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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February 19, 2023

Ukraine One Year On – Did Everything Change?


It is time to reflect on the last 12 months and update my thesis. Almost a year ago, after the Ukraine invasion, I wrote a piece called This Changes Everything. The previous 12 months have been bumpy and uncertain, but did everything change? Spoiler alert, the answer is no, but it has changed quite a bit.

Europe & NATO

A year ago, I wrote, NATO has lacked purpose for the last 30 years, and US strategic interests have been steadily diverting away from Europe; this has now changedThis analysis is broadly correct. NATO certainly has a new sense of purpose, and new member requests from Sweden and Finland in May 2022 take the number of new countries wishing to join NATO to five. (The other candidate countries are Bosnia Herzegovina, Georgia and Ukraine).

The US led the field on military aid to Ukraine, donating more than all other countries combined and five times more than the next largest donor nation. At the same time, the European Union supplied lethal arms through its institutions for the first time in its history. Despite being criticised for a slow response, the leading EU countries, Germany and Sweden, have reversed past policies against providing offensive military aid to support Ukraine.

Compared with a year ago, Europe does seem more united, with the UK on the verge of seeking a deal over the Northern Ireland protocol and the newly elected Italian government under Georgia Meloni playing well in the Eurozone tent. Even the tensions between Brussels and the “hard men” in Warsaw and Budapest are less fractious.

Energy Independence

A year ago, I wrote that 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. Europe’s success at kicking the Russian gas habit has been quicker than most believed possible a year ago. Consequently, lower-income countries could not get supply, but Europe avoided burning its furniture to keep warm.

Germany demonstrated that when the chips are down, it is possible to build an LNG importation facility in five months rather than the typical five years. So successful has this strategy been that the European natural gas price is now below where it was before the invasion and some 85% below the peak in June 2022, albeit the price remains roughly twice the average for the previous decade.

As for fracking, the UK tried this along with other supply-side reforms under the 49-day Truss administration, but like her premiership, it did not survive contact with political reality. However, a feature of 2022 was that the world, particularly Europe, burnt more coal. The coal price, which doubled in H1 2022, like gas prices, is now below the level of 12 months ago.

Regarding nuclear, Europe generated less energy in 2022 from this source. There were several factors, but the main one was French reactor closures for maintenance and low river water levels during the summer. While Germany delayed reactor closures, Belgium continued to close more of its perfectly operable nuclear capacity. However, the dialogue in Europe has changed, and nuclear energy is now officially part of the EU taxonomy for the green energy transition. Additionally, for the first time, the nuclear power industry was invited to a COP summit.

Europe avoided rolling blackouts, although keeping warm even during a mild winter has proven exorbitantly expensive to individuals, industry and governments alike. In addition to the broader acceptance of nuclear as an acceptable baseload contributor to our energy mix, there has been increased realism concerning the issue of energy security.

While Russia shut down the Nordstream I pipeline for “extended maintenance” in the summer, someone made sure this became semi-permanent by blowing it up along with its unused twin in an unclaimed act of industrial sabotage. The governments of Denmark, Sweden, and Germany have all launched investigations into who did it, but six months on, we have not heard anything. An uncorroborated account published by the veteran American investigative journalist Seymour Hersh saying it was American special forces in collaboration with Norway, has yet to be seriously considered by the mainstream media and political parties of Europe. [Myteriously, my summary of Hersh’s well-written article with a link to the 5000-word substack posted on LinkedIn was removed last week. So far, I am wearing my cancelled status with pride].

PM Sunak has signalled greater realism over energy policy by recreating the old Department for Energy under the new Department for Energy Security and Net Zero. What’s in a name, you may ask? I suspect Boris and Cameron would have done what I expect Starmer to do when elected and re-prioritise Net Zero over Security.

Financial Contagion

A year ago, I wrote that 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. The reality is that while the Ruble USD exchange rate, Russian GDP and interest rates have been highly volatile, Russia is still in the game.

Russia’s policy rate of 7.5% is where some FOMC members think the Fed Funds rate should be. Its inflation rate is similar to Europe, and it is coping without access to the western banking system or financial markets. Maybe sanctions are like fishing with a hand grenade, and we are in the delay between the thud and the bodies floating to the surface. It is hard to know, but the evidence is that Russia has done a better job of financial than military preparation for its act of war.

There is no denying that Western markets and economies struggled in 2022. But tighter monetary conditions and higher interest rates due to the non-transitory inflation in our economies before the invasion were the main culprits. The extent to which we are fighting Putin’s inflation, energy costs included, will be debated by historians, but blaming Russia, Putin, the war, and Uncle Tom Cobbley are all ultimately helpful political opt-outs.

But whatever the causes of our poor economy and markets in 2022, the reality is that we did not experience a financial crisis. The UK tried its best but stepped back from the LDI gilt market cliff edge just in time.

Economic and Financial Decoupling

The assessment that the West would restart monetary easing is what I got most wrong. A year ago, I wrote that there is a high probability of political and social unrest in places not closely associated with Ukraine or Russia… [and] a [high probability that] the pace of rate hikes will slow 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. OK, I may get a bonus point for the comment about the UK getting caught in the middle.

Sri Lanka, Lebanon, Argentina, Pakistan and Ghana have all had consequential economic crises and social disorder. The strengthening dollar and spiking energy and food prices (denominated in dollars) combined with dollar-denominated debt served as a poisonous cocktail for poorer countries unable to compete for resources with richer Northern hemisphere countries.

While I was wrong about the scope for easing of rates, the point remains that the US economy has endured the last 12 months in much healthier condition than any other large economy. As we face the most widely anticipated recession in memory, the Fed retains the only credible threat that it could move its policy rates up significantly from the current level. Fortunately for the rest of the world, the markets don’t believe they will do it and remain tied to the pivot petard. The dollar wrecking ball is no longer in full swing.

More G and Less E&S

A year ago, I wrote that 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. OK, we have yet to turn Lancashire into the fracking capital of Europe, but both BP and Shell have moved the goalposts on renewable energy commitments and green transition timetables. In the face of increasing investor resistance, Unilever has ditched its product-with-purpose mantra and is adopting a more traditional product-for-profit strategy.

But, it would be mistaken to assume that trends away from ESG targets to more traditional financial metrics resulted from the war in Europe. The normalisation of interest rates also plays a part. The revaluation of the present at the expense of the distant future increases the reward to management teams who cut out expenditures without a short-term payback. (For details, see the 100% increase in the Meta share price since Zuck drank the financial efficiency Kool-Aid). In reality, Shell and BP benefit from investing in hydrocarbon extraction. See Exxon Mobil for details.

As for the improved G, the governance consequences of the Russian infiltration of London’s property and financial markets, we have seen mixed results. Several large listed companies have disappeared from the London Stock Exchange. However, little of consequence has come of the army of legal, accounting and financial enablers of Russia’s looted wealth still resident in our economy.

Europe never considered the Russian government’s behaviour an ESG issue before February 2022, never mind its long-running human rights abuses, invasion of Crimea and operations in Syria. Now we see it for what it is. While we are now prepared to sanction Russia and send offensive weapons to push them out of Ukraine, we are ready to outsource the financing of our professional football obsession with blood money from the Middle East.

China & Taiwan

I wrote a year ago that 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. What was unclear in February last year was just how mired China was in its zero COVID policy. With China now opening up faster than expected, the main impact has been to help delay the impact of the recession on the rest of the world, particularly the US and Germany.

In addition, China’s loosening monetary policy has helped a world starved of financial oxygen by 2022’s rampant US$. Arguably the combination of China’s reopening and financial easing with the US Treasury’s use of its General Account with the Fed to mitigate the looming Government Debt Ceiling that has boosted Dollar liquidity so far in 2023 and helped markets party without the Fed’s punch bowl.

Of course, we don’t know if the invasion of Ukraine increases or decreases the likelihood of China invading or blockading Taiwan. But over the year, as we face the point where India takes over from China as the most populous nation, China risks losing its moment to act. China now knows the West won’t sit back and watch as it marches into Tapei. If the Chips Act serve its purpose, there will come a time when TSMC’s fabs are no longer a guarantee of peace in Taiwan. Whoever blew up the Nordstream pipelines might one day feel relaxed about collapsing TSMC’s clean rooms.

The invasion of Ukraine has changed many things, but it hasn’t changed everything. We have fought against inflation and avoided recession and financial crisis. Our investment universe is devalued but remains intact, yet it continues to evolve. The normalisation of interest rates has created more value opportunities, while the recent (temporary) loosening of financial conditions has created a “Party Like It’s 1999” rush to risk assets. As a result, 2023 has seen a mini rerun of an unsustainable everything rally. But the harsh reality is that the war in Ukraine, like COVID before it, is becoming endemic—another factor to consider in our assessment of the future.



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