Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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March 4, 2022

This Changes Everything

There are decades where nothing happens; and there are weeks where decades happen“–Vladimir Ilyich Lenin.

Things have changed over the past week. Not since the 1970s, maybe even the 1940s, have we seen geopolitics, macroeconomics, and financial markets in such intertwined turmoil. Russia’s invasion of Ukraine has initiated a period of radical uncertainty that will serve up more changes as second and third-order consequences play out. The following is an attempt to highlight the main changes to the fundamentals that we have already started to see. The hope is that it can help us understand the changing investment landscape ahead and how we might prepare for some of its consequences.

· Europe & NATO


NATO has lacked purpose for the last 30 years, and US strategic interests have been steadily diverting away from Europe; this has now changed. Europe is staring down the barrel of a gun. The clearest signal is Germany’s intention to spend 2% of GDP on defence. The unanswered questions for the Eurozone remain debt mutualisation, a common fiscal policy and joint defence. These thorny issues will be looked at again. We are likely to see the most significant European political re-set since the end of WW2. This process will generate much political heat, we could easily see a re-run of the Eurozone debt crisis.

· Energy Independence


Europe’s Russian energy habit will be kicked. Like any addiction, it is painful to do quickly. But over time, Europe will import more LNG, keep nuclear power plants open for longer (and maybe build more), re-examine the case for fracking and yes, we will be burning more coal. The West wants to reduce its dependency, but there is a non-zero risk that Russia might turn off the gas unilaterally. (It is an ironic but not coincidental fact that the gas Europe has built its dependency upon runs through the middle of Ukraine). I can remember the three day week and rolling power cuts of the mid-1970s, we might revisit these times.

· Financial Contagion


The primary Western response to Russia is to isolate it economically and financially. The Russian financial system is close to collapse. There is a risk that the West suffers a blowback into its banking system, and we get a 2008/9 repeat. However, our banking system is now more resilient, but the financial tide has gone out for Russian assets, and we do not know who is funding many of these now stranded and potentially worthless assets. Certain asset classes, including London mansions and luxury yachts, have become mispriced and over-owned by oligarchs. (Just a hunch, but I would imagine CS might have to send up a distress flare or two).

· Economic and Financial Decoupling


Ukraine is a European war, and the main costs associated with it will land in Europe. European natural gas prices are currently 7-8x higher than in North America. There is now an unprecedented arbitrage opportunity for any manufacturer using N American natural gas as an input that trades its products globally. Europe is heading towards a manufacturing recession; whole sections of its manufacturing industries are uneconomic. Meanwhile, the elevated oil price (more fungible than natural gas and hence more widespread) will significantly contract global consumer spending. The high price of other commodities and shortages of foodstuffs such as wheat risk the conditions last seen before the Arab Spring. History and economics inform us that poorer nations that tend to import energy and foodstuffs will suffer disproportionately in this scenario. There is a high probability of political and social unrest in places not closely associated with Ukraine or Russia. Finally, the pace of rate hikes in the US is slowing down, and in Europe are likely to be slammed into reverse, further decoupling credit cycles. As usual, the UK will probably be caught in the middle. With its own food and energy supplies and holding title to the world’s reserve currency, the United States should be a relative winner in this scenario.

· More G and Less E&S  


The West (and the UK particularly) has just fully realised how the Russian oligarchy has taken its property rights and market-based trading system for a ride over the last 20 years. A political backlash is underway. There will be a much stricter stance on financial transparency and corporate governance in the future. In this process, the E and S of ESG are likely to be unseated as the investment world’s pre-eminent obsessions. As of today, we will need a greater acceptance of oil and guns. There are threats now hanging over the intermediaries in London (and elsewhere) who have aided the washing of oligarch wealth over the last 20 years. Expect to see a crackdown on lawyers, estate agents, bankers and wealth managers who have enabled access to our laundromat for Russian unexplained wealth.

· China & Taiwan 


Despite the mutual support shown by China and Russia at the Winter Olympics, China abstained from the UN vote over Ukraine. What Putin has done will have a bearing on how Xi and the CCP pursue their claims over Taiwan. Although it remains unclear how this might play out, for the moment, Putin would appear to have spoilt things for China in his miscalculated excursion. This is unlikely to diminish the West’s appetite to source its semiconductors from places other than Taiwan. (Once bitten etc).

Russian actions in Ukraine over the past week have changed everything. The Western world has had a wake-up call and is assessing how to deal with a common threat to its future. Russia has revealed its hand and other nuclear enabled authoritarian regimes, such as China, will now be assessed differently. The invasion of Ukraine could end quickly (via military coup, internal Russian unrest or assassination) or it might endure for years. Either way, there will be fundamental implications for how our resources are allocated and what political choices we make.

It is far too disrespectful and premature to talk of any silver linings from events as grotesque as happening in Ukraine right now. However, the reality is the West’s liberal democracies built on property rights, markets and capitalism have previously endured similar threats and grown stronger as a result. Spontaneous order is complex, adaptive and antifragile. Autocratic dictatorships are centralised, prone to instability and contain existential flaws. The long arc of our history is not on Putin’s side. It is right to remain positive, as Churchill said, “I am an optimist, it does not seem much use being anything else”.

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