Military conflict and market impacts

Jonathan Armitage

MLC Asset Management

The terrible events in Ukraine, resulting from Russian military action, are above all else a human tragedy. Many innocent lives will be needlessly lost.

Against a backdrop of so much suffering already, discussing the investment and economic implications might appear unseemly.

However, we are privileged to be responsible for the financial wellbeing of many Australians, and so we believe it is appropriate for us to share our thinking with you.

I will address MLC’s investment approach and portfolio positioning a little later, but want to begin by providing some background to Russia’s action.

Latest event is out of the Russian playbook

In short, Russia has form when it comes to aggression against countries who gained their independence from the former Soviet Union.

For more than two decades, Russian troops have occupied Transnistria, a breakaway region of Moldova. This is the oldest of so-called ‘frozen conflicts’ Russia has inflicted on neighbours.

Roll forward to 2008, and Russia invaded Georgia in support of separatist governments in South Ossetia and Abkhazia, two provinces with large Russian-speaking populations.

On to 2014; Russia seized Crimea from Ukraine and began supporting an insurgency of pro-Russian separatists in eastern Ukraine, the self-declared Donetsk People's Republic and the Luhansk People's Republic.

As for what Russia gains from all this; an explanation from Erik J. Grossman, writing in the US Army War College Quarterly, specifically on the situation in Moldova, but applicable elsewhere, paints the grim picture:

“It has weakened Moldovan sovereignty and frozen its western integration for the past 25 years. This uncertainty has served to trap Moldova in a geopolitical grey zone between East and West and forced it to act as a vehicle for Russian corruption and money laundering.”(1)

Said differently, Russia wants permanently fragile post-Soviet countries in its ‘near abroad’ to be unable to act without Moscow’s approval.

An already ugly situation has been taken to a horrifying extreme in Ukraine.

Europe’s energy dependence

A discussion on the economic implications invariably begins with energy markets.

Russia is the world’s third-biggest oil producer and second-biggest producer of natural gas, and the country is the source of around 40% of Europe’s gas.(2)

The second half of 2021 underscored Europe’s energy dependence as gas prices shot up on the back of rising demand because of an unusually severe winter, low storage, and supply disruptions.

Germany has now suspended the Nord Stream 2 gas project — the undersea pipeline directly linking Russian gas to western Europe via Germany (and bypassing existing pipelines running through Ukraine and Poland). Meanwhile, the United States has imposed sanctions on Gazprom, the Russian state-owned giant running the pipeline.

Despite Nord Stream 2’s suspension, the Russia-Europe energy relationship has not ceased. Russia needs gas customers, and Europe needs gas. Interdependence would seem to suggest that the relationship will continue, at least for now, no matter deep strains.

European reluctance to take fuller action is exemplified by repeated opposition to booting Russia from The Society for Worldwide Interbank Financial Telecommunication (SWIFT).

“SWIFT is used by over 11,000 financial institutions to send secure payment orders and is key to the movement of funds to Russia’s oil and gas sector. Removing Russia from the system, it is argued, would make it close to impossible for financial institutions to send money in or out of the country, with consequences for both the country’s oil and gas sector and its European customers.”(3)

This is a business-as-usual assumption when things are far from normal.

Recent energy prices capitalise a fear and uncertainty premium with Brent crude futures jumping past US$100 a barrel for the first time since September 2014.(4)

Given the worrying rise in global inflation over the past year, central bankers will be keeping a nervous eye on the knock-on effects of higher energy prices.

They are already in a difficult spot as critics have taken them to task for being too slow to act against inflation with their reluctance to raise official interest rates, which in many cases are barely above zero.

Now they face the prospect of even higher inflation on the back of potentially steeper energy prices, on one hand, as well as possibly higher inflation coupled with some risk to economic growth, an even worse scenario.

Broader investment market implications

Trying to divine where financial markets go from here is a fraught task. The thing is, there isn’t always a straight-line relationship between geopolitical shocks and financial market responses.

The Cuban Missile Crisis, while nearly catastrophic, and the September 11, 2001 terrorist attacks in the United States, while traumatic, had relatively small and short-lived market impacts.

Of course, given Russia’s role in energy markets as well as a major military power, the current crisis has the potential to have a relatively larger impact on energy supply and inflation.

The current crisis is occurring against a backdrop of an overheating global economy, rising inflation, and supply shortages, which is likely to reduce central banks’ ability to offset any growth hit should the conflict persist and widen.

Large conflicts are generally inflationary, and most have coincided with or contributed to rising bond yields. However, over short periods of time, smaller events have frequently produced a flight-to-quality dynamic and lower bond yields.

So far, this case looks to have produced more of the flight-to quality dynamic than inflationary market action, although there hasn’t been a big impact either way.

Even prior to the rise of tensions in Ukraine, rising bond yields had been more closely driven by expectations for tighter central bank policies as inflationary pressures continued to rise.

Our approach to what’s happening

At MLC, we don’t try to predict the future, but rather prepare for it. One of the ways we do this is through an investment approach based on what we call “The Investment Futures Framework.”

The Framework of 40 possible scenarios, includes major military conflict. A glance at each scenario makes plain that none are zero probability eventualities. Consequently, we need to be factoring each scenario into our thinking.

Source: MLC Asset Management Services Limited

This Framework means that we’re constantly assessing the changing risk and return potential across financial markets – based on the many things that can happen – and feeding this analysis into portfolio positioning.

As it is, our MySuper portfolios have close to zero share market investments in Russia (substantially lower than the market index’s exposure), and all other funds have zero Russia share market exposure. Additionally, we have no Russian fixed income investments in any of our portfolios.

Even before the events underway, we had been preparing for changes in the investment environment.

For instance, we had been directing more of our clients’ money towards ‘alternative assets’, which we think are likely to perform differently to traditional assets, in times of market stress.

Sizeable levels of exposure to unlisted assets, such as infrastructure, private equity, and real estate, also help to provide some protection from share market volatility.

In the almost 40 years we’ve been managing money for Australians, we’ve steered our clients’ portfolios through dramatic market as well as geo-political events.

It’s by sticking to time-tested principles like diversification, active-management, and risk control, that gives us confidence that we can navigate our clients’ portfolios through what may lie ahead.

Learn more

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(1) Moldova, then Georgia, now Ukraine: How Russia built ‘bridgeheads into post-Soviet space’, by Benjamin Dodman, 22 February 2022, (VIEW LINK)

(2) What Russia’s invasion of Ukraine means for the global economy, by Pierre Briancon, 22 February 2022, (VIEW LINK)

(3) Kyiv furious as EU wavers on banning Russia from Swift payment system, by Daniel Boffey and Jessica Elgot, 25 February 2022, (VIEW LINK)

(4) Russia invades Ukraine. What’s next for energy prices?, by John Power, 24 February 2022, (VIEW LINK)

This information is current as at February 2022 and is prepared by MLC Asset Management Pty Limited (ABN 44 106 427 472 AFSL 308953) (“we”). We are part of the group of companies comprising Insignia Financial Ltd (ABN 49 100 103 722) and its related bodies corporate (Insignia Financial Group). While care has been taken in the preparation of this communication, no member of the Insignia Financial Group accepts responsibility for any loss or liability incurred by you in respect of any error, omission or misrepresentation in the information in this communication. The information contained in this communication may constitute general advice and does not take into account your objectives, financial situation or needs. Because of that, before acting on this information, you should consider its appropriateness, having regard to your objectives, financial situation and needs. You should obtain the relevant Product Disclosure Statement or other disclosure document relating to any financial product which is mentioned in this communication, and consider it before making any decision about whether to acquire or continue to hold the product. Target Market Determinations (TMDs) for relevant products are also required to be made available and considered by distributors. We recommend you obtain financial advice tailored to your own personal circumstances. A copy of the Product Disclosure Statement or other disclosure document and TMD is available upon request by phoning 13 26 52 or on our website at, or Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. Opinions constitute our judgement at the time of issue and are subject to change. No member of the Insignia Financial Group gives any warranty of accuracy, nor accepts any responsibility for any loss or liability incurred by you in respect of any error, omission or misrepresentation in this communication. Any projection or other forward looking statement (‘Projection’) in this communication is provided for information purposes only. No representation is made as to the accuracy of any such Projection or that it will be met. Actual events may vary materially. This information is current as at February 2022 and may be subject to change. Subject to any terms implied by law and which cannot be excluded, we shall not be liable for any errors, omissions, defects or misrepresentations in this communication or for any loss or damage suffered by persons who use or rely on the communication. In some cases the information in this communication has been provided to us by third parties. While it is believed the information is accurate and reliable, the accuracy of that information is not guaranteed in any way. This communication is directed to and prepared for Australian residents only.

Jonathan Armitage
Chief Investment Officer
MLC Asset Management

As Chief Investment Officer, Jonathan leads the investment team and assumes overall responsibility for the investment outcomes of the MLC portfolios for both retail and institutional clients. In addition to the Multi-Asset portfolios, he is...

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