If you thought the stock market’s sell-off to start the year was ugly, get ready: Wall Street’s most elite investors are bracing for an even deeper market shock as the war in Ukraine drags on.
In my conversations with some of the top minds in finance, many of whom talked to me on the condition of anonymity to speak candidly about where the market is headed, a consensus emerged: Russia’s invasion of Ukraine has kicked their predictions for a stock-market “washout” into hyperdrive. The murky global economic picture, clouded by supply-driven inflation pressures, is now even more complex and uncertain. And the shifts that turned some of the market’s high-flying winners into losers are only becoming more pronounced.
“Russia’s invasion of Ukraine accelerated the slowdown, and it accelerated inflation,” one billionaire value investor told me.
Beyond the massive
that the invasion will continue to inflict on markets, the war is also forcing Wall Street to undergo a frenzied gut check. It’s not just the US government that wants nothing to do with Russia. It’s Wall Street’s client base as well.
So the challenge for Wall Street’s biggest investors is threefold: Build a portfolio that survives the washout, make sure you’re not holding Russian assets, and, for the love of God, return any Russian clients’ money before old Uncle Sam lowers the boom.
Market mess and a ‘bone-crushing recession’
Vladimir Putin’s decision to invade Ukraine added another shock on top of a year already defined by a massive economic sea change. The
and other policymakers in the US have been trying to walk a fine line, increasing interest rates just enough to tamp down historically high inflation without pushing the economy into a
. This much has not changed: Inflation so far shows no sign of slowing, and the Fed’s plans to raise interest rates to fight it mean debt is already becoming more costly and loans are harder to access. In turn, investors are becoming more risk-averse and punishing the stocks of companies that relied on cheap debt to fuel speculative growth — many of which were the darlings of our seemingly unstoppable stock market of the past two years. All of that adds up to a nasty stock-market decline.
Putin’s war has not changed the shape of this market shift, but it is making the swerve even more aggressive. Other than “a re-rating of defense contractors,” the value investor told me, the stock market hasn’t changed fundamentally. It has only become more treacherous.
The thunderbolt of Ukraine’s destruction and of Russia being shoved out of the global economy has created additional scarcity in a world already struggling with a shortage of critical goods as well as the inflation these shortages have caused. The war is endangering the world’s supply of oil, steel, wheat, fertilizer and other commodities. Together, Russia and Ukraine export more than 25% of the world’s wheat supply. Russia is also a major exporter of fertilizer. The UN is warning that this conflict could lead to global food shortages. The food that remains will become more expensive, exacerbating inflation.
And then, of course, there is energy. Russia was supplying the world with just under 10 million barrels of oil a day before Putin attacked Ukraine. Since then the US has cut off imports, and the EU is working to quickly wean itself off Russia’s energy supply.
Eventually, without technology from American and European companies like Baker Hughes, Halliburton, and Schlumberger, Russia will also have trouble extracting oil from its territory, the geopolitical analyst Peter Zeihan said. Oil prices have been all over the place since the invasion began, mostly rising in reaction to the carnage, with occasional dips as the market tries to figure out how much oil we’ve really lost.
Earlier this week the International Energy Agency projected that Russian oil exports would drop by 3 million barrels a day by next month, but one person I spoke to, a Singapore-based hedge-fund manager who focuses on commodities, believes sanctions evasion will temper losses as Russia shepherds its gas through countries like China.
“I think oil prices could go a little bit higher as these issues work out, but I’d be surprised if prices were higher in June than they were right after Russia attacked,” they said. “I think some of this will be manageable as the Chinese figure out how to smuggle commodities out of Russia, and they will.”
In the meantime, low-income populations could face what the fund manager described as a “bone-crushing recession.” In the US, low-income Americans spend an average of 8% of their household income on energy expenses, from filling their gas tanks to keeping their lights on. In the EU, the figure can reach above 12% in countries like Romania. Even before Putin’s attack, researchers estimated that 80 million households across Europe struggled to stay warm, so when prices go up it hurts.
“The issue Europe has right now is figuring out how to reduce absolute gas consumption quickly while also figuring out how to help the most vulnerable people,” they said.
If the EU does not solve these massive problems, it risks forcing low-income citizens to choose between heating their homes and filling their stomachs. It risks the elimination of shifts at manufacturing plants, hitting workers’ wallets even harder. It risks political unrest. Right now the West’s top priority in supporting Ukraine is to maintain a unified front against Russian aggression, but none of this is good for economic and social stability.
What all of this amounts to is a temporary but indeterminate period of chaos. Prices for necessities will rage upward; central banks will fight inflation by raising rates; and money will become harder to find. While there might be money to be made as the turmoil sorts itself out, the fundamental shift underway in the market — an ugly, painful transition from growth stocks toward value — has not changed. The swings will just get wilder, as anyone who is trying to survive mid-March’s sucker punch of a bear-market rally can probably tell you. Without warning, the tech-heavy Nasdaq — which had been languishing — ripped over 8% in one week. In a market like this one, it could just as easily crash back down even harder the next.
A shunning on Wall Street
While the economic and market fallout from the war in Ukraine will take months to unfold, Wall Street’s scramble to rid itself of toxic Russian assets began quietly but swiftly after Putin invaded. Before Goldman Sachs started the big-bank exodus from Russia, before Citigroup and Deutsche Bank cut their losses and followed suit, before hedge funds started cutting off their Russian oligarch clients — emails and phone calls were flying around Wall Street, demanding that Russia be shunned.
“We cannot tell our clients that we put their money in Russian assets,” said Josh Brown, CEO of the wealth-management firm Ritholtz Wealth Management, which oversees $1 billion in assets. “So we’re calling our asset managers and saying you need to take our exposure to zero.”
Calls like this set off a chain reaction that Russia cannot stop. Wealth managers like Brown call their asset managers — companies like Vanguard, for example — and tell them to divest any Russian holdings in their clients’ portfolios. These massive asset managers then call the companies that make indexes, like MSCI, State Street (which makes the SPY index) or the London Stock Exchange (which makes the FTSE Russell) and demand that Russia be booted from the indexes — erasing Russian investments from virtually every American retirement account and millions of investment portfolios. Because asset managers like Vanguard run trillions of dollars, the index-making companies comply. Russian assets were thrown out of the FTSE Russell, for example, on March 4.
This excision from financial markets will be difficult to undo, partly because clients are unlikely to embrace Russia anytime soon but also because Russian assets have entered a sort of limbo. They’ve become part of a fire sale in which customers can only window-shop.
“Basically, whatever assets they have on hand have to go to zero and then become a write-off,” Brown said. “No one is buying these assets. Maybe you can sell it back to a Russian in three years, but for now there’s no liquid market.”
This goes not only for securities but also physical assets that once made their owners very rich. When BP announced in late February that it was offloading its 20% stake in Russian oil giant Rosneft, one veteran hedge-fund manager — who had just been expressing his guilt over profiting in a wartime stock market — told me simply, “that doesn’t mean anything.” In his decades of running money, you cannot sell something no one will buy. You cannot just leave billions in investments and walk away. No one in their right mind would simply renounce ownership of assets and write down the stake as a loss. But these times are not like any other.
It turns out when there’s a war on, you actually can just walk away. Especially when it seems Russia is isolating itself from the global financial system, or as the billionaire value investor described it, “going full North Korea.”