Are our strategies bomb-proof?
25 February 2022
The outburst of war in Ukraine is going to have profound consequences across many sectors. We briefly review in this document the more immediate impact on our investment themes.
Earlier this week, President Putin recognized the independence of two pro-Russian separatist regions in the east of Ukraine (Donetsk and Lugansk republics) and allowed the Russian army to enter these territories. On Thursday, Russian armed forces entered and shelled Ukraine, raising the odds of a full-scale war. As a result, Western countries are considering reactions, starting with economic sanctions.
Impact on our Investment Case
We believe that this conflict did not start this month and more is behind the scenes. In the following paragraphs, we provide a first analysis of the possible impact of this conflict on our strategies.
Between the two quarrelers, the third enjoys
Fifty years ago, U.S. President Nixon went to China alongside Kissinger, the then National Security Advisor, to formalize relations between the two countries. However, the real reason behind this move was to form an alliance between the U.S. and China against the Soviet Union at the expense of Taiwan. This strategic shift might have contributed to the fall of the Soviet Union. Today a similar move appears to be in the making, uniting China and Russia to the detriment of the U.S. and potentially, once more, Taiwan.
Russia can provide China with the energy supply it needs to fuel its growth and buy Chinese technology to develop its economy. Also, President Xi may use this conflict as a distraction to invade Taiwan as the U.S. will hardly be able to sustain two military fronts at the same time. China will thus maneuver to increase its influence and boost its internal growth. We remain confident in the added value of the China exposure in our portfolios.
Sanctions may not be as effective on Russia
Learning from the 2014 sanctions that followed the annexation of Crimea, Russia, in fear of further U.S. and international sanctions, turned to the East. It reduced its U.S. Treasury holdings to almost zero, and now Gold represents ~23% of Russian reserves, USD ~22%, and Yuan ~12%. This suggests that the U.S. dollar may affect the Russian economy much less than a decade ago when after the annexation of Crimea, the Ruble roughly halved in value vs. USD. Furthermore, commercial relations between the US and Russia diminished to the benefit of China, which has become Russia’s most significant trading partner. New sanctions on Russia would exacerbate the move to the East and, in effect, weaken the role of the U.S. Dollar as a reserve currency for international trade.
Blockchain as an alternative to SWIFT
Since the Crimea annexation, Russia was threatened with being removed from the SWIFT payment network. Therefore, Russia created its payment network, also known as SPFS. However, unlike the SWIFT network with more than 11’000 participants, SFPS still only counts ~400 participants. Similarly, and in pursuit of financial independence, China also built its payment system called CIPS. But, without international participants, both these systems are worthless. Nevertheless, this mirrors a general trend, with many countries advocating for a new cross-border independent payment system. The current reliance on America, mainly because U.S. law applies to any USD transactions, is considered a form of loss of sovereignty by many emerging economies.
In this context, an alternative solution would be leveraging blockchain technology via its originator, the Bitcoin blockchain network. Indeed, the Bitcoin network has many similar characteristics to the SWIFT network (e.g., non-repudiation of payments). But, most importantly, it is not owned or managed by a central entity like SWIFT, and consequently, no transaction on the network can be forbidden.
Thanks to the various infrastructure (e.g., the lightning network) being built to develop its functionalities, the Bitcoin network could eventually be used as a tool to settle international trades, in the respective currencies of each participant, without the control of any central authority. Thus, increased use of financial sanctions against countries is a structural driver for the potential adoption of blockchain technology to settle international transactions.
Our Fintech strategy has a sizeable exposure to blockchain technology.
Renewable Energy, Cyber Security, and the overall market
With Russia supplying about 40% of Europe’s total gas consumption, European energy prices have spiked to unsustainable levels. This conflict may be the wake-up call for Europe to improve its energy independence by building up its energy infrastructure and focusing on renewables. Thus, companies building such clean infrastructure might get strong governments incentives. Our Sustainable Future portfolio is well exposed to this sector.
In an increasingly digitized world, as tensions escalate, a significant acceleration in cyberattacks is also likely. The resulting demand for cyber security solutions shall benefit our Security & Space strategy, whose highest allocation is in cyber-security.
Moreover, regarding the overall market, history suggests that a bottom tends to occur when the conflict eventually starts, as the uncertainty surrounding the build-up to a conflict is finally cleared.
Finally, the Fed hiking cycle was priced as if growth and inflation would continue to rise and no adverse event could disrupt it. While far from disrupting the Fed’s intentions completely, this conflict has nevertheless shifted the probability for the March meeting back from two hikes to one hike. In other words, market expectations about tightening have become less aggressive. We believe that, throughout the year, a similar pattern shall repeat (i.e., less aggressive expectations), acting as a tailwind for the market. Given the exposure of our portfolios to high-quality stocks, we expect them to outperform as sentiment shifts away from fear.
As the conflict between Russia and Ukraine takes proper shape, and the uncertainty about the involved parties subdues, the ripple effects will also be seen as opportunities for investors. The rise of exogenous uncertainty should prevent the central banks from being extremely aggressive, providing some tailwind for the markets. Among our strategies, Cybersecurity, Sustainable Future, Fintech, and our overall exposure to China shall eventually benefit.
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