You might be getting bored of reading about Russia and Ukraine.
It’s one of those irritating stories that just won’t go away. You think they’re nearing a reasonable ‘diplomatic’ solution.
You start to wonder if maybe the people who talk about ‘spheres of influence’ and ‘what would the US do if Mexico turned communist overnight’ have a point.
And then it all flares up again as it turns out that it’s all wishful thinking, and that the Russians have no intention of backing off.
Well, don’t get bored. You should be paying attention to this. It isn’t just going to blow over. And the long-term investment consequences could be very significant indeed.
The Ukraine conflict is just the tip of the iceberg
There’s an interesting and scary piece in the FT by Sam Jones this morning (it’s worth a read in full if you get the chance).
In short, he’s talking about how Russia’s actions in Ukraine have set “a high watermark in the art” of covert war.
It’s still not clear what’s going on there. Russia apparently now has plenty of troops inside Ukraine and on the border. Russia, of course, still denies everything.
But it’s about a lot more than military presence in any case. Nato is calling it a ‘hybrid war’ – one that involves a “broad range of hostile actions, of which military force is only a small part, that are invariably executed in concert as part of a flexible strategy with long-term objectives.”
We’re talking about everything from widespread computer viruses attacking utilities across Europe to energy supply blackmail to the use of organised crime as a weapon of the state.
A lot of it is spy novel stuff – in other words, it’s uncomfortably reminiscent of the bad, old Iron Curtain days.
Why a new Cold War would be inflationary
This is a fascinating if depressing discussion in the abstract. And it’s miserable for the people directly affected. But what does it mean from an investment point of view?
Geopolitics is a knotty topic for investors to navigate. Based on the relatively small post-1945 sample size we have, history suggests a couple of things. If oil is involved, war can cause problems – mainly because of the impact on the oil price. And if it involves Western troops on the ground, markets don’t like it either – though usually only until war is actually declared and the pre-conflict uncertainty clears.
I’m not sure that looking at past wars helps much here though. For a start, the idea of sending troops into Ukraine isn’t even on the cards. That would represent an escalation of terrifying proportions.
The most effective weapon against Russia in this conflict is financial, not military. The Russian economy is already fragile and overly dependent on oil revenues. Economic reform is difficult and unpopular, as countless leaders across the globe have discovered. It’s always a lot easier to appeal to nationalist pride.
So, Russia is vulnerable to being cut off from foreign money, foreign trade, and foreign technological expertise.
Of course, this would hurt the companies and countries that trade most closely with Russia. But if the situation continues to escalate, it’s hard to see what other choice they’ll have.
The risk is that this would represent something of a retreat from globalisation. It means companies and countries making decisions about investment, recruitment and trade with political and security implications uppermost in mind, rather than pure economics.
This in turn would mean that we’d lose a lot of the post-Cold War economic benefits we’ve enjoyed. Globalisation has been a largely benign deflationary force. Yes, globalisation is complicated and has its winners and losers and you can debate all that in the comments below.
But the combination of a flood of new workers and consumers entering the global marketplace has kept both wages and prices suppressed. And that’s been at least one major factor that has allowed interest rates across the world to remain low for so long.
A more paranoid, protectionist world, bristling with trade wars and sanctions, is a more inflationary world too. At a time when most things are priced for a ‘new normal’ of persistent deflation, that could mean a lot of nasty surprises for the unprepared.
How to invest now
Russia is dirt-cheap, as Merryn Somerset Webb has pointed out here. But I’ll be honest, this is one opportunity I’m sitting out for now. I think this situation will get worse before it gets better. The risk of asset confiscation or mass bankruptcy is significant enough to put me off investing. If you feel more optimistic than I do, then by all means have a punt – but I’d make it a small one.
A more likely bet – if not a terribly cheerful one – is to invest in defence stocks. Even if you believe that the situation in Ukraine has been overblown and will have a happy ending, government defence agencies are not known for looking gift horses in the mouth. They will milk this situation to argue the case for added spending for all they’re worth.
And compared to lots of other sectors just now, defence stocks are not expensive. For example, BAE Systems (LSE: BA) yields over 4% and has a decent level of exposure to US dollar revenues (which could be good news if the US dollar continues to strengthen against the pound, as it has been).
Regular MoneyWeek magazine contributor, Jonathan Compton, had some other suggestions in his recent cover story on rising geopolitical risk. Take a look at it here (and if you’re not already a MoneyWeek subscriber, subscribe to MoneyWeek magazine).
Cybersecurity is also another massive issue. We looked at some of the best ways to play that in our recent ‘crowdpower’ report – you can find out more about it here.
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