Weighing up the Russian sanctions

The Cold War is on again, but will the sanctions against Russia chill your returns?

Summary: An increase in economic sanctions against Russia, amid its rising border tensions with Ukraine, is reminiscent of the Cold War. The US and the European Union are intent on keeping up the pressure, but the sanctions are already having an impact on some foreign stocks. But should Australian companies, and investors, be concerned?

Key take-out: A spike in energy prices could be on the cards, especially in Europe. But, at worst, investors only need worry about a temporary hike if Russia decides to match US antagonism.
Key beneficiaries: General investors. Category: Economics and Investment Strategy.

Judging from market moves last night, investors are starting to get a little nervous. That may correct over the next few sessions, but having heard warnings from policymakers over the last few months about complacency, it looks like the market is now at least listening.

Now it’s not that there was just one catalyst for the slump – there is a lot going on in terms of concerns over the Federal Reserve, Argentina’s possible debt default (already declared by ratings agency Standard & Poor’s), and rising tensions between Russia and the Ukraine.  

By the by, on paper at least, any Argentine default should be irrelevant for the market. That’s largely because Argentina hasn’t had access to global markets for about 13 years. It really is just a court case between the Argentinian government and a handful of investors.

Arguably then, it was the Russian-Ukraine crisis that was more important, especially for European bourses where a string of earnings downgrades or concerns have been issued, mainly because of the intensification of sanctions on Russia. For instance, Adidas issued a profit warnings and is closing stores in Russia. That stock slumped 15% overnight. Royal Dutch Shell, Total and some European banks have expressed concerns about how sanctions may affect trade and the European economy more broadly.

Need Australian investors worry?

Well, there doesn’t appear to be any immediate or direct threat to either Australia or our market. According to the Department of Foreign Affairs, bilateral trade between Australia and Russia amounts to only to $1.79 billion, which isn’t a great deal when you consider that our total trade with the world is about $500 billion.  Russia ranks 31st in terms of trade importance. As far as exports go, the bulk of what we sell includes meat and dairy – foodstuffs basically – and these are largely exempt from sanctions anyway.

The key threat is indirect then – market anxiety, or flare-ups in volatility. And on that front there could be quite a few more. One reason for that is the circularity of the Russian-Ukrainian crisis. This makes it difficult to determine how long the crisis could last and to what extent sanctions would be escalated. In essence, sanctions are in place to pressure and punish Russia for annexing Crimea and supporting Russian separatists in the East of Ukraine.

Russia, in turn, is of the view that it wouldn’t have needed to annex Crimea and support separatists in East Ukraine if the US and Europe hadn’t acted to remove the previous Ukrainian government – hadn’t involved themselves in what should have been regarded as ‘neutral’ territory. They crossed a line, as Vladimir Putin puts it.

Viewed like this, there really isn’t any clear or near-term end to the crisis. The US has ruled out a policy of non-intervention, and Russia has no plans to allow Ukraine to simply be absorbed into NATO (The North Atlantic Treaty Organisation). That suggests that the crisis is likely to get worse before it gets better, as the US is not willing to concede anything and Russia feels like it can’t.

At this point sanctions are only targeting the finance, technology (including technology for energy exploration) and defence sectors. They don’t include energy exports from Russia itself or food, and nor are they likely too. Europe relies on Russia for 30-40% of its energy needs, although some European members are almost entirely reliant on Russian energy – and the cost to the European economy, should things escalate too far, would be immense.

That doesn’t preclude bouts of fear as to where energy prices might head. Russia need only threaten to raise prices in retaliation, for there to be a marked impact on global energy prices. There is no telling how long something like that might last though. On that note, while there is a lot of talk about the US supplying Europe with its energy needs, there is very little chance of that morphing into reality. Europe relies on Russia, and that won’t change quickly.

At worst then, investors only need worry about a temporary energy price spike if Russia decides to match US antagonism. This is great for our large energy producing companies – oil, thermal coal etc – but not great for the economy at large.

My view that any flare-up would be temporary is based on the mutual reliance that Russia and Europe have. Sanctions are ultimately a lose-lose situation. It would be pointless, but pride and bravado can do strange things.

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