Bad things come in threes: Geopolitical, economic, and policy uncertainty increased due to the military standoff at Ukraine’s borders
Global markets entered the current week on a weak footing as the Ukraine crisis escalated further, worsening the prospects for growth (lower) and inflation (higher). Russia recognized the independence and sovereignty of the self-proclaimed People’s Republics of Donetsk and Luhansk, located in eastern Ukraine. Moreover, Russia decided to deploy military troops in these two regions.
The international community’s response is still taking shape, with an emergency meeting of the United Nations Security Council being called. For the time being, the US decided to prohibit new investment, trade and financing by US persons to, from, or in the aforementioned regions of Ukraine. At the same time, the US, the European Union, the United Kingdom and Japan have pledged to impose significant economic sanctions against Russia, with details expected soon.
Looking forward, the latest developments argue against a swift, diplomacy-driven, resolution of the ongoing geopolitical crisis, with a full-scale military conflict in Ukraine remaining a major risk.
The MSCI ACWI has declined by -2.3% in February (-7% YtD), with Developed Markets (-2.7% | -8% YtD) underperforming their Emerging peers (-1% | -1% YtD). The Eurostoxx50 index has decreased by -2.2% in February (-7% YtD).
On Tuesday, the Eurostoxx50, which initially fell by 2%, broadly erased losses at the time of writing. Long-term Government bond nominal interest rates have been slightly up at +1.95% (US Treasury) and +0.27% (Bund), following their early-trading declines. Having said that, the dispute between Ukraine and Russia is expected to continue to generate volatility.
Euro area equities’ valuations have headed south in the past six months, with the 12-month forward P/E ratio declining to 14.2x from 17.6x in July and approaching its 20-year average (14x). On the other hand, expectations for 2022 corporate profitability have drifted up by 9% to circa €278 per share in the same period. An environment of decelerating economic growth due to escalating geopolitical tensions could drive EPS revisions lower.
While euro area imports (from) and exports (to) Russia are circa 0.5% and 0.6% of GDP, the skewness of imports toward minerals and fuels suggests asymmetric risks to euro area outlook. Note that Europe depends on Russia for circa 25% of its oil imports, 40% of its natural gas imports and 45% of its coal imports.
In terms of leadership, Energy stocks have increased by +2.4% in February, widening their YtD gains to +21%, as oil prices climbed toward $100/barrel reflecting the likelihood of a substantial disruption to Russian crude oil supply with exports of 4.5M barrels/day (production: circa 11M barrels/day). The Dutch TTF Gas March 2022 contract increased by 8% to EUR79/MWh on Tuesday.
Euro area Technology stocks have declined by -9% in February (-20% YtD) as rate-sensitive long “duration” stocks have lost ground amid rising real interest rates. Equally importantly, have underperformed their US peers, with the Nasdaq’s Composite index (-13% YtD) 50-DMA declining below its 200-DMA.