We could be facing a financial Cold War

As tensions between the West and Russia increase, and the US imposes harsher sanctions, John Stepek looks at how the threat of financial Cold War could affect the markets.


Russia may have to swallow its pride

A Malaysian Airlines passenger aeroplane was shot down over east Ukraine yesterday.

Nearly 300 people died. My heart goes out to them and their families. It's horrific. That should go without saying.

There's a lot of speculation over exactly what happened, with a lot of rumours and propaganda flying around.

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From an investment perspective, that makes for an easy environment to make mistakes in.

So this morning, I want to look at the facts, and the potential implications.

The facts and the most plausible speculation

A Malaysian Airlines passenger plane crashed over Ukraine yesterday. There was a lot of speculation as to how it happened, with both the Ukrainians and the Russians trying to blame each other. The US later confirmed that the plane had been shot down.

The plane was flying at around 33,000 feet. That suggests more sophisticated weaponry than the sorts of shoulder-mounted rocket launchers we all associate with pictures of insurgents' around the world.

(And in case you're wondering as I did when I first heard the news why the plane was flying over what is effectively a warzone, it was at a height deemed safe by international aviation authorities).

As I'm writing this, those are the facts.

In terms of the most likely scenario, being covered by the most credible sources it seems that the plane probably was shot down by Russian separatists. Presumably whoever did it somehow mistook it for a military target.

A recording released by Ukraine's security ministry (which may of course not be reliable) seemed to show separatists discussing bringing down the plane. And earlier in the day, a rebel military commander boasted of having shot down a Ukrainian military transport plane.

This is all conjecture for now. Maybe it had nothing to do with Russia. But it certainly makes the situation in Ukraine far more dangerous than it was before now. We're hearing calls from some US politicians to arm Ukraine's military, for example.

The threat of financial Cold War

The crash comes a day after the US had imposed harsher sanctions on Russia, over its support of rebels in eastern Ukraine. These, says Ambrose Evans-Pritchard in the Telegraph, are designed "to choke access to long-term Western finance" and raise the cost of borrowing for Russian companies.

The moves have been targeted particularly at key energy companies. Oil giant Rosneft, natural gas company Novatek, and two major banks Gazprombank and VEB were all blacklisted. That means they're blocked from raising money via the US markets for any period longer than 90 days.

Already this threat seems to have had more impact than earlier sanctions. The Russians who essentially sneered at the sanctions introduced in March were much less happy about this particular round.

You can see why they're worried. The fact that the US has stepped up its sanctions will put Westerners off lending money to any Russian companies at all, for fear of further restrictions.

As the FT notes: "The new sanctions are likely to stop the recent reopening of capital markets for Russian issuers, resulting in higher borrowing costs and growing budget pressures as the government has to come up with a larger share of banks' funding." That could hit growth and state spending on infrastructure.

It also raises the prospect of retaliation by the Russians. The FT quotes one Russian state bank official as warning that US assets in the country would be nationalised. A new financial Cold War could easily erupt.

This latest disaster only makes that more likely.

What you should do if you've invested in Russia

We haven't got the full information on this yet. You've got gold as insurance in your portfolio, you've got some cash in case things get really out of hand, and you've been avoiding the most egregiously-overvalued stocks.

However, I do want to talk about Russia. We have been suggesting that you buy into Russian markets. That's because Russia was and remains among the cheapest markets in the world, and over time, cheap markets get more expensive, almost regardless of what happens.

But I'd be being wilfully blind if I said that this atrocity was something to shrug off. If it turns out that Russian-backed rebels did this, then Russia will have to withdraw its backing for them unconditionally. It will have to swallow its pride in a way that it's not known for being good at.

The US may not be interested in committing troops to the region. As far as it's concerned, this is Europe's patch and Europe should be doing the heavy lifting on that front. And in a way I'm glad of that, because it hopefully reduces the chances of Ukraine turning into a global conflagration.

But on the financial side, the US has a lot less to lose than Europe by imposing far more severe sanctions. And that could hit Russian assets very hard indeed.

So here's my take on it: if you already own some Russian stocks, I'd hold on to them. I still suspect that over a much longer period of time, they'll be valued more highly than they are now.

If you don't, or you're drip-feeding money into Russia, I'd hold off just now. Russian stocks may be cheap, but they could get a lot cheaper if access to global capital markets is shut down. Allocate that money to your cash holdings instead for now.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.