The fight in Ukraine is unlikely to spill over into a shooting war between Russia and the NATO countries. That doesn’t mean impossible, and investors “should absolutely worry about unintended consequences.”
For the last month or so, investors have been reading the entrails of a beast they’re broadly unfamiliar with – geopolitics – to determine whether Russia’s invasion of Ukraine will turn into something nastier, with even greater consequences for markets and economies. In a far-reaching note, Canada-based BCA Research warns that while there’s unlikely to be a third world war, the world will be more unstable – and that the politically stable developed markets will an obvious safe haven.
“Germany will ultimately cleave to the West, China will ultimately cleave to Russia, a new shatter-belt will emerge from East Europe to the Middle East to East Asia, and US domestic politics will fall short of civil war,” the note says. “Given that US financial assets are already richly priced, global investors should seek to diversify into cheaper international equities that are nevertheless geopolitically secure, especially those in the Americas, western Europe, and Oceania
BCA believes the war in Ukraine will remain limited to Ukraine, as it has been since conflict first kicked off in 2014, unless Russia “faces regime collapse and grows desperate”. Ukraine’s battlefield successes and the materiel support provided by NATO countries make a near-term Russian victory unlikely, “portending further war”. But Russia still has a hope of destroying Ukraine’s military capabilities without destroying its own economic foundations, and “the evidence does not suggest that Russia aims for world war.”
“The war’s limitations are positive for global investors but only marginally,” the note says. “The law that governs the history of war is the law of unintended consequences. Investors should absolutely worry about unintended consequences, even as they strive to be clear-headed about Russia’s limited means and ends (ed.: emphasis theirs).”
“If Russia fails or grows desperate, if it makes mistakes or miscalculates, if the US is unresponsive and aggressive, or if lesser powers attempt to provoke greater American or European security guarantees, then the war could spiral out of control. This risk should keep every investor alive to the need to maintain a reasonable allocation to safe-haven assets.”
Otherwise, Russia’s end-game will likely be the “deliberate or de facto” partition of Ukraine, effectively annexing Crimea and the Donbass, destroying Ukraine’s military capability, and installing a pro-Russian government in Ukraine. While peace talks are currently underway on neutral ground, Ukraine’s reported demands – security guarantees stronger than those that would be granted through membership of NATO, which was cause enough for Russia to get edgy – likely mean they won’t go smoothly.
“Over the course of this year Russia is likely to redouble its efforts to achieve its aims – a summer or fall campaign is likely to try to break Ukraine’s resistance,” the note says. “But if and when commodity revenues dry up or Russia’s economic burden becomes unbearable, then it will most likely opt for ceasefire and use Ukrainian military losses as proof of its success in de-militarizing the country.”
But the world, overall, will be more fractious. Germany will continue to refuse an outright boycott of Russian energy; its historical integration with Russia stems from its desire to retain independence and prosperity while maintaining security through its alliance with the United States. While its other interactions with Russia will be sharply curtailed, but Germany will be “extremely wary” of accelerating the process of economic disengagement with China.
But BCA believes that US sanctions on China are “likely this year, sooner or later.” President Biden has already formally threatened China with such sanctions if it supplies Russia with military aid or helps them bypass existing US sanctions – which BCA believes they will. Still, China needs to maintain Europe as a strategic partner, an export market, and a source of high-quality imports and technology. Europe is three times larger of an export market than Russia, and the country cannot risk “a catastrophic economic adjustment.”
“When push comes to shove, however, China cannot afford to reject Russia,” the note says. “Russia’s decision to break ties with Europe reflects the Putin regime’s assessment that the country cannot preserve its national security against the West without allying with China.”
“Ultimately Russia offers many of the strategic benefits that China needs. Most obviously, if China is ever forced into a military confrontation with the West, say over the status of Taiwan, it will need Russian assistance, just as Russia needs its assistance today.”
BCA has previously warned that the risk of all-out nuclear war had increased substantially as a result of Russia’s invasion of Ukraine, though perhaps not as much as the risk of a market freakout of epic proportions over the fear of one.
Founded in 1949, BCA – currently headed by executive vice president, Nicoletta Manoleas – has offices in London, New York, San Francisco, Hong Kong, Sydney, Cape Town and São Paulo as well as home base, Montreal.
Lachlan Maddock is contributing editor to Investor Strategy News (Australia)