The Likely Market Implications of Putin’s Latest Ukraine Gambit

Is the dam finally breaking? Over the long weekend, Russia disavowed Ukrainian sovereignty, formally recognized the country’s breakaway provinces—Luhansk and Donetsk—as independent states and sent troops into them. In response, the UK announced some sanctions, Germany officially abandoned its pursuit of the Nord Stream 2 pipeline, and the US is reportedly prepping new sanctions of its own. Oil prices jumped closer to $100 a barrel, and as we write, the S&P 500 is down about -1.7% on the day—in correction territory from early January’s high.^[i] If markets close at present levels or lower, it will be this bull market’s first official correction—the first drop below -10% from the prior closing high. Stay cool. In our view, stocks are behaving as they normally do amid escalating geopolitical tensions. Regional conflict can hit sentiment and cause short-term declines, as it has this year. But there is a long history of regional conflicts, and none have been the proximate cause of a bear market. We don’t think this time is likely to prove different.

Not that any of the present situation is good—it isn’t. War is tragic. Our hearts go out to the many Ukrainian people whose lives and property are at risk, and we hope conflict doesn’t escalate from here. Yet markets are cold-hearted and rational, so when assessing conflict’s impact on stocks, we think it is vital to be more detached and assess the facts. One tough fact Western pundits seem to broadly overlook: Russian presence in Luhansk and Donetsk—the two eastern Ukrainian provinces “President” Vladimir Putin recognized Monday—isn’t new. Russian soldiers reportedly entered these areas back in 2014, in unmarked combat fatigues, earning the moniker of “Putin’s little green men.” As many in the region reported at the time, they were offering support to “pro-Russian” separatist forces in these provinces as Russia executed its annexation of Crimea. As with Crimea, Putin argued these areas were much more ethnically Russian than western Ukraine, seemingly attempting to justify his actions on cultural grounds. Many observers in the US and Europe were surprised when Putin didn’t annex Donetsk and Luhansk as well as Crimea, instead settling for fomenting chaos and severing them from Kyiv’s oversight. Diplomatic recognition of Luhansk and Donetsk is noteworthy, but it—and the official statement Russian troops are headed into these regions—is tantamount to Russia formally admitting to its stance from the last eight years.

Obviously, there are a lot of US political considerations to the above, as the current White House has a lot of overlap with the administration that dealt with this in 2014. We aren’t going to wade into any of that, and please understand that our analysis of this situation is nonpartisan—rather, we bring up the events of eight years ago to make a critical point for stocks: Markets move most on surprises, and nothing happening in Ukraine today is all that new or surprising. Stocks have known and dealt with the possibility of Putin carving up the country for many years now. Once official Russian troops amassed along the border, many started seeing formal activity in Luhansk and Donetsk as a foregone conclusion. The chief question was how much the West would stomach before applying economic pressure, and we are now getting some clarity on that.

Where this goes precisely is unknowable. Maybe Russian troops will advance on Kyiv, maybe not. Some geopolitical analysts think Putin’s goal is to win a firm commitment to keep Ukraine out of NATO and the EU—perhaps that is true, and maybe that is the outcome. Yet we have also seen speculation that he wants more control of the supply chains for strategic gases and minerals that run through Ukraine, in order to have more leverage over Western militaries and the Tech industry. Some think any fighting would stay in Ukraine. Others think it would quickly ripple through Moldova to Eastern Europe. Some think tough Western sanctions won’t invite retaliation, as Russia’s government financing depends on selling oil and gas to Europe. Others disagree. In short, there are myriad possibilities, and the widespread discussion is helping markets deal with them. The more chatter there is now, the less surprise power there is if and when something worse occurs.

Yet markets also move most on probabilities, not possibilities. Regional conflicts routinely drive localized economic problems in the areas around the fighting, and stocks are pricing that in accordingly. The MSCI Russia’s double-digit drop is evidence of that. But unless conflict goes global, the damage tends to be too small and localized to cause bear markets. Of all the conflicts since good S&P 500 data begin in 1925, only the advent of World War II caused a bear market. In 1938, we think stocks were recovering from the 1937 bear market, which erupted from misguided and harmful Fed policy. But when Nazi Germany annexed the Sudetenland (which was then part of Czechoslovakia), it forced markets to reckon with Hitler’s territorial ambitions and the mounting likelihood of war engulfing Continental Europe. Thus began a renewed bear market, which lasted until 1942. 

None of the many conflicts that marred the ensuing decades caused a bear market. Not the Korean War. Not the Cuban Missile Crisis. Not the Six Day War. Not the Iran/Iraq War. Not the first or second US wars in Iraq. Not the Balkan War. Not Israel’s conflict with Hezbollah. Not the Syrian Civil War. Not the US involvement in Libya or Afghanistan. And not Russia’s invasion and annexation of Crimea. In most of these instances, stocks tumbled as tensions escalated, but they began bouncing back as or shortly after fighting broke out. Not because armed combat is bullish, but because the fighting ended the uncertainty. When markets get clarity, even if what they see isn’t great, it lets them weigh the extent of the damage and move on. In this case, while this might sound cold to say, Ukraine’s investible market contains just two companies, and its GDP is just 0.2% of the world’s total. War ravaging the nation would be awful, but it takes trillions of dollars’ worth of damage to cause a global recession. Ukraine just isn’t big enough—nor are the surrounding former Soviet states that aren’t in NATO and therefore stand the highest likelihood of being drawn in.

It won’t shock us if the announcement of US sanctions, possibility of escalating conflict and potential Russian economic retaliation draws out the volatility for a while longer. Brace yourself for that now—fearful headlines can trigger short-term reactions. But eventually that wears off and markets resume weighing fundamentals, coldly and rationally. As they do, we think they will see that the probability this spirals into a recession-inducing global conflict is exceedingly low. On the oil and gas front, we have already seen non-OPEC producers help mobilize a supply response, which should help take some of the sting out. Higher prices will likely bring even more US production back online. Commodity markets are fungible—when one supplier leaves a market, others take its place. That should keep Europe’s lights on, and spring’s approach should offer additional relief.

We will continue watching things closely and will share updates and analysis as warranted. For now, take a deep breath, steel your nerves, and remember how markets work.