The writer is president of Queens’ College, Cambridge and an advisor to Allianz and Gramercy.
Russia’s invasion of Ukraine has thrown policymakers, businesses and markets into an inherently uncertain and troubling world.
The temptation for investors is to try to understand what will happen next on the ground and react accordingly – understandable but very difficult to obtain given the multi-faceted forces that have been unleashed by the turmoil and those that are still future.
The invasion has not only geopolitical, military and diplomatic repercussions but also economic, financial, social and institutional ones. They are felt at global, regional, national and individual levels. They are certain to interact with each other in variable and difficult to predict ways.
Rather than basing portfolios on wonky specifications of inherently uncertain outcomes, a better approach may well be to formulate more flexible responses based on the following six factors.
First, even up until the eve of the invasion, many viewed what is happening today as highly unlikely. Few of them had prepared a playbook, and even fewer were sufficiently “self-insured” against direct effects and negative fallout.
Second, we are only at the beginning of the process — military events of this magnitude are difficult to reverse quickly. Even if it were possible, a series of additional sanctions and counter-sanctions are still in the works. And it would be naive to dismiss the possibility that other authoritarian regimes are trying to exploit a situation in which the West is scrambling to respond.
Third, much like their military counterparts, Western economic policymakers lack the traditional flexibility to respond to the crisis, including typical early movers in the central banking community. It is extremely rare for the Federal Reserve and European Central Bank to begin facing another major crisis with interest rate floors at or below zero and with central bank balance sheets already so bloated. In such a situation, emergency “break the glass” measures risk a much higher likelihood of collateral damage, unintended consequences and more limited effectiveness.
Fourth, while countries and companies with direct ties to Russia and Ukraine are hardest hit, the economic effects are much wider.
The stagflationary economic forces have already been released. The vast majority of countries and businesses around the world are likely to experience falling demand and rising input costs.
Fifth, it comes at a time when inflation is already a problem, threatening to further unanchor inflation expectations, especially with the world’s most powerful and influential central bank, the Federal Reserve, already behind management. of the price increase. Having repeatedly failed to exploit orderly policy windows, he no longer has any “first-order” answers available.
Finally, flows and liquidity are additional complexities for investors. Much of what happens in financial markets over the next few days will depend on fund flows, the depth of liquidity and the strength of investor conditioning to “buy the dip”.
This increases the scope for intraday volatility and contagion, where even the strongest companies temporarily trade with an unusually high correlation to the market as a whole. The most interesting arm wrestling will be between, on the one hand, the “pain trades” which force the sale of securities whatever the market conditions and, on the other hand, the buyers seeking to exploit what they regard as a rapidly reversible drawdown in market pricing.
Since initial conditions inevitably differ from country to country, company to company and investor to investor, the specific implications of these six factors will differ from case to case. other. For example, they will mean for some “doing nothing” while others will have to scramble to realign suddenly unbalanced portfolios.
What will be common, however, is the importance of financial resilience that allows investors to hold onto as many options as possible for the time being. Rather than reflecting indecision, it is an important acknowledgment of an extremely uncertain situation that is far from resolved. Eventually, the time will come for such optionality to give way to the need to focus on attractive new opportunities to reposition portfolios as developments on the ground become far less unpredictable.