With USDJPY algos, and thus the S&P, reacting as if stung like bees by every fabricated headline emerging out of Ukraine (only to reverse the move promptly after once the market realizes the biggest war in Ukraine continues to be one of disinformation), there appears to be far more confusion about how the Ukraine conflict will play out than what the Fed will do (recall that everyone is certain today Yellen will release even more dovishness). So to help out with the confusion here are three scenarios and trades from JPM, on how the Ukraine conflict may play out, if only in capital markets.
The market continues to be headline driven, with frequent surprises, since the onset of the Ukrainian crisis in March, yet the signs of de-escalation are emerging more frequently. We try to address the “what’s next and what to do” among investors’ FAQs. The effect of the crisis and sanctions becomes clearer through performance comparisons for Russia vs. EMs with more granularities provided through the industrial sector indices’ comps. Not surprisingly, the biggest damage can be seen in Energy and Financials, as both have some major names already sanctioned. These remain in a risk zone, yet it’s fair to assume that the de-escalation would warrant a symmetrical recovery trade. We assess the potential scenarios and strategies here.
Conceptually, the nature of the negative effects should be two-fold: (A) A higher risk premium related to deterioration of earnings visibility and investability of shares; and (B) the macro impact on earnings expectations through top line and FX hits. Both are visible in the general and sector index performance comparison in the table below.
Scenarios and trades. The gap analysis suggests the following scenarios and trades:
- the positive “de-escalation” scenario triggering gradual sanctions removal, and moderate acceleration of the macro environment could see the repetition of the April-July rally (~15% upside) with the most pronounced catch-up in Financials;
- the “status quo” scenario – Russia distances itself from Ukrainian events yet the conflict drags on and fades into the cold season with no further sanctions, triggering reduction of risk premiums benefiting the three laggard sectors (EN, FN, TC);
- the negative “escalation” scenario: the impact would match the extent of the additional sanctions’ scope and depth; at the extreme, investability of the market could be severely impaired.
In focus: the next big catalyst is a high level Russia/Ukraine/EU meeting in Minsk on August 26
Stock-specific performance is illustrative. The July-to-August trough and the recovery from the August low is shown in the chart below. We show the names with the most negative performance combo, featuring many of the sanctioned names.
[7]
