March 2022 - Russia tanks its own share market
Investors have sharply turned from inflation concerns to worrying about the impact of Russian tanks rolling into the Ukraine, and the possibility of wider conflict in the Balkans. The big, good news for investors is that they are not fearing for their lives and fleeing their homes, like nearly a million Ukrainians are currently being forced to do. But the reality is that readers of this article will, understandably, also be concerned about the likely impact this conflict on their equity and bond investments.
The financial market and economic impacts can clearly follow a number of different paths but there are certainly central scenarios we are likely to see unfold. The first fairly clear outcome is that any Russian shares or bonds you own are in the process of being very heavily marked down but the good news, if you can call it that, is that your ability to join the panic selling has been heavily curtailed. The Bank of Russia closed its MOEX stock exchange effective Friday 25th February.
A few investors had already decided to exit stage left and sell at whatever price they could get. The chart below is the MOEX Russia index which is their main equity index. It’s a market weighted index that represents their 50 largest listed companies. It shows what a quick 50% sell off before they closed the exchange looks like.
Chart showing the impact of the conflict on Russian shares
While the closure of the Russian stock exchange has stopped investors panic selling Russian domiciled shares, where there is a will there is still often a way. And in this instance the way is to sell NYSE listed ETFs that track the Russian share market. Below is the iShares MSCI Russia ETF which has continued to trade despite the closure of the Russian stock exchange. While BlackRock, the issuer of units in the iShares MSCI Russia ETF, suspended the creation of any new units, it allowed the ETF to continue trading as a closed end fund. This allowed panic selling to continue and in the four trading sessions thus far since the close of the exchange another 50% has been wiped off this proxy of Russian shares. Certainly a chance to catch a falling knife!
Chart showing that investors can still panic sell Russian ETFs listed on the NYSE
The reality though is that a very limited amount of investors outside of Russia have more than a negligible exposure to this share market implosion. Russia had a weighting of around 3% in MSCI's emerging market benchmark and a weighting of around 30 bps in the MSCI World index. So, it’s likely that a New Zealand-based balanced investment fund, with 50% in equities and 50% in bonds, has somewhere between 0.01% and 0.10% exposure to Russian shares.
However, the next likely flow on effect of the conflict has the potential to be far more significant for such balanced funds. Economic sanctions that have been placed on Russia are having a major impact on many commodities, such as crude oil. As the third largest exporter of oil, Russia supplies around 10% of the world’s crude oil. The current sanctions will restrict that supply into the system just at a time that global demand is rising due to economic activity picking up post virus restrictions. The chart below shows how that combination has seen crude oil prices jump by over 25% in recent days.
Chart showing crude oil futures spiking higher
European natural gas prices have also gone hyperbolic, prices there have doubled in the past week. While such price responses to imminent supply constraints are unlikely to be permanent, they represent a potential existential problem for central bankers seeking to control inflationary pressures. It’s effectively spraying lighter fluid on the nascent flames of inflation.
Already Jerome Powell, Chair of the Federal Reserve, has made it clear that any further signs of rising inflation will see their first move a 50bps increase to their OCR. Due to these spikes in commodity prices in response to the conflict in Ukraine it’s rapidly becoming much more likely that it will be a 50bp move by the Fed at their next meeting. This would be a clear signal of increasing upward pressure on bond yields which in turn will weigh heavy on local investors with balanced investment funds that have 50% invested in bonds.