Equities Investment: Don’t let global crisis go to waste! This may be the best time to invest in equities

The events of the last 10 days have upended the world. Russia’s unexpected attack on Ukraine and, more importantly, the even more unexpected launch of full-scale invasion as opposed to expectations of attack in just Eastern Provinces of Ukraine is going to change geopolitics profoundly.

This marks the beginning of a new era of proliferation, significant increase in defence-spending and realignment of global strategic partnerships, and the emergence of a new world order in which many of the underlying assumptions of the last few decades will undergo a change.

It seems Russia’s initial plan of a swift control over the capital city of Ukraine has already failed and the Ukraine resistance has taken the world and the Russians by big surprise. Russia is already working on alternative plans as they realise that much to their chagrin this is going to be a long haul.


The Inevitable

Irrespective of the timing and terms of a cease-fire that will happen at some point of time, it is apparent that the Russian Military cannot exit Ukraine for the rest of this decade. Russia went into Afghanistan in 1979 thinking it’s a 6-month project and it took them 10 years to exit with a bloody nose.

The US military entered Afghanistan thinking it as a 6-month project and it took them 20 years and $2.3trn to exit with a bloody nose. Russia is not as resourceful! The question then is – Can Ukraine hold its resistance until the Russian economy implodes?

Russia cannot sustain this warfare for long as the cost of this so-called “Special Military Operations” as termed by Russia is $1 billion every day and cannot be sustained beyond a few months. Neither can they control Ukraine even if they gain military dominance because they would need at least 500,000 people to control Ukraine which they don’t have.

The Russian economy was about $1.7 trillion before the attack and should be about $1.2 trilion by the end of CY 2022 due to at least 25% currency depreciation and 10% contraction this year. We don’t know the new normal for Rubble.


Economic Nightmare

But apart from the Russian military setback, what has taken Russia and everyone by surprise is the nature and magnitude of economic sanctions that have been imposed on Russia. These are the most stringent sanctions that the world has never witnessed so far and far beyond expectations.

By virtue of the economic sanctions, the Russian Central Bank cannot access 50% of its forex reserves ($640 billion) thereby impeding its ability to defend the rouble. The bank rate in Russia has shot to 20% and it’s a matter of time that there is scarcity of essential/non-essential goods, significant spike in inflation, and middle-income Russians decimated.

I would believe, it’s a matter of time before Russia defaults on its bond obligations too and that’s nothing new because – it did default in 1998 as well in the aftermath of the rouble crisis which led to the rouble depreciating by 70% and led to the infamous LTCM crisis which shook the world stock markets.

The western economies have every intent to bring the Russian economy to its knees and destroy their firepower. If the western world imposes embargo on Russia’s energy trade, that could be the final nail in the coffin, but that could come at a significant cost to the world economy; probably a global recession.

Russia’s energy industry contributes 15% to the GDP and 33% of government revenues. Any significant dislocation of Russian oil output (10 million bbl per day) could lead to oil prices closer to $150 in the short term. But it would make strategic sense for the western world to put an embargo on the Russian oil and gas trade even at the short-term economic cost and market dislocations.

Given this backdrop, it is conclusive that the Russian economy is not going to come back to normal soon and the western world is not likely to lift sanctions quickly either; unless there is a change in leadership in Russia with some sort of coup, which is wishful thinking.


Financial Breakdown

Russian stock markets already collapsed by two-third since their peak in October 2021 before the sanctions and have been closed since then. It had a market cap of over $550 billion at peak and now the Russian stock market has been excluded from the regional indices and has become un-investible. 80% of the Russian market is owned by foreigners and I am sure investors are nursing significant losses as the holdings have become worthless.

Russian sovereign default could lead to an exodus of capital from Emerging Markets. The second-order effect of collapse of the rouble, Russian stock markets, and sanctions on Russian banks are not known. We don’t yet know if there could be a contagion though the possibility can’t be ruled out in the interconnected world of finance.


Global Impact

All of this means, we are getting into an era where prices of commodities including oil, natural gas, steel, aluminum, wheat, barley, and other agri-commodities which have already spiked 20-50% in the last 10 days will remain elevated. This has significant implications for the global economies and for stock markets.

Unfortunately, all of this comes at a time when the world economy was resilient, exiting the Covid pandemic on a strong footing but with elevated inflation levels. The sharp and wild spike in commodity prices will make the historically high inflation even worse and hurt consumer sentiment and corporate profitability.

If the high commodity prices persist for long, it could hurt global growth and lead to a stagflationary environment with growth stalling and inflation being high and sticky. This can have an adverse impact on the Indian macro economy over the short term. As India imports 85% of its energy requirements, a $25 increase in oil prices for 6 months would impede growth in the short term.

Any contagion could lead to sell-off in risk assets including equities and given that FII have already sold $22 bn in Indian equities in the last 6 months, an exodus from emerging markets could accelerate selling by Macro Funds and ETF and this would lead to corrections in stock markets.


India Opportunity

Amongst all the gloom, there is a silver lining for India. Higher commodity prices are already leading to the revival of private sector investment in India which will revive India’s moribund investment cycle. Russia cannot sustain this warfare beyond a few months.

India is now the fastest-growing economy in the world and will remain so for the next 20 years which means it will attract significantly higher capital flows when the global economic environment is conducive for growth and the geo-political environment is stable. India has a large domestic economy which can support its growth and also has the fourth-largest forex reserves in the world to tide over short-term global macro-economic volatility.

We are in uncertain times and in unchartered waters, that too in a matter of weeks. “Too much; too soon”. From Goldilocks the world has jumped like a frog in boiling water to stagflation or so it seems in the very near term. But, every cataclysm has an end. This one will have one sooner than later but given the magnitude of events that have unfolded in the last 10 days, it will inflict short-term damage to the world economy, India included.

If one were to look beyond this upheaval, India’s growth prospects are bright as it remains the most promising investment destination. The best time to invest in equities is during periods of considerable uncertainty as it is at this point that fear overtakes rational decision making and stock prices are marked down.

I have always maintained that long-term investors should not waste a crisis – “Don’t let a crisis go waste”. Investments made during times of crisis lead to superior returns over the medium to long term. We have one such on our hands.


(The author is Founder & CIO of Renaissance Investment Managers)