Will Russia go nuclear? News Flash, Dynasty Asset Management

Last weekend, President Vladimir Putin ordered Russia’s nuclear forces into a higher state of alert, the first time the Kremlin has done so since the Russian Federation was established in 1991. According to Daryl Kimball, executive director of Washington-based Arms Control Association, “This is the first time in the post-Cold War era that a US or Russian leader has raised the alert level of their nuclear forces to coerce the other side’s behaviour”.

But what are the chances Russia will actually go nuclear? Bloomberg mentions two theories as to how nuclear weapons are shaping the Ukraine conflict. The one school of thought is “nuclear evolution theory” whereby the logic of mutually assured destruction would act as a deterrent to full-scale conflict. The theory postulates that the proliferation of nuclear weapons has made the world safer by increasing the risk of large-scale destruction due to the threat of activating nuclear weapons.

However, there is another theory known as the “stability-instability paradox” which posits that even though nuclear armed states feel secure that neither side will chance annihilation, the comfort provided facilitates a larger appetite for warfare, crisis and violence on a lesser scale.

It is this latter theory that we believe is currently playing out in Putin’s military strategy. Russia can be relatively confident the United States and its allies will not come to Ukraine’s defence directly, because this would increase the threat of nuclear war. At the same time, the paradox provides a mantle for Russia to escalate its non-nuclear warfare strategy.

In the interim, Russia’s perseverance in the invasion of the Ukraine has triggered a flurry of severe impacts on Russia’s financial markets, causing them to have gone dark. This highlights the risk of why we have avoided region-specific funds or ETFs for inclusion in our clients’ portfolios.

Our news this week sheds light on how the regional conflict has impacted financial markets, companies and commodities. We focus on those exposed to Russia, either directly or indirectly.

The following quotes, dated 1961 and 1965 respectively, are with acknowledgment to Glenn Snyder, former professor emeritus of political science, University of North Carolina:

“The Soviets probably feel, considering the massive retaliation threat alone, that there is a range of minor ventures which they can undertake with impunity, despite the objective existence of some probability of retaliation.”

“The point is often made in the strategic literature that the greater the stability of the ‘strategic’ balance of terror, the lower the stability of the overall balance at lower levels of violence.”

Global News

Standard & Poor’s has lowered Russia’s rating to “junk” status and Moody’s dropped its long-term debt rating for the Russian government from Baa3 to B3 – a six-notch freefall that leaves Russia’s credit firmly in “junk” or non-investment grade status. Moody’s also downgraded the Russian ruble in its short-term ratings to “not prime” while Fitch swiftly cut Ukraine on default concerns.
At the same time, the Russian stock market is closed, and US ETFs have signalled the scale of the rout facing the nation’s equity market. The VanEck Russia ETF (RSX) plunged 30% while the iShares MSCI Russia Capped ETF (ERUS) dropped 27% in US trading on 28 February alone. At the time of writing, the RSX was down 78% year-to-date and the ERUS down 81%.
The Nasdaq and the New York Stock Exchange have temporarily halted trading in the stocks of Russian-based companies listed on their exchanges. This is due to regulatory concerns as the exchanges seek more information following economic sanctions imposed on Russia.
Oil has reached ten-year highs, with brent crude peaking this week at almost $120 a barrel.
Russia’s economic fallout continued to grow as its central bank banned transferring coupon payments for sovereign debt, raising the risk for investors that the Kremlin could default.
The US and European nations have agreed to impose the most potentially crippling financial penalties yet on Russia over its unrelenting invasion of Ukraine, going after the central bank reserves that underpin the Russian economy, and severing some Russian banks from SWIFT, a vital global financial network.
This comes as Google switched off some of its mapping features in Ukraine, having learnt that the tools used to provide live updates about traffic were also being used to track activity at reported sites of Russian attacks in the country.
At the same time, Apple CEO Tim Cook informed staff that the company will stop sales in Russia, and match donations to support Ukraine. You can read his full letter to staff here.
Facebook and WhatsApp parent company, Meta, is barring Russian state media from running ads or monetising on its platforms anywhere in the world.
BP is set to exit its shareholding in Russian oil company Rosneft, the latest sign the West is willing to take dramatic measures to isolate Russia’s economy. The British oil company, which has been in Russia for three decades, said it will take a charge on its first-quarter results with a carrying value of $14 billion.
With more than one million refugees reportedly fleeing to neighbouring countries, Volkswagen and Ikea became the latest companies to suspend business in Russia.
Notwithstanding all of the turmoil outlined above, global markets have actually gained slightly since Putin’s invasion last Thursday, with the S&P 500 up 1.74% to yesterday’s close and the MSCI World up 1.3%.
Russian businessman Roman Abramovich is selling Chelsea Football Club, 19 years after buying it and setting the team on a path to sporting glory. He has promised to donate money from the sale to help victims of the war in Ukraine.
Major cryptocurrency exchanges have been asked by the Ukraine to block Russian users. However, the boss of one of the world’s biggest cryptocurrency exchanges has ruled out restricting ordinary Russians from using the service. Binance founder and chief executive Changpeng Zhao told BBC Radio 4 Today programme: “Many normal Russians do not agree with war.”

Local News

The rand’s multi-month recovery has been slightly disrupted by side effects of the conflict in Ukraine, which has caused a halt to downtrends in exchange rates like GBP/ZAR and USD/ZAR. The currency had been rising strongly against major currencies during the two months to the end of February, but the downtrends in USD/ZAR and GBP/ZAR were stalled by the unprovoked Russian invasion of Ukraine, returning the rand to levels last seen against the dollar in mid-January.
Local bonds fell with their international counterparts on Wednesday, pushing benchmark yields which move inversely to the price, to their highest level since December. Money markets are pricing in higher inflation due to the surging oil price, potential disruptions to other commodities, and the prospect of the SA Reserve Bank being forced to accelerate interest rate hikes. For the week, the ten-year South African bond yield has increased 1.27%.
Still considered one of the safest assets in times of uncertainty while also acting as a hedge against inflation, gold companies are cash flush and have been paying healthy dividends as they benefit from economies opening, inflation concerns, and heightened geopolitical tensions in Europe. Last week, gold traded at its highest level in more than a year, elevated by increased safe-haven demand.
Packaging company Mondi released a telling stock exchange notice. Mondi has operations in Russia, representing around 12% of the group’s revenue by location of production. Unsurprisingly, Mondi’s share price dropped 9.6%, wiping R18.9 billion off its market capitalisation.
Barloworld, another JSE-listed company with operations in Russia, has done business in that country since 1998. As recently as 2020, the company agreed to buy all of Wagner Asia Equipment, which has extensive operations in Mongolia, for R3.25 billion. Although it claims to not have excess cash in Russia, all Barloworld’s local payments from Russian customers are processed via the Russian central bank system, which is now under fire from the EU.
MTN Group is reaching market values last seen almost seven years ago, which is partly due to the rally in oil prices. (MTN has operations in oil-producing countries in Africa). MTN shares climbed 5.3% in Johannesburg on Wednesday to their highest since August 2015. The stock has risen for four days in its longest winning streak since November, supported by recent positive earnings updates from MTN’s listed units in Ghana and Nigeria.
The conflict has also impacted locally based Coronation Fund Managers, which has 9% exposure to Russian assets in its Global Emerging Markets Fund. Furthermore, its Global Optimum Growth Fund has 3.6% exposure to Russia, while its Global Opportunities Equity Fund has 1.2% of assets in the region. The company seems to have been caught off guard by how quickly the conflict escalated.
In line with foreign counterparts, the JSE remains above its closing price last Wednesday (just before the invasion of Ukraine), gaining 0.85% at the time of writing, despite a strong sell-off on the local bourse on Friday.
On the currency front, our research partner, Analytics Consulting FX Solutions, says, “It can be argued that the performance of emerging market currencies has been more resilient in recent weeks than would be expected, given the Russia/Ukraine crisis, with the clear exception of the Russian ruble”. Their article earlier this week categorises emerging market currency performance in 2022 into three distinct groups: The first being the currencies caught up directly in the crisis, with the ruble having lost over 28% of its value; the second group being countries surrounding Russia, such as Hungary and Czech Republic, which have tended to lose less than 5% of their value; the third group comprises commodity-producing emerging markets which have benefited from the commodity price boom (especially platinum group metal prices), following the imposing of sanctions against Russia. These countries include Chile, Brazil, Peru and South Africa, with their respective currencies generally holding up firmer than the first two groupings.