First week of conflict: how stock markets are reacting

The attacks by Russian troops on Ukraine continue to put the markets on edge, with no way of predicting the true consequences of not only the armed conflict, but also the decisions made in the economic arena to stop Russia's advance. For the time being, according to Alberto Matellán, chief economist at MAPFRE Inversión, in an interview on Radio Intereconomía, “the markets’ reaction to the conflict has not been as catastrophic as we might have expected.” In the expert’s opinion, as the invasion progresses, the markets’ behavior will depend on both the duration of the crisis and “the decisions that will be made by the central banks,” especially the ECB. “The longer the conflict lasts, the laxer monetary policies will be, which will affect the markets,” he stated.

Despite this turmoil, the hope remains that the dust will settle, and every diplomatic solution will be exhausted until the last moment. But the United States has expressed more skepticism in this regard. Although Biden warned in his State of the Union speech that Putin would pay a high price for invading Ukraine (if he is not already paying through sanctions), U.S. intelligence has hinted that “the worst is yet to come.” After all, according to Daniel Sancho, head of investments at MGP, “when you have a blank canvas there are always risks, but the current ones are quite serious.”

Therefore, the challenge for the European economy (more so than the U.S. economy) over the coming weeks will be the presence of severe risks. In what way? On three fronts:

• Lack of confidence. Alberto Matellán believes that this aspect “generates instability,” albeit indirectly, but no less importantly. While this uncertainty was previously driven by other factors, the current situation is adding fuel to the fire, “and it will be difficult to predict the consequences of all this,” Daniel Sancho asserted. This is reflected by the VIX (volatility index), which has picked up on investors’ fears and is currently at its “highest levels since October 2020.” What is the problem? In MGP’s opinion, there is a lot of noise. “We’re seeing lots of short-term news that only serves to generate volatility around risk assets,” the expert explained. Therefore, investors are now turning to more defensive positions, such as fixed income, with the aim of avoiding greater problems in their portfolios.
• Higher inflation. Russia is an important provider of energy to Europe, whose prices could push the price level above 6.5% (currently at 5.8% in the Eurozone). Although the oil rally is expected to continue its upward course, MAPFRE Inversión points out that the concern is that pressure on inflation will “ultimately be passed on to salaries.”
• Lower growth. “A rise in inflation decreases purchasing power, which reduces cash flow and investment.”

The fact is that the recent economic sanctions imposed by the West have shown that we are facing a de facto “economic war”: the crash of the ruble, the exodus of foreign investment, and the expulsion of Russian banks from the SWIFT international payment system have left Russia in a financially weak position. Although the most direct consequence is the deterioration of the Russian economy (which, by the way, is a problem not only for the Kremlin, but also Russian citizens), Alberto Matellán noted that sanctions could take their toll outside the country. The risks are: “Putin could look for trade alternatives in China; being excluded from SWIFT, some loans from Europe are not collectible; and, if assets in dollars are frozen, it could become the wrong currency to hold capital.” In any case, the pressure on Putin will continue (we don't know for how long), but as the experts know, a weakened enemy can be even more dangerous.

One of the problems making investors’ heads spin is the incessant news. In Daniel Sancho's opinion, we are facing a situation with lot of noise. “We’re seeing lots of short-term news that only serves to generate volatility around risk assets,” the expert explained.

The current context could trigger structural changes in portfolios, with investors moving “towards more defensive positions.” According to Matellán, this movement should take place “if you are not comfortable with your position” and “with an advisor's help.”