Recently, tension between Russia and Ukraine has escalated. The latest news is that President Putin officially recognized two self-proclaimed separatist republics in Eastern Ukraine, driving the stock market futures into significant volatility.
The current Russia-Ukraine conflict is essentially another one of many armed conflicts in history. As you can see, the blue line is the number of armed conflicts, and the orange line is the S&P 500 index. If history repeats itself, the stock market's long-term trend is not likely to be altered by the current conflict.
Source: Uppsala Conflict Data Program (UCDP), Bloomberg
A Brief History of Ukraine:
Geographically, Ukraine is at the junction of Eastern Europe and Western Europe. Furthermore, it’s the intersection of Catholicism and Orthodox Christianity, determining the importance and challenges of Ukraine's geopolitics.
Since the 1570s, Ukraine has been the battleground of the Polish–Lithuanian Commonwealth and Russia. In 1654, Ukraine formed a military and political alliance with Russia and claimed loyalty to the Russian tsar. Various forces, however, have repeatedly contested the Ukrainian region for centuries and eventually formed a division similar to that of today's Eastern and Western Ukraine. Eastern Ukraine believes in the Orthodox and has a high degree of identification with Russia; while most of Western Ukraine believes in Catholicism and does not identify so much with Russia. Despite the fact that Ukraine was united during World War II and claimed independence after the collapse of the Soviet Union, the ideological division between the regions remains.
The History of the Ukraine-Russia Conflict:
Following the alliance of Ukraine and Russia in 1654, Russia adopted a Russification approach in Ukraine. Russia migrated a large number of Russians to the Ukrainian region. It inhibited the development of Ukrainian national cultures, prohibiting the publication of Ukrainian books and teaching of the Ukrainian language. Presently, native Ukrainians account for the majority of the total population, mainly in the central and western states. On the contrary, Russians account for the minority, mainly in the southeastern states.
In the late 1920s, the Soviet Union began its industrialization construction. In order to solve the problem of insufficient food and raw materials in large-scale industrialization, the Soviet Union launched a campaign of agricultural collectivization. This campaign led to a decline in agricultural productivity. To ensure adequate food supply in large cities, the Soviet Union forced the confiscation of large amounts of grain from Ukraine. The decline in agricultural productivity and the takeover of grain resulted in a severe famine. It is believed that the total number of deaths in the Soviet Union's 1932-1933 famine was no less than 7 million, including 3-3.5 million of Ukrainians.
In the 1930s, many Ukrainians were persecuted during the Great Purge campaign. Also, it is believed that more than 2 million have suffered from various diseases as a result of the Chernobyl disaster in 1986.
Considering Ukraine's population is only about 40 million, Russification measures, famine, purges, and nuclear leaks resulted in Ukrainian hatred toward the Soviet Union.
The Bigger Conflict:
The entanglement of interests hidden between Russia and other countries is much bigger than the conflict within Ukraine. While the European Union wants to expand to the east to achieve geopolitical stability and further economic prosperity, Russia has been trying to revive its superpower status since President Putin came to power. Nonetheless, Russia and the EU are economically dependent and have been very cautious about geopolitics. Another power entangled in the conflict is NATO (North Atlantic Treaty Organization), which involves the United States.
Currently, nearly 40% of the EU's natural gas comes from Russia. Eighty percent of that supply must channel through Ukraine. There are proposed pipeline projects in talk between Russia and Germany for direct natural gas transportation. In turn, these projects would imply significant geopolitical and economic impacts. Thus, the evolvement of the Ukraine-Russian conflict could alter the future development of natural gas projects.
The Possible Outcomes:
The million-dollar question is to predict the outcome of current tension. Hopefully these these perspectives can assist in drawing some ideas.
- Ukrainians could take advantage of this tension if the ultimate goal is to join the EU and NATO.
- Considering the aspects, the United States will benefit if the conflict is escalated to fires.
- If Ukraine joins the EU and NATO, Russia will lose its last geographical buffer zone to the west.
- The EU could go both ways since it has incentives on both sides.
No one can predict how each party will operate from here; but if we view this case from a long-term perspective, things are more clear.
- The Ukraine-Russia tension is a long-time geopolitical problem, which all parties understand well.
- Whether the conflict is escalated or not, it is a process of power and negotiations between major forces.
- Even if a war results, it will most likely be limited to the eastern side of Ukraine, given Ukraine's history, demographics, and current economic backdrops.
- The world will benefit if the long-term problem behind this conflict is resolved.
While we stated logical, assuring reasoning above, the market appears uneasy regarding headlines around the conflict. Potentially, this is due to the Fed’s urge to raise interest rates if energy prices jump as a result. Combined with some endogenous economic problems, the economy could potentially face some challenges. However, we hold our view that the market will calm down once Fed announces its first rate hike.
We hope you find this analysis helpful as you continue to follow the market’s performance. Please contact your advisor to discuss questions specific to your investment portfolio.
Lanny Bao, CFA
Portfolio Manager
LPL Operations Manager
Cornerstone Wealth Management, LLC
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