It has been almost two months since Russia invaded Ukraine. During this time, we have been witnessing the dramatic impact the war has had on global markets and economies. There is also concern with how these events will impact our portfolios and investments.
Inflation numbers are expected to continue rising higher and this war will put more upward pressure on inflation. Russia is a large global oil exporter. Increased sanctions on Russia will undoubtedly cause a supply squeeze in the oil market, which will lead to higher oil prices. In addition, Russia and Ukraine both account for about 25% of total wheat exports, which will now be limited. This can drive up food costs on a global scale. The war will also continue to restrict supply chains. For example, planes are being diverted because Russian air space is closed to more than 35 countries. Having to go around Russia leads to longer travel, resulting in increased fuel consumption and trip costs.
We have data on the stock market’s reaction to past wars and invasions (table below). Taking a deeper look at the market’s reaction to these events, we see that overall, there was market weakness leading up to each event, signalling that the market was already anticipating or “pricing in” the events to come before the event occurred. The immediate weeks and months following the event, there was a lot of volatility (which is what we are experiencing in today’s markets), which tends to linger as the market continues to assess the impact of these wars and invasions.
However, looking at the longer-term returns (3 months and beyond), market returns generally normalized. Over the 12-month period, we see a market return of approx. 7.7% with a median of 9.7%.
This tells us that there tends to be some short-term volatility around these events, but long-term market returns have been driven by other major economic factors.
Source: National Bank Research, February 2022
What has been unique about the Russia Ukraine war today is the level of sanctions placed upon Russia. Judging the impact of these sanctions and whether there will be any spillover effects into other parts of the global economy is still being understood by capital market analysts which is causing current market volatility.
What are the implications for Emerging Markets ETFs?
There is definite concern around emerging market equities and the impacts that Russia and Ukraine (both emerging market economies) will have on this asset class. Many investors in Canada may be holding an emerging markets ETF that is exposed to these economies and wondering how these investments specifically will be impacted.
Prior to the invasion on February 23, The BMO Emerging Market Index ETF (ticker: ZEM), which tracks the MSCI Emerging Markets Index, had 3.5% exposure to Russian equities. Since the invasion, MSCI removed Russian equities from all their indices at a value of zero because the underlying market is frozen (un-investible). For investment products like ZEM which hold Russian stocks, these portfolios will still hold Russian equities for now (as they cannot be sold because the market is frozen) but will price them at $0.
As some of these companies still have economic value attached, we expect that when the Russian market reopens, these equities would be sold at a price, although when and for how much is still undetermined at this time. However, because the initial weight in these ETFs to Russia was so small, the impact to overall returns from this repricing has been muted.
For a detailed version of our blog, please view our Market Insights Episode: Navigating Through A Crisis – Here
Sa’ad Rana has been in the financial services industry for the last 12 years in a variety of roles. In 2019 he joined the BMO ETFs sales team, supporting Portfolio Managers and Advisors in Central Canada. Sa’ad is an intrapreneur that is helping spearhead the development of BMO ETF’s Direct Channel segment. He is currently focusing working with investors and other partners to provide education, insights on ETFs within the Direct Channel segment and building relationships with key stakeholders.