How long can markets keep their calm over Russia?

Markets are taking Russia’s isolation from the global financial system in their stride. But tread carefully, says John Stepek. Things could go bad very quickly.

The progressive cutting off of Russia from the global economy is continuing.

Russian assets are now toxic, much as mortgage-backed bonds were in 2008.

No one wants to hang on to them, and no one knows what they’re worth.

As yet, markets appear to be remarkably relaxed about all this. I’m not sure it’ll last.

The squeeze on Russian assets is growing

Yesterday BP pulled out of its stake in Rosneft, while the Norwegian sovereign wealth fund said it will “divest” from Russia. Shell has now announced that it is getting out of Russia too. Will Exxon and TotalEnergies be next? Quite possibly.

Whoever buys these assets is likely to get a bargain, much as those prepared to buy Russian oil right now will. That said, they’ll also run the risk of falling foul of sanctions. So it’ll be interesting to see who does actually step in.

Mastercard, meanwhile, has blocked several Russian financial institutions. Various Russian companies had trading in their shares halted on the Nasdaq and New York stock exchanges due to uncertainty over the effects of sanctions. Various UK funds investing in Russia have frozen trading.

Elsewhere, everyone is keen to do “the right thing” and to be seen to do “the right thing”. As a result, on the less consequential front, Hollywood studios are pulling releases of new films in Russia, so Russian cineastes won’t get to see yet another remake of Batman on the big screen.

Meanwhile, Canada has banned Russian oil imports (in similar news, I’m hearing that Newcastle has this very morning turned away every last one of the Russian coal boats presently chugging their way up the Tyne).

From an investor’s point of view, what’s interesting so far is that this hasn’t had the sort of effect you might have expected on wider markets.

I’m not going to deny that, by Sunday evening, I was expecting to see a real slide when markets opened on Monday. Not 2008 levels of panic (central banks are now too thoroughly embedded in markets for that to happen easily), but more than we got.

This may be partly because investors hope that there will be some sort of solution. It may also be because, while exposure to Russia exists, it’s discrete and lower than it was when Russia invaded Crimea in 2014. It may also be because investors think that war = less chance of rising interest rates.

But it may also be because they have no real idea what to do or how to price this risk. Markets are very good at putting prices on risk; they’re the best method we have. The problem is that “very good” is quite different to “perfect”, and lots of people in the financial industry don’t really like to draw attention to that difference.

So don’t be lulled into a false sense of security. Just because there hasn’t been a panic yet, doesn’t mean there isn’t one coming down the line. Tread carefully.

Political risks don’t just affect the baddies

And there’s another risk I think investors should be making sure they’re more keenly aware of than usual.

There’s a bit of “goodies vs baddies” fever around right now, so I just want to preface what I’m about to say by stating the obvious. You can believe that Russia’s actions are completely out of order and need to be challenged, and you can be supportive of the sanctions that have happened so far.

You can simultaneously recognise that current conditions – a serious European conflict in the wake of a historic pandemic – provide a great deal of cover for governments and central banks to act in ways that wouldn’t necessarily otherwise be easy to get away with.

On the central bank front, for example, and the knotty problem of what to do about interest rates and the potential effect on government interest costs as inflation rises – well, this is a good excuse to intervene if things get out of hand.

As Eoin Treacy of FullerTreacy Money points out, “yield curve control in service to a war effort is not unusual and control over how banks make lending decisions is also a possibility.”

And it’s not just about who gets access to money and on what terms, it’s about what ownership entitles you to. As owners of Russian assets (and potentially Russian owners of any assets at all, depending on what happens next) are starting to realise, property rights are the base on which is built everything that makes markets and our modern economy work. Without them, the value of any asset is in question.

If you’re reading this, chances are you’re not directly affected by the sanctions. But even as a standard UK-domiciled investor, that security is something you should throw into your decision-making process to think about when you’re investing right now.

The more vulnerable an asset is to interference from the authorities (which includes direct intervention and less direct intervention – eg, taxation), the more of a risk premium you need to demand. In other words, the range of assets where you need to think about political risk has expanded greatly.

I’m not saying you shouldn’t invest in anything politically sensitive, as right now that list ranges from energy companies to resource producers to house builders to defence stocks to media, not to mention anyone geopolitically exposed to Russia or companies and entities still working with Russia.

But I am saying that it’s something you need to think about.

The old rule book we were used to investing by (overriding respect for property rights; expansion of trade was in everyone’s best interests; taxation was best when it was predictable and relatively low; war was senseless; market-based capitalism with a cuddly global face was best) was torn up in the wake of 2008, and it’s still in the process of being rewritten. Don’t take anything for granted.

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