction in consumption and thus hurt companies targeting European consumers.”
By some standards, the despondency is more pronounced than it seems from the movements observed immediately after the start of the war.
Paul O’Connor, head of multi-asset at Janus Henderson, noted that eurozone stocks are now trading at a 25% discount from analysts’ consensus forecasts, “a level of distrust has previously only been seen during the U.S. subprime crisis, the debt crisis in euro and the first days of the pandemic”.
But not all industries were affected. European renewable energy shares rose 24% and shares in companies like Vestas Wind Systems A/S surged on expectations that the invasion would bolster Europe’s political will to accelerate the shift away from fossil fuels.
Similarly, defense stocks rose as Germany responded to Russian aggression with a promise to lift decades of restrictions on military spending. Mining and energy are currently the only sectors to post gains this year in the Stoxx 600, betting that the commodities rally will continue.
So, where can investors put their money?
“High quality companies that deliver consistent dividends,” says Janus Henderson’s Perón. “While inflation is generally a challenge for markets because it squeezes margins, lowers multiples, and raises the risk of more aggressive central bank policy, relatively, sectors with price power tend to outperform.”
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