War between Russia and Ukraine will lead to stock market crash, economic chaos

If you thought the stock market sell-off to start the year was ugly, prepare yourself: Wall Street’s most elite investors are bracing for an even deeper market shock as the war in Ukraine continues.

In my conversations with some of the top executives in finance, many of whom spoke to me on the condition of anonymity to speak candidly about where the market is headed, a consensus emerged: Russia’s invasion of Ukraine has changed their predictions. a stock market down. “washout” in hyperdrive. The murky global economic picture, clouded by supply-driven inflationary pressures, is now even more complex and uncertain. And the shifts that turned some of the market’s high-flying winners into losers are only becoming more apparent.

“The Russian invasion of Ukraine accelerated the slowdown, and it accelerated inflation,” a billionaire value investor told me.

Beyond the crowd

volatility

that the invasion will continue to inflict the markets, the war is also forcing Wall Street into a frenzied gut check. It’s not just the US government that wants nothing to do with Russia. It’s also Wall Street’s customer base.

So the challenge for Wall Street’s biggest investors is threefold: build a portfolio that will survive the leach out, make sure you don’t hold any Russian assets, and for God’s sake give back Russian clients’ money before old Uncle Sam lowers the boom.

Market clutter and a ‘crushing recession’

Vladimir Putin’s decision to invade Ukraine added another shock on top of a year already marked by a massive economic turnaround. The

Federal Reserve

and other policymakers in the US have tried to walk a fine line, raising interest rates just enough to curb historically high inflation without pushing the economy into crisis.

recession

† That much hasn’t changed: inflation is showing no signs of slowing so far, and the Fed’s plans to raise interest rates to combat it mean debt is already getting more expensive and loans more difficult to access. In turn, investors are becoming more risk averse, punishing the stocks of companies that have relied on cheap debt to fuel speculative growth – many of which have been the darlings of our seemingly unstoppable stock market for the past two years. All this leads to a nasty stock market decline.

Putin’s war has not changed the shape of this market shift, but is making the evasion even more aggressive. Other than “a revaluation of defense contractors,” the value investor told me, the stock market hasn’t fundamentally changed. It just got more insidious.

The lightning bolt of destruction of Ukraine and of Russia being pushed out of the global economy has added scarcity to a world already struggling with shortages of critical goods and the inflation that these shortages have created. The war is endangering the world’s supplies of oil, steel, wheat, fertilizers and other goods. Together, Russia and Ukraine export more than 25% of the world’s wheat supply. Russia is also a major exporter of fertilizers. The UN warns that this conflict could lead to global food shortages. The food left over becomes more expensive, exacerbating inflation.

And then of course there is energy. Russia supplied the world with just under 10 million barrels of oil a day before Putin attacked Ukraine. Since then, the US has stopped imports and the EU has been working on a rapid phasing out of Russia’s energy supply.

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Ultimately, without technology from American and European companies like Baker Hughes, Halliburton and Schlumberger, Russia will also struggle to extract oil from its territory, geopolitical analyst Peter Zeihan said. Oil prices have been everywhere since the invasion began, mostly rising in response to the carnage, with the occasional dip as the market tries to figure out how much oil we’ve really lost.

Earlier this week, the International Energy Agency predicted that Russia’s oil exports would fall by 3 million barrels a day next month, but one person I spoke to, a Singapore-based hedge fund manager who focuses on commodities, believes sanctions evasion could hurt the economy. losses will dampen as Russia pushes its gas through countries like China.

“I think oil prices could go a little higher as these problems wear off, but I’d be surprised if prices were higher in June than right after Russia’s attack,” they said. “I think some of this will be manageable once the Chinese figure out how to smuggle goods out of Russia, and they will.”

In the meantime, low-income populations could face what the fund manager described as a “crushing recession.” In the US, low-income Americans spend an average of 8% of their household income on energy costs, from filling their gas tanks to keeping their lights on. In the EU, this figure can rise to over 12% in countries such as Romania. Even before Putin’s attack, researchers estimate that 80 million households across Europe struggled to keep warm, so when prices rise it hurts.

“The problem Europe currently has is figuring out how to quickly reduce absolute gas consumption and help the most vulnerable people,” they said.

If the EU doesn’t solve these huge problems, it threatens to force low-income citizens to choose between heating their homes or filling their stomachs. It risks eliminating shifts in factories, hitting workers’ wallets even harder. It risks political unrest. At the moment, the West’s top priority in supporting Ukraine is to maintain a united front against Russian aggression, but all this is not good for economic and social stability.

All this amounts to a temporary but indefinite period of chaos. Prices for supplies will skyrocket; central banks will fight inflation by raising rates; and money will be harder to find. While there may be money to be made as the turmoil spreads, the fundamental shift underway in the market—an ugly, painful transition from growth stocks to value—has not changed. The swings will only get wilder, as anyone trying to survive a bear market rally in mid-March can probably tell you. Without warning, the tech-heavy Nasdaq — which was languishing — ripped more than 8% in one week. In a market like this it could just as easily collapse even harder the next.

A avoid on Wall Street

While the economic fallout and the fallout from the war in Ukraine will take months, Wall Street’s struggle to get rid of toxic Russian assets began quietly but soon after Putin invaded. Before Goldman Sachs kicked off the big banks’ exodus from Russia, before Citigroup and Deutsche Bank cut their losses and followed suit, before hedge funds started cutting off their Russian oligarch clients — emails and phone calls flew through Wall Street, demanding that Russia is shunned.

“We can’t tell our clients we’re putting their money in Russian assets,” said Josh Brown, CEO of wealth management firm Ritholtz Wealth Management, which oversees $1 billion in assets. “So we call our asset managers and tell you to bring our exposure down to zero.”

Such calls set off a chain reaction that Russia cannot stop. Asset managers like Brown call their asset managers – companies like Vanguard, for example – and tell them to divest all Russian holdings in their clients’ portfolios. These huge asset managers then call the companies that make indexes like MSCI, State Street (which makes the SPY index) or the London Stock Exchange (which makes the FTSE Russell) and demand that Russia be booted off the indexes – erasing Russian investments from virtually every US retirement account and millions of investment portfolios. Because asset managers like Vanguard make trillions of dollars, the index-making companies comply. For example, on March 4, Russian assets were kicked out of the FTSE Russell.

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It will be difficult to undo this exclusion from the financial markets, partly because customers are unlikely to embrace Russia any time soon, but also because Russian assets have entered a sort of limbo. They have become part of a fire sale where customers can only showcase.

“Basically, all the assets they have on hand should go to zero and then be written off,” Brown said. “Nobody is buying these assets. You may be able to sell it back to a Russian in three years’ time, but for now there is no liquid market.”

This applies not only to securities, but also to physical assets that once made their owners very wealthy. When BP announced in late February that it was losing its 20% stake in Russian oil giant Rosneft, an experienced hedge fund manager – who had just expressed his guilt over gains in a wartime stock market – simply told me, “that doesn’t work” means nothing.” In his decades of making money you can’t sell something that no one will buy You can’t just leave billions in investments and walk away No one in their right mind would simply relinquish ownership of assets and stake the stake as a loss But these times are not like any other.

It turns out that when there’s war, actually you can just walk away. Especially when it appears that Russia is isolating itself from the global financial system, or as the billionaire investor described it, “going completely to North Korea”.