Investors are by nature a nervous bunch, but despite escalating geopolitical tensions over the past few weeks, markets have not been as jittery as expected.
This collective indifference may be a function of two things. First, the economies embroiled in civil strife may represent 12 per cent of the global population but only account for 3 per cent of global GDP and less than 1 per cent of total equity market capitalisation.
Second, while Ukraine/Russia and Israel/Gaza are providing plenty of headlines, this is mere background noise to the main driver of equity markets, which has continued to be central bank policy.
Such indifference could be about to change, however, given the fresh wave of sanctions against Russia that have been just announced by the European Union and the US.
At the time of writing, full details of the EU sanctions have yet to be announced, although it is known that both the EU and the US Treasury’s measures will explicitly target Russia’s financial, energy and defence sectors.
European leaders have previously been accused of dragging their feet compared to the US, in terms of willingness to impose tougher sanctions against Russia.
European leaders have previously been accused of dragging their feet compared to the US, in terms of willingness to impose tougher sanctions against Russia.That’s unsurprising, given that the EU conducts roughly 10 times more trade with Russia than the US does. Full economic sanctions could be equally damaging to what is still a fragile recovery at best in the eurozone. But now it seems the EU and the US are ready to present a more united front in their hopes of getting Vladimir Putin to abandon his tacit support for separatists in Ukraine.
The measures may be tough and the most punitive brought against Russia since the cold war. However, they do not yet carry the weight of full economic sanctions.
An outright ban of Russian energy exports would arguably have had a greater impact, given the country’s heavy reliance on oil and gas for revenues and economic growth.
The MSCI Russia Index has a 57 per cent weighting towards the energy sector. But as the chart illustrates, the countries in the east of Europe are naturally more reliant on Russian gas, as the west can tap into gas fields located in the Nordic countries.
While the latest round of sanctions are finally showing some teeth, they are still relatively targeted in their nature — and the tendency for national interests to outweigh foreign policy concerns — mitigating some of the downside risk to the European economic recovery and market returns.
Economic self interest by national leaders is not to be unexpected, as the impact of wider sanctions may be disproportionate across the region.
While acknowledging that it was right for the EU to “increase the pressure” on Russia, German foreign minister Frank-Walter Steinmeier noted: “If there are negative consequences, then they must be borne across Europe as a whole.”
Those negative consequences are already starting to be felt. Germany’s most prominent leading indicator of economic growth, the ifo index, fell for the second consecutive month in June.
Despite strong economic fundamentals, the country is still facing headwinds from the Ukrainian conflict, and the details of the survey highlighted the impact of political tensions on the German economy through exports. It was reported that one-third of the respondents to the ifo survey expected some adverse effects, with some suggesting that customers were already looking for suppliers outside of Europe as a means to circumvent any future sanctions.
For investors, tougher sanctions do pose a higher level of risk, and certain sectors and companies may feel the pain more than others.
However, the full impact of the new sanctions, if any, is almost impossible to quantify, as it is unknown how long they will be in place for or how successfully they can be implemented. Investors can protect themselves, to some extent, through the principles of diversification and balance in their portfolios.
Investors would do better to focus on the risks they can quantify and plan for. The biggest of these quantifiable risks remains monetary policy and the path of interest rates.
The Bank of England and the US Federal Reserve will begin to change gears in the coming months, and it is unlikely they will be able to do this without adding to market volatility. Remember when we were all wondering when the conspicuous lack of volatility in global markets was set to change? Be careful what you wish for.
Kerry Craig is global market strategist of JP Morgan Asset Management
