Investing

Market Implications of the Russian Invasion of Ukraine

At Alerus, our investment philosophy and process are to take a long-term view and to prudently manage risk through asset allocation. This philosophy extends to periods of global economic change.

Following Russia’s military attack on Ukraine, the international community has responded forcefully with sanctions against Russian oligarchs, financial institutions, and other parts of the Russian economy. While the actions in Ukraine are an obvious tragedy, they were not unexpected due to the lengthy staging actions by the Russian military. Considering the increased geographic risk profile over the last few months, we curtailed our overall portfolio risk as we sought a more neutral stance. We are also closely monitoring key commodities impacted as a result of the conflict in Ukraine.

We expect energy supply to be a key area of focus throughout the conflict as Europe is heavily reliant on Russian natural gas for residential and industrial heating. According to the International Energy Agency, Russian gas supplied 32% of Europe’s total gas demand in 2021, up from 25% in 2009. Any disruption in supply could be detrimental to the European economy given limited alternative supply sources in the near term. Russia also plays an outsized role in the global oil markets as the third largest oil producer behind United States and Saudi Arabia, as the world’s largest exporter of oil to global markets, and as the second largest crude oil exporter behind Saudi Arabia.

Agriculture commodities will also be another key area of concern, as prices had already experienced strong increases in late 2021 and 2022 due to supply chain and COVID-related disruptions.  Russia’s invasion of Ukraine has further added fuel to that inflationary fire with the most severe impacts to two of the world staple grain markets – wheat and corn – both at multi-year highs. Countries that rely on imports of these two critical food commodities are now seeking alternative supplies and have concerns about food inflation and hunger.  Such progress may be slow however, due to Russia and Ukraine accounting for more than a quarter of global wheat trade and nearly a fifth of corn.

Given the fluid nature of the situation, we believe the prudent course is to maintain our neutral stance — while looking to add to preferred positions during bouts of extreme volatility.

Historically, high quality bond portfolios — with allocations to U.S. government backed debt — typically perform well during such periods of uncertainty and may provide a cushion to equity market volatility. Our belief that this will again be the case underpins current fixed income portfolios and reflects our belief of broad diversification through asset allocation.

While inflationary pressures remain a concern, the bond market has shifted its focus to the military action, sanctions, and longer-term economic impacts. Safe-haven demand for Treasuries has caused short-maturity issues to drop in yield and prices to rise. The decline in the two-year yield reflects the prospect that the Fed will move more conservatively than previously expected. Markets had suggested earlier this month that a 50-basis point hike in March was possible, but now it appears that a hike of 25 basis points is more likely. Further out, two hikes are priced in by the end of the May meeting, and three hikes by the end of the June meeting. Thus, a minor silver lining to the conflict could be lower-for-longer interest rates.

This content was authored by Sunil Swami, Chief Investment Officer, Alerus