If you thought the stock market sell-off earlier in the year was ugly, brace yourself: Wall Street’s elite investors brace for an even deeper market shock as the war in Ukraine drags on.
In my conversations with some of the top minds in finance, many of whom spoke to me on condition of anonymity to be candid about where the market is headed, a consensus emerged: Russia’s invasion of Ukraine has their predictions for one Stock market nullified “washout” in the hyperdrive. The gloomy global economic picture, clouded by supply-side inflationary pressures, is now even more complex and uncertain. And the shifts that have turned some of the market’s high-flying winners into losers are becoming increasingly apparent.
“Russia’s invasion of Ukraine accelerated the slowdown and accelerated inflation,” a billionaire value investor told me.
Aside from the massive volatility the invasion will continue to inflict on markets, the war is also forcing Wall Street into a frenzied colonoscopy. Not only the US government wants nothing to do with Russia. It’s also Wall Street’s customer base.
So Wall Street’s biggest investors face three challenges: build a portfolio that will survive the washout, make sure you don’t hold any Russian assets, and for heaven’s sake return all Russian clients’ money before the old one does Uncle Sam dampens the boom.
Market chaos and a ‘bone-breaking recession’
Vladimir Putin’s decision to invade Ukraine added another shock to a year already marked by massive economic change. The Federal Reserve and other US policymakers have tried to walk a fine line by raising interest rates just enough to contain historically high inflation without pushing the economy into recession. That much hasn’t changed: inflation has shown no signs of slowing yet, and the Fed’s plans to raise interest rates to fight it mean debt is already becoming more expensive and credit harder to access. In turn, investors are becoming more risk-averse, punishing the stocks of companies that have relied on cheap debt to fuel speculative growth – many of which have been the darlings of our seemingly unstoppable stock market for the last two years. All of this adds up to a nasty stock market decline.
Putin’s war hasn’t changed the shape of this market shift, but it does make the dodge move even more aggressive. Aside from “a re-rating of defense companies,” the value investor told me, the stock market hasn’t changed fundamentally. It’s only gotten more treacherous.
The thunderclap of Ukraine’s destruction and Russia’s ousting from the global economy has created additional scarcity in a world already grappling with shortages of critical goods and the inflation that shortages bring. The war jeopardizes world supplies of oil, steel, wheat, fertilizers and other commodities. Together, Russia and Ukraine export more than 25% of the world wheat supply. Russia is also a major exporter of fertilizers. The UN warns that this conflict could lead to global food shortages. The food that is left becomes more expensive, which exacerbates inflation.
And then of course there is energy. Russia supplied the world with nearly 10 million barrels of oil every day before Putin attacked Ukraine. Since then, the US has halted imports and the EU is working to quickly decouple from Russia’s energy supply.
Russia’s oil and gas exports will be cut off from the rest of the world, leading to higher prices for consumers in the US and Europe. — especially low-income households. castenoid/Getty Images
Eventually, without technology from American and European companies like Baker Hughes, Halliburton and Schlumberger, Russia will also struggle to extract oil from its territory, said geopolitical analyst Peter Zeihan. Oil prices have been up everywhere since the invasion began, mostly in response to the carnage, with occasional dips as the market tries to figure out how much oil we’ve really lost.
Earlier this week, the International Energy Agency forecast that Russian oil exports would fall by 3 million barrels a day by next month, but one person I spoke to, a Singapore-based hedge fund manager who focuses on commodities, thinks so that circumventing sanctions will mitigate losses as Russia routes its gas through countries like China.
“I think oil prices could go a little higher if these issues resolve, but I would be surprised if prices were higher in June than immediately after Russia attacked,” they said. “I think some of that will be manageable once the Chinese figure out how to smuggle goods out of Russia, and they will.”
Meanwhile, low-income sections of the population could face what the fund manager described as a “bone-cracking recession”. In the US, low-income Americans spend an average of 8% of their household income on energy, from filling up their gas tanks to turning on their lights. In the EU, the number can reach over 12% in countries like Romania. Even before Putin’s attack, researchers estimated that 80 million homes across Europe were struggling to stay warm, so it hurts when prices go up.
“The problem Europe is facing right now is figuring out how to quickly reduce absolute gas consumption while figuring out how to help the most vulnerable people,” they said.
Unless the EU solves these massive problems, there is a risk that low-income citizens will be forced to choose between heating their homes and filling their stomachs. It risks eliminating shifts at manufacturing plants, hitting workers’ wallets even harder. It risks political unrest. Right now, the West’s top priority in helping Ukraine is to maintain a united front against Russian aggression, but none of this is good for economic and social stability.
All of this amounts to a temporary but indefinite period of chaos. Prices for essentials will skyrocket; central banks will fight inflation by raising interest rates; and money will be harder to find. While there might be money to be made if the turmoil resolves itself, the fundamental shift underway in the market — an ugly, painful transition from growth stocks to value stocks — hasn’t changed. The swings are only going to get wilder, as anyone trying to survive the goofball of a mid-March bear market rally can probably tell you. Without warning, the tech-heavy Nasdaq – which was languishing – rose over 8% in a week. In a market like this, it might as well fall even harder in the next.
A avoid on Wall Street
While it will be months before the economic and market fallout from the war in Ukraine unfolds, Wall Street began purging itself of toxic Russian assets quietly but quickly after Putin invaded. Before Goldman Sachs began the exodus of big banks from Russia, before Citigroup and Deutsche Bank cut their losses and followed suit, before hedge funds began barring access to their Russian oligarch clients — emails and phone calls circulated on Wall Street demanding was to avoid Russia.
“We can’t tell our clients that we’re investing their money in Russian assets,” said Josh Brown, CEO of wealth management firm Ritholtz Wealth Management, which has $1 billion in assets under management. “So we call our money managers and say they need to reduce our exposure to zero.”
Calls like this set off a chain reaction that Russia cannot stop. Money managers like Brown are calling their money managers – companies like Vanguard, for example – and telling them to sell all Russian holdings in their clients’ portfolios. These massive money managers then call the companies that create indices, like MSCI, State Street (which creates the SPY index) or the London Stock Exchange (which creates the FTSE Russell) and demand that Russia be removed from the indices – thereby Russian investments will wipe out virtually every American retirement account and millions of investment portfolios. With money managers like Vanguard managing trillions of dollars, index compiling companies are complying. For example, Russian assets were kicked out of the FTSE Russell on March 4th.
Russian financial assets – from stocks to debt to gold – have been cut out of the global system due to sanctions. This exclusion from the financial markets will be difficult to reverse. Maxim Shemetov/Getty Images
This lockout from financial markets will be difficult to reverse, partly because customers are unlikely to embrace Russia anytime soon, but also because Russian assets have become somewhat in limbo. They’ve become part of a sale where customers can only window shop.
“Basically, any assets that they have on hand have to go to zero and then become a write-down,” Brown said. “No one is buying these assets. Maybe you can sell them back to a Russian in three years, but there is no liquid market at the moment.”
This applies not only to securities, but also to tangible assets that once made their owners very rich. When BP announced in late February that it was divesting its 20% stake in Russian oil giant Rosneft, a veteran hedge fund manager – who had just expressed guilt at profiting from a wartime stock market – told me had – simply: “That’s not true. It doesn’t mean anything.” In your decades-long money business, you can’t sell what nobody will buy. You can’t just leave behind billions of dollars in investments and walk away. No one in their right mind would simply relinquish ownership of assets and write off the interest as a loss. But these times are not like others.
It turns out that in war you can just walk away. Especially when it looks like Russia is going to isolate itself from the global financial system or, as the billionaire value investor put it, “go full North Korea.”