Economic Impact of Russia’s Conflict With Ukraine
I have previously noted that Russia’s mobilization around Ukraine’s borders has important economic implications and should be taken seriously by investors.
It’s one of the reasons why I have bought shares of defense sector stocks like Lockheed Martin (LMT) and Northrop Grumman (NOC). In fact, I’m planning to increase my spending in this sector.
I intend to initiate a stake in Raytheon (RTC). Raytheon plays a key role in next-generation aerospace technology. This includes government contracts for the development of interceptors against a new class of hypersonic missiles.
Russia’s hypersonic missile tests have made the news in recent years. Additionally, adversaries like China and North Korea have also invested in this technology, further raising the stakes. The media attention has no doubt increased political pressure to ramp up defense spending to stave off such threats.
As I’m writing this, the situation in Ukraine seems increasingly unlikely to be resolved diplomatically. The U.S. administration has publicly announced that severe sanctions would be imposed on Russia if it were to move forward with the invasion of Ukraine. The latest intelligence suggests Russia is prepared to invade within a month. Diplomatic talks have gone nowhere.
Let’s consider what will happen if sanctions are imposed.
At a recent State Department press briefing on January 11, Victoria Nuland, who is the Under Secretary of State for Political Affairs, said the following about possible U.S. sanctions against Russia: “We will respond with massive economic measures, including those that have not been used before, and will inflict very significant costs on Russia’s economy and its financial system.”
It’s likely that the administration is considering not just one set of sanctions but various options to respond to a number of different scenarios. However, what’s clear is that Russia’s economy will incur punitive measures.
Since Russia is a major oil and gas exporter, the impact of the sanctions on its energy sector is going to be of primary importance to the U.S. stock market.
Given the global state of inflation, it’s unlikely the U.S. administration will want to make things worse by imposing direct sanctions on the Russian energy sector. There would also be little support among European allies, who are especially reliant on Russian energy supplies. However, there could be indirect fallout.
First, there could be transactional hurdles. Payments for Russian energy exports may become more difficult to handle if Russia was to be excluded from the international payments system SWIFT or if major Russian banks were sanctioned directly.
Second, Russia itself could threaten to cut off energy exports to countries supporting the sanctions. While actually following through on such a threat would also hurt its own economy, the threat alone could spook markets and cause energy prices to increase.
The U.S. may respond by releasing oil from its Strategic Petroleum Reserve. However, that would be a short-term fix only and markets may discount the measure as such.
Higher energy prices could then have a ripple effect on the economy and further boost inflation. The worst case scenario would be a rerun of the 1970s style stagflation, which interestingly enough was also brought about by deliberate supply restrictions in the oil sector, in that case the OPEC oil embargo.
Optimistically, the economic prospects may be less dire than they seem. Over the past decade, the world has overcome numerous challenges and avoided recessions. If the past is any lesson, that may happen yet again.
That said, it’s fair to say that Russia’s conflict with Ukraine adds to global jitters and is ultimately yet another factor in support of higher inflation.
This is important to keep in mind when weighing what kind of stocks to invest in.
In times like these, it is important to consider sectors that are somewhat insulated or even benefit from inflation.
