I often find myself writing about strategic investment issues we are managing on behalf of our clients or discussing big-picture market views from the 10,000-foot level. Today I’m planting both feet firmly on the ground to address a more troubling and granular issue — our immediate views on the unsettled and fluid conflict in Ukraine and, more specifically, its ramifications for markets and investors.
Our strategists regularly share their ideas among our investment teams. Their varied perspectives come from talking with 300+ subadvisors, receiving analysis from independent research shops, and sorting through (too much!) information from sell-side financial firms. This week our strategists distilled their analysis into six key points:
- Current geopolitical uncertainty in Ukraine (a frontier market) and in Russia (5.36% of the Russell Emerging Market Index) is likely to persist over the next several months. However, new developments and political postures are developing daily, even hourly. These heightened risks and associated negative market sentiment reinforce our short-term (up to three months) caution on emerging markets equities and bonds, relative to developed markets.
- In fact, GDP growth had already slowed to a crawl in Russia, and to effectively nil in Ukraine. Therefore, the immediate developments do not change our positive view on the potential for resurgent global economic growth in 2014.
- Economic contagion affecting some neighboring financial markets has already commenced and is likely to continue.
- The difficulties of Ukraine (internal socio-political and/or financial problems undermining domestic growth) are also symptomatic of a similar dynamic in Brazil, Thailand, South Africa, India, and potentially Turkey. However, Ukraine is facing its own idiosyncratic set of economic, financial, social, geographic, and political challenges. In our view, this set of circumstances is unlikely to result in contagion to, for example, Latin America and Emerging Asia.
- We do not expect the tensions in Ukraine, in and of themselves, to generate substantial further upside for safe-haven assets such as U.S. Treasuries and gold.
- For commodity markets, it’s important to note that Ukraine’s economy is import-driven, not export-driven. Ukraine produces a small amount of the world’s wheat. A greater issue for commodity markets would arise if sanctions were to be imposed on Russian commodity exports. In addition, Russia’s natural gas markets, in particular, are at risk of some disruption from the current situation.
Of course, our views are subject to change and could be wrong, when looking beyond the immediate horizon of this Ukraine situation. Still, it’s worth remembering that history often proves “it’s darkest before dawn.” And it is important to note that such strategist observations are just one part of the complex work that goes into making portfolio management decisions. Although different circumstances are at play in each geo-political conflict, while sometimes the markets experience a downturn, often the investment markets respond counter-intuitively to crisis, even rallying in the face of outright military conflict. Still, markets can always experience extreme volatility, regardless of the geo-political circumstances and measuring one’s tolerance for risk when evaluating markets and investments is important.
For our part, we remain vigilant on behalf of our clients, and our team is working hard to understand the nuances between investment safeguards and opportunities. With valuation looking much more compelling and currency depreciation potentially benefiting emerging markets exporters, we will continue to watch for any turn in market sentiment before moving to put more money to work in emerging economies. We remain cautious in the short term, but we see potentially constructive opportunity for those with longer time horizons or those with investments that create limited trading flexibility in the near term.
 As of March 6, 2014, in the Russell Emerging Markets Index: this index measures the performance of the investable securities in emerging countries globally. The Russell Emerging Markets Index is constructed to provide a comprehensive and unbiased barometer for this market segment and is completely reconstituted annually to accurately reflect the changes in the market over time.
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