Every winter, here in eastern Massachusetts, we are visited by Nor’easters. Each storm is plotted on weather maps days in advance. A low pressure area swoops down from the Rockies, gathers moisture in the Gulf of Mexico, rides up the east coast over the warm waters of the Gulf Stream and then stalls in the Gulf of Maine, churning into its full intensity. Every storm has the potential to turn into a blizzard. But whether it does or not depends on two things: First, what is the exact track of the center of the storm and second, how much cold air is in place before the storm arrives?
In the same way, the investment implications of the gathering storm in Ukraine depends both on how far the Russian president is willing to escalate the crisis and the economic and financial backdrop as the situation begins to unfold.
On the first issue, it is useful to consider two broad scenarios.
The first, a partial invasion of Ukraine, is already underway. On Sunday, President Putin signed decrees recognizing two regions in the east of Ukraine, Donetsk and Luhansk, as independent republics and ordered Russian troops into the area to perform what he described as “peace-keeping duties.” In response, the White House announced that President Biden would sign an executive order barring Americans from investing in, trading with or lending to these regions. It could be that this annexation will satisfy Mr. Putin for now and, if that is the case, it will have limited global repercussions.
However, given the buildup of Russian forces on the Ukrainian border, a second scenario of full-scale invasion is also very possible, involving tanks and artillery blasting their way into Kyiv. This, with all the horrific civilian casualties that it would entail, would undoubtedly lead to a more strident western response.
Having spent months trying very publicly to talk Putin off the ledge, political leaders such as President Biden, President Macron of France and Chancellor Scholz of Germany would feel huge pressure to make sanctions very painful for Russia and for Putin’s supporters. The U.S. Senate has already compiled a list of sanctions and a bipartisan majority would likely quickly agree to measures to seriously hurt Russian banks, limit trade, and penalize western institutions that continued to deal with Russia.
In addition, European leaders might feel compelled to cut off imports of natural gas and oil from Russia, despite the very serious economic pain that this would entail. Putin could, of course, turn off the energy tap himself in reaction to Western sanctions. However, in either case, the long-term consequences for Russia would be very severe, as Europeans would likely, belatedly, resolve to never again make themselves energy dependent on the whims of a Russian leader.
A third scenario of even further escalation is also possible. Putin could launch cyberattacks on European and U.S. targets. This would, however, be both counterproductive and dangerous. It would be counterproductive, as the west would likely do the same to Russia. It would also be extremely dangerous, given the obvious and horrific potential end game of any series of escalating retaliations among the world’s biggest nuclear powers. We can only hope that Putin has enough sense to avoid such a path. However, it is troubling to consider that, by invading Ukraine, given its cost both in lives and long-term damage to Russia, Putin would be confirming how much he lacks both basic humanity and strategic foresight.
As U.S. investors consider these scenarios, it is also important to consider the current state of the U.S. economy.
On economic growth, last week’s January retail sales report suggested that the Omicron wave may have done less damage to the economy than initially feared. We expect this Thursday’s GDP report to show an upwardly revised 7.5% growth rate for the fourth quarter and this could be followed by between 1% and 2% growth in the first. In addition, as the pandemic continues to fade, we expect real GDP growth of close to 5% in the second quarter with service sector activity rebounding strongly.