First and foremost, without any rhetoric, we feel close to the people of Ukraine, people who see the prospects for them and their loved ones dramatically change in a matter of hours. For no apparent reason. These are things we see in films or read in books. That belong to distant historical periods or distant lands.
Our history, the history of mankind over centuries and millennia, is nothing more than a series of great changes. Most of these changes are represented by conflicts. Yet we enjoy the privilege, too often unrecognised, of living in an era and a geographical area where the last three generations have never encountered war. This now seems to be coming to an end. To see it touching our doorstep, in cities and territories close to us, makes one wonder and reflect. And that is why we believe that 24 February 2022 will remain as a historic date, not far removed from the collapse of the Berlin Wall, the Russian Revolution, the French Revolution, Pearl Harbour, or the dismantling of the Soviet Union by Mikhail Sergeyevich Gorbachev, moments when the political balance of the world structurally shifts. This brings risks, but also opportunities.
In an industry like the financial sector that makes dietrologia a mantra, we have no problem admitting that we saw little likelihood of what happened, namely a full Russian invasion of Ukraine. This is despite the fact that we had clearly considered it as one of the possible scenarios. Our idea was based on the fact, as we have already written in recent weeks, that an invasion would have entailed consequences that even Vladimir Putin’s Russia could not bear: the “Cubanisation” of the country. We were wrong. We have also been wrong about Putin in the past and this has led us over time to decide not to invest directly in Russia any more until the leadership is changed. It’s not long now.
Putin went into government in 1999, elected following a wave of nationalism during a very difficult financial economic phase for Russia, a phase that readers with a few grey hairs like us remember well. Too many times we have seen how prolonged and/or deep recessions and/or extreme increases in inequality go hand in hand with political extremism. Delving deeper into history would allow politicians to better understand how assisting countries in dire straits is not only, humanly speaking, a categorical imperative, but also, selfishly, a hypothetical imperative, i.e. an insurance policy for the future well-being of one’s own nation.
The young Putin began to apply KGB methodologies in mainstream politics, organising a series of domestic attacks to justify a second war against Chechen separatists who had humiliated Yeltsin’s Russia. This time with no respect for human rights. The world threatened sanctions for the Grozny massacre, but nothing was done. In 2004 he expropriated the oil giant Yukos, speciously imprisoning the powerful oligarch Kordhokovsky who had dared to challenge him politically. Yukos was a public company listed in NY, but this did not stop Putin from going ahead. Politicians and financial institutions protested and threatened, but then turned their heads the other way, seeing the potential business as more interesting than restoring the rule of law and punishing the autocrat who was heedless of laws and the market. We remember well that episode when we made a small investment betting on a West capable of restoring the rule of law. In the end, we understood and resold Yukos at a loss. Putin was therefore right.
According to Catherine Belton’s acclaimed book Putin’s people (Penguin, 2020), the Kordhokovsky deal opened up the possibility for Putin and his KGB acolytes to take control of the country’s economy and its judiciary. By 2012, 50% of Russia’s GDP was controlled by Putin’s men.
Then came Georgia. Then tensions with Moldova and the Baltic republics. Then Crimea. Each time, business started again with Putin’s Russia. Indeed, in Europe, investing and intensifying ties and dependencies. The economic logic was represented by short-term greed, towards which, alas, the financial markets are concentrated. The political and strategic logic, at least not the one in turn conditioned by the economic lobbies, was to keep the great country close in order to prevent a great nuclear power from isolating itself, a bit like what is often done with difficult children in order not to create deep, irreparable and dangerous rifts. Tying the country economically with a double thread would have accompanied it to the demise of Vladimir Putin. A logic that some sincerely believed in and others speciously exploited, always for the usual short term economic reasons or, worse, the object of the exceptional corruption machine of the Putin administration, extremely rooted in Western politics. The result has been that the boy has thus grown more overbearing and confident. And today he has crossed the line.
This time Europe will not turn its head again. This is not just a wish, we believe it is very likely to happen and we see hour after hour that it is happening.
Patrick Cockburn, a former FT journalist who is a great expert on Russia and the Middle East who we follow and who now works for the Independent, came out with an interesting article over the weekend (Putin has gambled everything on Ukraine, and now his political survival in Russia is in doubt (inews.co.uk)) that tries to understand why Putin has gone to such lengths. The journalist’s explanation is condensed into a nice English word, ‘hubris’. The translation is ‘excess of arrogance’, a disease common to despots in power for many years, overconfident and surrounded by yes men who dare not oppose his every idea. Not far from what is happening to Turkey’s Tayyip Erdogan or what happened to Muammar Gaddafi or Saddam Hussein. The good thing is that this usually leads to a mistake that also marks his end. The journalist also relates a nice anecdote. In the early 1900s in Russia there was nervousness among the masses. Tsar Nicholas II decided that there was a need for ‘a short and victorious war’. He embarked in 1904 on a war with Japan, which was short but not victorious, making the situation worse. The major internal dissent that followed led him to take part in the First World War which, in turn, inevitably led to the Russian Revolution of 1917. With Putin we believe it will take much less.
Looking back, with hindsight, we now understand the dogged selling on certain Russian securities, or those sensitive to Russian affairs, in recent weeks. As connoisseurs of technical analysis know, it is difficult to know whether someone is better informed than others or whether it is just panic. Putin and his acolytes knew what was going to happen. So did the American intelligence, which repeated it through Biden and which few believed. The negotiations were sham, based on demands unacceptable to any independent state or any alliance that makes sense. The goal? We believe it is to unite Crimea with the new self-proclaimed republic of Donbass, giving the latter access to the sea and giving Crimea access to Russia. Basically Putin would like to take 30/40% of the country and be able to influence the rest. Thus finishing the job he started in 2014. Not far from what was done in Georgia or Moldova. This responds to the nostalgic/sick instances of historical revisionism common in many Soviet politicians, but above all to the need to distract the Russian population in turmoil over a gradual reduction of civil rights in the country. 24/02 was, strangely enough, also the day of the hearing of Navalny, the Russian politician unjustly imprisoned by Putin.
In the long run we are all dead, goes an old adage much used in the market. However, let us try to understand what will happen in the long term, a relaxing exercise because no one will ever ask you to account for the rubbish you say. In the long term, finally, the outlook is pink. Funny how when things look dramatic is actually when the mechanism of change is set in motion. Again, going through the history books, we see that dictators fall when they make their people feel bad. As in China, the masses give up their freedom but only in exchange for economic well-being; and while maintaining that well-being is a significant concern for Xi Jinping today, it is a utopia for Putin. When prosperity fails, prosperity defined as the status you were used to, you can shuffle the cards and extend the time with a war, but then your time runs out. It is hard to say when this will happen, but Putin last Thursday laid the groundwork for his demise and the demise of the country’s autocratic system. We believe there will be no turning back.
Russia will become investible again in the not too distant future.
It is more important to try to analyse what can happen in the short term, which is also more difficult and dangerous. But we try. Let’s start by saying that the repercussions stem from the very fact that the invasion has taken place, and that the course of the conflict itself, important though it is, now has no effect on its geopolitical repercussions, only on market volatility. Any threat or fear of a direct conflict with NATO, a hypothesis that remains very remote, can only increase short-term market volatility. So let’s expect a very sensitive market on this front. The tougher the conflict, the harder it will be for Putin to justify domestically and it will be inevitable that Western sanctions will become extreme, as we can already see in these hours. However, whether Kiev falls tomorrow or never, the shape of the new world will not change.
Just last night it was announced that Putin, having called a meeting with the Ukrainian leadership to initiate a ceasefire, had put the Russian nuclear apparatus on alert. This indicates a state of substantial desperation. While this move creates anxiety and must be treated with caution by the West, it inevitably makes for a binary future for Putin: either relinquishing power or returning the country to a 40-year Soviet dictatorship. After a twenty-year phase of capitalism tested by the Russian population, we consider the second hypothesis extremely difficult to manage.
The new world
The new world will see two clearly delineated axes. Russia/China (for us the “bad guys”) and USA/Europe/Japan/Korea (the “good guys”). Emerging countries will fall into one sphere or the other depending on the case and the economic support provided. Clearly, the less you have, the less support you can give.
Russia. Russia will see the welfare of its population severely curtailed. This will have to be accompanied by increasing restrictions on personal freedom (movement, information, free expression, democracy) and thus repression. This will also increase the instability of the country and the possibility of the regime being overthrown. Part of the output and economic input lost to Europe will be compensated by China, which will be happy to sell it some of the goods that were previously bought by Europeans and buy raw materials, gas and oil at a discount.
China. It will gain a loyal ally, which will guarantee it raw materials and an outlet for its goods and which will partly compensate for the process of deglobalisation underway towards it by Europe and the USA. Apparently it paves the way for Taiwan’s ‘integration’. In reality, if things go badly for Putin’s Russia, as we believe is likely, the result will be the opposite, i.e. it will turn out to be a deterrent for China. All the more reason for the US to show resolve today. China’s focus today is to raise the welfare of 600 million of its citizens living on less than USD 200 a month. To fail to do so would be to undermine the party’s legitimacy. Given its delicate political/economic phase, we believe that China will avoid aligning itself too closely with Russia in order to avoid sanctions, and will try to adopt an opportunistic attitude.
Europe. It will lose a not insignificant portion of Russian exports, which account for over 4% of European exports, and thus a significant blow to aggregate demand. In addition, it will have to gradually redefine the supply of raw materials, oil and gas, redirecting itself to other players, probably at high prices for a certain period of time; therefore, a blow to consumers’ purchasing power. Europe also has some USD 400 bln in direct investment in Russia, and some of that will be lost.
- some of the lost Russian exports will be made up by improved trade relations with the US
- the price of fossil fuels will gradually decline as Russian production finds other markets, rebalancing global supply/demand
- the high price of fossil fuels and raw materials will partly return to Europe through increased demand from fossil fuel producing countries (South America, Africa, Middle East, South-East Asia)
- in general, European companies have limited specific exposure to Russia, thanks to risk diversification policies put in place after 2014
- the event accelerates the continent’s investments to become more independent (manufacturing, semiconductors, raw materials, renewables, electric cars, etc.) and this should help full employment and wage dynamics, which, as in the US, are already moving upwards in the wake of tax measures and the deglobalisation process
- the event unites Europe and provides an incentive to strengthen the EU, which has been torn apart by political differences in recent years
- the event strengthens the impetus towards banking and fiscal union in the US.
USA. It will benefit from major investments to accelerate the process of deglobalisation that this event has made more important. It will also benefit from the substantial increase in investment in armaments throughout the New World. It will benefit from European demand for its fossil fuels. Benefit from renewed political support for energy transition investments.
Emerging countries. 2 out of 3 Emerging Countries are dependent on the price of soft and hard commodities, i.e. commodities account for over 60% of total exports. The crisis we are experiencing will keep commodity prices high for some time, while reducing the fear of interest rates to which these areas are very sensitive. The high price of commodities therefore has a positive effect on the economies of these countries, many of which have stock markets with modest valuations after a decade of underperformance.
- Luxury (wealth effect following weakness in the US tech market, rates normalising and loss of part of Russian demand)
- Energy (many have invested heavily in Russia and although they are showing excellent profits now this phase opens the way to a definitive reversal of the oil and gas trend in a few years/months and the market is anticipating, particularly after the recent rises in these stocks)
- And clearly any company with strong sales and especially earnings exposure to Russia (a minority among European stocks)
- Renewables and zero carbon (nuclear and CO2 filtering technologies)
- Energy infrastructure (regasifiers, grids, pipelines)
- Banks (a more united Europe represents a stimulus for M&A in a sector that is too fragmented)
- Telecommunicaton (a more united Europe is a stimulus for M&A in a sector that is too fragmented)
- Electric mobility (subsidies will be prolonged and infrastructure development accelerated)
- Mining outside of Russia (which will suffer high commodity prices for a longer period of time)
The above adds to the trend of deglobalisation pushing companies to bring production back home, helping to increase employment and wages and reduce the large inequalities developed over the decade.
In the short term it is a dance and it is difficult to say where the market will go because it is driven by flows. However, once the market has, for each stock, calculated the future profitability losses associated with Russian isolation and ruled out the possibility of a widening war it will return to focus on the fundamentals which remain good.
To conclude, the tragedy unfolding in these days also brings with it positive changes and human, political and financial opportunities.