Curmi & Partners

The Ukraine invasion moves the narrative away from reflation to stagflation

By Robert Ducker

The invasion of Ukraine by Russian forces initially led to a sharp re-pricing of risk by investors. Heightened Russia/Ukraine tensions are not new, and the risk of invasion has been present for various months as back as November 2021 when Russia moved troops close to the Ukraine border. Yet, this was generally seen as more of a threat by Russia to Ukraine, rather than a clear intention to initiate conflict. A full-scale invasion of Ukraine was certainly not being priced in and the significant moves in equity markets since then confirm this view. However, the correction in equity markets started before the Ukraine invasion, triggered by persistent inflationary pressures which led to a more hawkish tone by central banks and more aggressive guidance on interest rates.

In the summer of 2021, the market was pricing-in no rate hikes in the US in 2022, but by February, rate hike expectations for the year had moved up to seven rate hikes of 25bps each. At a macro level, investor focus was firmly on the growth and inflation mix, with growth expectations remaining above trend but with momentum slowing, whilst inflation pressures persisted. Against this backdrop of reflation, long duration equities underperformed as investors moved away from growth to value. The positive investor sentiment around the reflation trade hinged on economic growth remaining fairly strong.

The invasion of Ukraine by Russian forces on the 24th of February led to higher uncertainty around the growth and inflation mix, which drove up the equity risk premium demanded by investors sharply. The Goldman Sachs Risk Appetite Indicator (“GSRAI”) tumbled to -1.9 by 07/03 (a reading below 0 represents negative risk sentiment, with readings of +/- 2.0 considered to be very bullish/bearish), down from roughly flat at the start of the year. Equity market performance diverged by geography, with global stocks falling -3.7% (total return measured in US$) during the period 23/02 (a day before the invasion) and 08/03 (peak concern). Yet, while US stocks (S&P 500) fell by just -1.2% (US$), European stocks tumbled -8.4% (€). Although some of this move can be attributed to catch-up, as European stocks outperformed pre-invasion, we think that it is mostly explained by the different economic implications of the Ukraine invasion including economic sanctions and the reliance of the region on Russian energy.

As the conflict developed a number of countries announced sanctions on Russia, which raised the uncertainty  around economic growth forecasts especially for Europe. The surge in energy prices since the invasion, and the potential for supply-side constraints for various metals and agricultural products impacts the growth and inflation mix. The higher energy cost will likely weigh on consumer spending and consequentially, on economic growth whilst also putting more pressure on the inflation forecast for 2022. As for additional supply side constraints, this will potentially lead to lower manufacturing in affected sectors (like autos and food and beverages) and higher prices as demand is still expected to remain elevated. On balance, the Ukraine invasion has led to a worsening in the growth/inflation mix moving the narrative away from the reflation narrative to stagflation concerns.

As the famous saying goes, history does not repeat itself, but it often rhymes. Equity market drawdowns during past geopolitical events have generally led to a lot of pain at the onset but tended to quickly fade away. Barclays estimate that the median peak to trough move for the MSCI Europe has averaged around -9%. More importantly, the median peak to trough measured in days was of 22 days, which is relatively short. Assuming there is no further deterioration, the peak to trough move in Europe was close to the median at -8.4% and lasted around 13  days. We believe that sentiment was boosted by the lower risk of a world war as both NATO and the US have so far refused to commit any boots on the ground in Ukraine. Any such move would likely increase the risk of a world war, the worst case scenario for risky assets at this stage.

Notwithstanding, the conflict is still ongoing and we think this poses a risk for risky assets such as equities. Recent news-flow of a growing military relationship between China and Russia is a negative. The US has already warned China of sanctions if it provides military aid to Russia, which would weigh further on the global economic outlook.


Despite the significant change in outlook following the Russia invasion we remain positive on the prospects for equity markets for 2022. We believe that investors need to manage their exposure carefully, especially the balance between value versus growth and geographical exposures. With uncertainty at such elevated levels, we recommend having a diversified portfolio to reduce stock-specific risks as macro conditions could change further.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business