Morgan Stanley: Investors Needs To Understand Something Else The Russian Offensive May Bring About

By Michael Zezas, Head of Public Policy Research at Morgan Stanley

“There are decades where nothing happens, and there are weeks where decades happen.”

          – Vladimir Lenin

While I certainly don’t count myself a fan of Lenin, I have to admit that he grasped the way that changes in geopolitics can shift from a crawl to a sprint in the twinkling of an eye. He’d likely identify the actions of his native Russia over the past two weeks as one of those catalyzing moments. And while focus is rightfully on their terrible humanitarian toll, investors would also do well to understand something else this offensive may bring about: an acceleration of ‘slowbalization’, with clear implications for how global governments, corporates, and consumers allocate resources going forward.

Consider some of the apparent results of the invasion of Ukraine:

  • A more unified ‘West’ than we’ve seen in nearly a generation: Poker players will recognize the upshot of the invasion as a ‘hammer bluff’ gone wrong. The Russian government may have assumed that Western nations were too disorganized and too inward looking to respond with forceful sanctions and substantial support for Ukraine. They appear to be wrong, given the coordinated actions that seemed unlikely just a few weeks ago. These include sanctioning Russia’s central bank, Germany abandoning its policy of not exporting weapons to conflict zones, and Turkey cutting off Russian military access to the Black Sea. Russia may ultimately achieve regime change in Ukraine, but at the cost of rekindling Western unity and risking its own long-term economic isolation.
  • An incomplete China-Russia partnership: While many investors commented to us that the bilateral ‘Olympic communiqué’ meant a clear bloc was forming, the past two weeks have seen some daylight appear between the countries, with China’s message on Ukraine focused on a negotiated solution. Surely China is still interested in the possibility of partnering with Russia in an economic bloc that rivals the West (i.e., one world, two value chains, payment systems, etc.). But China may prefer to play the long game, viewing global stability as supportive of its economic ascendancy and growing geopolitical bargaining power. Russia’s actions suggest that it did not similarly see time as on its side. This dynamic, plus other wedge issues (i.e., India) risk keeping the Sino-Russian relationship skewed more toward convenience than alliance.
  • A potential acceleration of ‘slowbalization’: These points seem to underscore that global powers have de facto realized the limits of globalization. To put it in investment terms, powers are acting like we’re beyond the efficient frontier on the trade-off between GDP and security. That’s the message I see from Europe’s embrace of tough sanctions, which implicitly risk higher energy costs in return for security. The US is doing the same by, among other things, limiting its semiconductor exports business and potentially promoting the development of an alternative global payments system. It’s all part of the ‘slowbalization’ and ‘multipolar world’ policy playbooks we first highlighted a few years ago. Then it was mostly US led and incremental, but now it is accelerating.

For investors trying to look beyond the short term, that last point is crucial – we may see a rapid rewiring of the global economy consistent with slowbalization: The preferences revealed by the world’s reaction to the Ukraine crisis are compatible with the creation of economic spheres where supply and tech chains are insulated from geopolitical concerns. While this has myriad potential market implications, we see the following most clearly:

  • Amped-up investment in defense and cybersecurity: The US has long pressed its NATO allies to boost their defense spending, in vain. But in response to Russia’s actions, Germany announced that it will increase its defense spending to 2% of GDP, in line with the 2006 NATO agreement. We see other countries following suit, with our colleagues estimating the potential for an extra US$60 billion annually in defense spending within NATO. The defense and software sectors could be key beneficiaries. Further down the road, this could also be a step toward more coordinated fiscal action by Europe in general, with broader macro implications.
  • Elevated commodity costs for a time: Russia and Ukraine are key producers of several metal, energy, and agricultural commodities. While sanctions on Russian banks were designed to permit payments for various commodities, there are still restrictions on and disruptions to their transport. Consider oil, where supply was already tight. With Russia producing 10% of the world’s oil, it’s not surprising that global oil inventories have declined. Hence, our colleagues see the price of a barrel of oil remaining above US$100 and resulting potential for the oil E&P sector to outperform.
  • Elevated supply chain costs for a time: While many multinationals were already investing in geographically diversifying their supply chains in the wake of US/China trade tensions, recent events may accelerate this trend. Sanctions, and Russia’s response to them, included fresh non-tariff barriers and capital controls. This may remind corporate decision-makers of the jurisdictional risks in emerging markets. That could add to cost pressures, underscoring our equity strategy team’s view that earnings estimates may be too high and, accordingly, equity markets overall may remain choppy, even as the sectors we note above could outperform.

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