Russia’s involvement in Crimea has sparked concerns about the impact of this conflict on local and global investments. While tensions in the region have led to volatility in debt, equity, and commodity markets, structural reform and supply-and-demand dynamics should dictate longer-term investment performance. To help investors better understand this situation and make more informed decisions, Fidelity Emerging Market Strategist Bob von Rekowsky shared his insights with Viewpoints on potential investment risks and opportunities associated with this unfolding state of affairs.
Despite the turmoil, Ukraine is viewed as a solvent sovereign credit, albeit one with significant liquidity issues. Longer term, however, if structural reforms are not addressed—such as trade liberalization with the European Union (EU) and improved fiscal and energy policies—Ukraine faces further deterioration in its economic profile, putting it at a higher risk of credit downgrades and defaults.
Ukraine’s receipt of international financial support—currently being considered by the European Union and the International Monetary Fund (IMF)—is key to bolstering the country’s ability to service its debt obligations in 2014. In this case, various dollar-denominated shorter-maturity sovereign debt and specific corporate debt issues may be compelling investments.
The case for Ukrainian equities is much less clear, given an unfavorable risk/return balance between liquidity and a deteriorating outlook for company earnings. Importantly, a fact-finding team from the IMF is in Kiev, conducting an analysis to “begin preliminary dialogue with Ukrainian authorities on a possible IMF-supported economic program,” which we understand may be coordinated within the current election timetable.1
The impact on Russia
Regarding Russia, the risk of any significant or lasting trade or economic sanctions seems unlikely at this time, given the reality of the EU’s overall economic relations with Russia. Gazprom, the Russian state-controlled gas company and world’s largest extractor of natural gas, supplies an estimated 26% of European natural gas supply, which includes nearly 40% of Germany’s annual natural gas needs. In addition, the EU is the most important investor in Russia—an estimated 75% of foreign direct investment in Russia comes from EU member states.2
The recent volatility of the ruble and the 150-basis point interest rate hike challenge an already-lackluster economic outlook for 2014, which has weighed heavily on Russian stocks of late. Ukraine’s economic woes do not pose great risk to Russia’s economy this year. However, if the Ukraine crisis is prolonged with increased Russian entanglement, this may lead to accelerated capital flight from Russia, pressuring the ruble exchange rate as well as risking a downgrade to earnings estimates for the equity market, which is already trading at a depressed 4.8x forward price-to-earnings ratio.
If cooler heads ultimately prevail regarding Ukraine and its future, elevated political and economic risk would weigh less heavily on regional and world debt and equity markets. In the near term, gold, oil, and other commodity prices may remain volatile, but ultimately these events do not alter the investment case for any of these industries one way or the other, as longer-term supply/demand factors should outweigh these transitory issues.
One long-dated industry that may receive lasting support is oil and gas fracking in both the U.S. and Europe, as the need for bolstering energy independence away from potentially unstable energy suppliers is reaffirmed. Ultimately, more energy supply could weigh on energy prices, which would be akin to a tax cut to consumers and a tailwind to industry. In this light, all boats would rise for energy consumers—both government and individuals—at the expense of energy producers. That would be a positive development for economic growth as this crisis abates.
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