A dramatic escalation
Summary
Russia has reportedly started an invasion of Ukraine. Ukraine said it was a ‘full-scale invasion’ while Russia said it was carrying out a “special military operation” in the Donbas region and was targeting military infrastructure across the rest of the country.
Risky assets sold off sharply while some safe havens extended gains. At the time of writing, the Hang Seng closed over 3% lower while gold extended gains to USD 1945/oz.
Prior public statements suggest further sanctions against Russia may be in the offing. How commodity markets respond over the coming days may be key to whether broader market volatility sustains, or not.
Background
It has been widely reported that Russian military forces have started to enter Ukraine. Ukraine’s government called it a ‘full-scale invasion’ while Russia said it was carrying out a ‘special military operation’ in the Donbas region and was targeting military infrastructure across the rest of the country. The G7, NATO and the EU were all scheduled to hold meetings later today, potentially to discuss retaliatory measures.
These events marked a significant escalation of previously simmering geopolitical uncertainty, which is now weighing on markets. As of 6pm SGT, Asian equities had fallen sharply, with the Hang Seng down over 3% and India’s Nifty down over 4%, European equities opened sharply lower and Brent oil had risen to USD 104/bbl. On the safe-haven side, the 10-year US government bond yield was down to 1.88% and gold rose to USD 1945/oz. The response in currency markets, though, was much more muted both among riskier currencies like the AUD as well as perceived safe-havens like the JPY.
What does this mean for investors?
It is almost certain that equity and corporate bond market volatility is likely to extend as US markets open later today. For investors, however, we believe it will be key to separate the knee-jerk reaction from the bigger perspective:
• History has shown us that financial market reactions to major geopolitical events have usually been short-lived. While the market bottoming process can take several days or weeks, the table illustrates that they often fully reversed their losses over 3-6 months.
• Today’s volatility also comes at a time when the S&P500 is already down about 12% from its prior peak. Given the six 10%+ pullbacks over the 2009-2020 period ranged from 10-19%, a significant portion of this pullback may already have occurred assuming there is no economic recession on the horizon.
• A significant Fed hiking cycle in 2022 is also already priced by markets.
While it is always very difficult to time precise market bottoms, these two perspectives argue that investors worried about the prospect of further volatility may be better served by adding on risk hedges rather than significantly reducing long-term equity allocations this far into a pullback. Gold offers one traditional approach, of course, having just broken above key technical resistance, but the JPY may be another given it has thus far reacted more mutedly.
From here, we would watch the following factors closely to assess the near-term market direction: (i) the nature of retaliatory measures by the US and Europe, especially whether they target Russian exports (Russia is a significant exporter not only of energy, but also several key industrial metals), (ii) whether the military conflict itself escalates further or remains restricted to current players and (iii) how equity market technicals evolve following a likely volatile day.