The tragic events in Ukraine these past few weeks have demanded our close attention, and probably like many of you, we follow the news with heartbreak for the suffering of the Ukrainian people and admiration for their remarkable fortitude. Obviously, we are keenly interested in the financial repercussions as well. With President Biden following up enhanced economic sanctions on Russia with a ban on petroleum and gas imports to the US, and Putin threatening a commodity export ban, this seems like the right juncture to share the issues and consequences we have been reflecting upon.
Client Portfolios. The potential for conflict was in our minds at the turn of the year, and we came into 2022 with the understanding that direct exposure to Russian debt was essentially nil, while exposure to Russian equities was present, but reasonably limited. Recent reviews of that understanding have confirmed no direct Russian debt in portfolios of debt funds we recommend. Several equity managers had been trimming positions in Russian stocks leading up to the invasion, though holdings continue to be present in small amounts in most emerging market funds (0-3% of the funds). This means that within client portfolios, the overall exposure to Russian stocks is less than half a percent (0.5%) for most clients.
Stability of the Financial System. With most major Russian banks removed from the SWIFT international payment system, Russia’s foreign reserves frozen (other than renminbi), a variety of additional governmental sanctions, plus “self-sanctioning” by European and US companies reducing their involvement with Russia, it is self-evident that the effect of non-payments by the Russian government and Russian firms will reverberate through the world economy in a variety of ways, perhaps echoing the Russian debt default of 1998. Thus far, financial funding markets do not show worrisome levels of stress, which accords with the low exposure to Russia of most banks (especially US banks). That said, nothing on this scale of sanctions has been tried before, so we must expect some dislocation that financial commentators (including us) have not identified.
Near-Term Global Economic Impacts. Already high energy prices and the prospect of further price increases in response to US and European action to reduce energy purchases from Russia will dampen near-term economic activity and make the Federal Reserve’s (and other central banks’) job of hiking interest rates and reducing inflation more difficult. We believe the main challenges for markets remain the start of the hiking cycle and the economy’s transition from fiscal stimulus to self-sustaining growth.
As disturbing as this conflict is, geopolitical events and their consequences for financial markets are consistent features of investing and something we have managed through since the founding of our firm around the time of the first Persian Gulf War. Although it seems impossible and even troubling on an emotional level, most such events cease to animate financial markets after a remarkably short time as market participants’ attention moves on to other developments. A notable exception was the Arab Oil Embargo of 1973 in connection with the Yom Kippur War. The embargo persisted for some time and helped to precipitate an economic recession and bear market for stocks. Other policy mistakes over several years likewise contributed to that unfortunate period but the parallel to today of easy monetary policy is difficult to ignore.
Financial markets began the year focused on estimating the extent and timing of Fed rate hikes and reductions in ownership of mortgage bonds and US Treasury securities, which was the subject of our January newsletter. While it is impossible to say the extent to which concerns over Russian actions contributed to stock market declines, most of the 10-20% or so decline in various categories of US stocks this year was priced in before the Russian invasion began. We are watching asset prices and client portfolios and thus far are not in a situation where a general move across all clients to purchase stocks is warranted by clients’ investment policies. However, clients who are deploying capital to markets in phases have the opportunity at present prices to buy at discounts to those that prevailed at year end.
Two years hence, it’s hard to ignore the parallels of the present environment to the early days of Covid, when governments threw the brakes on large swaths of economic activity with unprecedented speed in the face of a what was then a new and uncertain threat but one known historically from prior epidemics. The even swifter decoupling of Russia from the global economy, along with the still-unknown extent of Putin’s machinations, will likewise continue to roil populations, economies and markets to an unknowable magnitude and with unforeseen consequences. As always, we brace for these conditions with discipline, guided by collaborative planning and prudent, enduring investment policies. And on a human level, we follow the news along with all of you, with the odd couple of sorrow and hope in our hearts.
Thank you for your trust and confidence. We’ll be in touch again soon.
Scott D. Benner
Cameron J. Barsness
Ryan V. Stevens
IMPORTANT DISCLOSURE INFORMATION
You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from KBBS. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. KBBS is neither a law firm nor a certified public accounting firm.