Old Embers Never Die

The situation in Ukraine could become worse than markets now anticipate as Putin’s best interests might not be what investors expect.

April 30, 2014   |    By Scott Minerd

Global CIO Commentary by Scott Minerd

So far, financial markets have failed to recognize the potential long-term seriousness of the situation in Ukraine. I suspect this may be because very few investors remember the Cold War period, and therefore, may not always place current events into a historical context. Many feel that having annexed Crimea, President Putin is satisfied with his lot and will not invade Ukraine. If history is our guide, this may be only the beginning of this crisis. It is worth remembering the initial feeling of relief in the United Kingdom after the signing of the Munich Agreement in the fall of 1938.

The belief that the situation will not get much worse is predicated on the notion that all political players ultimately act in the best economic interests of their country. The argument goes that in light of the inevitable sanctions and international isolation that would follow, Putin would not dare advance into eastern Ukraine. However, considering the strategic importance of controlling Ukraine, it can be argued that Putin is in fact acting in the long-term best interests of Russia and would be willing to suffer some short-term pain.

So what does this mean for markets? In the short-term, any “risk-off” trade in Europe will likely be positive for U.S. assets, particularly bonds. I expect to see more capital flow into the United States as a result of this ongoing conflict. Events could also slow the ongoing European economic recovery, stemming perhaps from the potential disruption to gas supplies, although it is unlikely to derail the expansion on the continent. Longer term, heightened aggression from Russia could reduce the pressure to cut the U.S. defense budget.

Heightened Tensions over Ukraine Would Hurt but Not Derail Europe

As the conflict in Ukraine drags on, the probability of more severe sanctions on Russia is increasing. Such sanctions could send Russia into a recession, but the impact would also be felt in Europe. In addition to potential disruptions to natural gas flows, it is likely that European exports and financial activity in Russia could fall, whether due to sanctions or to decreased Russian demand. Though not a substantial portion of European economies in aggregate, Russian exposure is meaningful in countries, such as Austria and the Netherlands. Germany’s trade linkages are also heavier than many other European countries, which may explain its reluctance to apply tighter sanctions.



Source: Haver, BIS, IMF, Guggenheim Investments. Trade data as of 12/31/2013, bank data as of 9/30/2013. Note: AT=Austria, BE=Belgium, CH=Switzerland, DE=Germany, ES=Spain, FR=France, GR=Greece, IT=Italy, NL=Netherlands, PT=Portugal, SE=Sweden, UK=United Kingdom.

Economic Data Releases

U.S. GDP Frozen in First Quarter

Economic Confidence in Euro Zone Dips

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2014, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.


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