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Day 43 – Q 3. How does international crises affect the equity market? Examine in the light of the ongoing Ukraine crisis. (15 Marks)

  • IASbaba
  • March 14, 2022
  • 0
GS 3, Indian Economy
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3. How does international crises affect the equity market? Examine in the light of the ongoing Ukraine crisis. (15 Marks)

अंतरराष्ट्रीय संकट इक्विटी बाजार को कैसे प्रभावित करते हैं? मौजूदा यूक्रेन संकट के आलोक में जांच करें।

Approach- 

Candidates need to write about the journalistic ethics and how objectivity will be important pillar of it is to be addressed with substantiating views. 

Introduction 

Brent crude prices hit $96.7 per barrel on Tuesday, the highest mark since September 2014, following Russian President Vladimir Putin’s deployment of troops to separatist areas Donetsk and Luhansk in Ukraine. While the West has termed it a blatant violation of international law, the rising global tensions and threat of invasion in Ukraine have caused oil prices to surge and the stock markets to crash. The spike has been driven primarily by fears of supply side disruptions as the threat of Russian invasion in Ukraine looms large following Putin’s deployment of troops to separatist areas Donetsk and Luhansk. 

International Crises Effect on The Equity Market

  • Ukrainian bonds just got very cheap relative to history. Ukraine bonds collapsed following Russia’s invasion. 
  • A Russian invasion of Ukraine could not only disrupt crude supplies globally, but also lead to sanctions by the US and Europe. 
  • Oil prices have been rising over the last couple of months on concerns over supply, following tensions between Russia, the world’s second-largest oil producer, and Ukraine. 
  • Ukraine bonds reflect the fact of the invasion, but not the likelihood of new international support. The impact of sanctions imposed on top personnel, directly involved companies and financial institutions on emerging markets equity will be similar to what was outlined above for emerging markets debt. 
  • While banks have indicated that they have a back-up plan in place from being excluded from SWIFT, the uncertainty may mean a greater initial impact. 
  • While secondary market sanctions are more likely to impact debt securities than equities, we certainly can’t rule out equity holdings, which may lead to potential forced selling.
  • Ukraine is expected to enter the J.P. Morgan GBI-EM Global Core Index at the end of March, and given the fluidity of the situation, any impact to liquidity bears watching. 
  • We expect that the index provider, J.P. Morgan, will continue to assess Ukraine’s eligibility up until the expected inclusion date. 
  • Any additional rounds of sanctions will likely be stronger, but we believe they will focus on the same targets: sovereign, state owned entities (especially banks), strategic industries and individuals. 
  • Any sanctions that result in the inability to transact in Russia related bonds (including those already issued and outstanding) will lead to the removal of those bonds, or the country, from emerging market debt indices.
  • Our emerging markets debt ETFs are passively managed, so allocation shifts will be in response to any changes made by the indexers. 
  • The impact of sanctions imposed on top personnel, directly involved companies and financial institutions on emerging markets equity will be similar to what was outlined above for emerging markets debt. 
  • While banks have indicated that they have a back-up plan in place from being excluded from SWIFT, the uncertainty may mean a greater initial impact. 
  • While secondary market sanctions are more likely to impact debt securities than equities, we certainly can’t rule out equity holdings, which may lead to potential forced selling.
  • Our Emerging Markets Equity Strategy has some Russian exposure, but this is concentrated in companies which are domestic oriented and can fund and their growth plans entirely out of internally generated cashflow. 
  • We are in a very fluid situation and we are constantly re-assessing risk. While certainly not immune, Russian companies, we believe, are generally better insulated against potential external events than in 2014. 
  • The Russian equity market is currently trading at a steep discount even to its own history, despite the benefit of elevated commodity prices.
  • Now that the Russia-Ukraine war is looking like the worst possible case, markets are reflecting the rising commodity supply risks. Ukraine and Russia together are critical supply sources for several very important commodities. 
  • Together, Russia and Ukraine are the major suppliers of wheat, sunflower oil and fertilizers to Europe and the Middle East. 
  • Additionally, the record prices in Europe for natural gas and electricity are shutting down fertilizer and aluminium production. Russia is also a very important producer of aluminium, nickel and palladium. 
  • All of these commodities were in short supply before the war, and in the near term, we believe there is no easy fix to the supply shortages.
  • As safe haven assets, we believe gold and gold stocks stand to gain the most from the Russian invasion of Ukraine. 
  • This conflict has raised risks globally as hostilities in other parts of the world may also escalate. U.S. sanctions on Russia have driven energy prices higher, further increasing inflationary pressures.

Conclusion

We have already positioned our Gold Strategy for stronger gold prices that we expect to be driven by inflation and the risks to the economy and markets posed by the coming U.S. Federal Reserve rate hiking cycle. The Strategy is fully invested in gold mining stocks, thereby potentially achieving leverage to gold price gains.

 

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