Western countries have moved quickly over the past week to impose economic sanctions on Russia.
We consider the implications for investors.
- PWL Waterloo clients have very limited direct exposure to Russian stocks and bonds. We estimate only 0.05% of a balanced portfolio of 60% stocks and 40% bonds would be Russian securities. Most of this small exposure is through emerging market stocks. Typically, emerging market stocks are less than 5% of total assets, of which not more than 3% is Russian stocks.
- The Russian stock market has been closed since 28th February. This means that market prices for Russian securities are unavailable and that they cannot be traded. This does not mean that Russian stocks are of no value but that they are illiquid.
- The ramifications of economic sanctions go beyond the value of Russian stocks and bonds.
- The Russian currency, the rouble, has fallen 30% against the US dollar in the past month. This makes purchases of foreign goods, even if available, more expensive for Russian consumers.
- Sanctions have been aimed directly at the Russian central bank to freeze its foreign exchange reserves, estimated at $630 billion dollars. If successful, this would limit the ability of the central bank to undermine the impact of sanctions by offering foreign currency for roubles. It is estimated that 22% of these reserves are held in gold and 14% in China but the rest is held in Western banks, which is now out of reach.
- Other sanctions have restricted some Russian banks to SWIFT, which is like a private email system for moving international payments. SWIFT is used by correspondence banks who acts as financial intermediaries for (mostly) US dollar payments between firms. The U.S. has imposed sanctions forbidding US banks from acting as correspondent banks to Russia’s two largest banks, Sberbank and VTB Bank. As of March 2nd, the UK stock exchange listing of Sberbank has lost 99.9% of its value since the beginning of the year.
- Russia provides 10% of global oil and 30% of natural gas to Europe. Sanctions seem to have been effective in deterring the purchase of Russian oil, even at discounted prices. Shifting demand elsewhere has caused prices to rise above $100 a barrel. Germany has suspended certification of Nord Stream 2, a gas pipeline from Russia to Germany.
- Ukraine is the world’s biggest producer of sunflower oil and the fourth biggest producer of corn. Some countries already suffering food insecurity rely heavily on Ukrainian wheat: Lebanon (50%), Libya (44%), Yemen (22%), Bangladesh (21%) and Egypt (14%).
- The ripple effect of higher energy and commodity prices is likely to compound inflation concerns.
Markets are processing all this information, and more, as it becomes available. To date, the impact on major stock markets has been small. In February, the Canadian market fell by -0.76% and the US market (S&P500) by -3.64% and a diversified, balanced portfolio (VBAL) of 60% stocks and 40% bonds by -1.63%.
Of course, we do not know how events will unfold. Recent history, mercifully, has relatively few data points about the performance of markets during conflicts. Taking the impact on the Dow Jones Industrial Average as our measure, the decline when Russia invaded Crimea (2014) was -0.9% over one day and the decline from the start of the Cuban Missile Crisis (1962) was -1.9% over one day. In recent history the most severe response was when Iraq invaded Kuwait (1990) the decline was -18.4% over 51 days. Markets price stocks over a 20 to 30-year horizon and historical data of acts of war supports the idea that acts of war rarely have a large or lasting impact.
To acknowledge that short term investment responses to acts of war are unlikely to profit the investor or punish the aggressor is not to be passive but to be resolute. While we cannot anticipate specific acts of war or other contraventions of international law, we can and do limit exposure to countries with a history of such behaviour when designing portfolios. Limiting exposure to Russia has protected our clients and raises the cost of capital for the Russian economy. As citizens, we can express our views through political action and support charities who help the dispossessed. We can also increase our vigilance to cyber warfare and disinformation.
