3 Steps for Investors to Take Amid Ukraine Turmoil

With Russia's move into Ukraine, a Wells Fargo expert suggests strategic moves, as others opine on U.S. options

A Wall Street Journal writer argues the U.S. could pressure Russia by lifting its oil export ban. A Wall Street Journal writer argues the U.S. could pressure Russia by lifting its oil export ban.

Rich Gordon, a fixed income market strategist with Wells Fargo Securities (WFC), described the effects that Russia’s intervention in Ukraine could have on the future direction of asset prices in a brief web-based video Wednesday. He also highlighted three tactical moves advisors and investors could consider taking in response to the current crisis and what the markets are saying in general today.

“Russia is trying to send a message to both Europe and the U.S. by doing so: that they will aggressively defend their own best interests in their own backyard,” Gordon explained in the video, part of Wells’ Market Summary Online series.

“During the last two months, a severe disassociation has been identified between the U.S.’s fixed income and equity markets,” the analyst said. “If this were to persist, it would indicate to us that the bond market has it right; and bonds have been overturning last year’s performance thus far in 2014, while the S&P continues to rise, despite the disappointing economic data recently, which has been primarily blamed on the inclement weather.”

Wells Fargo, though, believes there is more going on than bad weather. “There are too many risk indicators that are providing some foreshadowing,” he noted. For instance, gold is up 12% this year.

Plus, there’s been a rally in the German Bund, Gordon points out. “The 10-Year Bund yield has declined by 10 basis points, while the U.S.’s 10-year Treasury has declined by 1 basis point. This is not surprising, as Germany’s proximity to Russia and the Ukraine is taken into account here,” he explained.

“A feud between the NATO allies and Russia provides absolutely no benefit to economic growth,” the analyst said, noting that the Russian stock market is down more than 21% year to date.

3 Strategies to Follow

Gordon’s first piece of advice is to “take some risk chips off the table immediately” in stocks and high-beta fixed income sectors.

“There’s not enough upside left in many of these assets to justify leverage and long sectors, given the destabilizing [situation] in Europe,” he explained.

Plus, stocks charts show that the equity markets “could easily correct by 4%-5% and still hold their bull trend line,” the analyst says.

Second, advisors and investors should consider reducing, or at least not raising, any stakes in high-beta fixed income. “Reduce exposure and wait on a better entry point,” he explained.

Third, buy interest rate volatility to hedge bets tied to near-term Treasury yields.

“Treasury volatility is cheap,” Gordon said, “and if things deteriorate in Eastern Europe, then Treasuries would likely be the asset of choice.”

The analyst says that his Wells team has “developed a healthy respect for the occasional powers of moves in the Treasuries market. It’s also long on the U.S. dollar, given the support the currency had in late February.

Alternatives

Late last year, a survey of 800 high-net-worth investors found they were looking for ways to further diversify their portfolios, including investments in commodities — which Russia boasts plenty of, MainStay Investments said Wednesday.

“Allocations into alternatives are growing as HNW investors are taking a closer look at their investment returns and diversification goals, and learning how alternatives can fit into a smart asset allocation strategy,” said Stephen Fisher, president of MainStay Investments, in a press release. “However, with 39% of respondents reportedly lacking confidence in their knowledge of alternatives, there’s a real opportunity to bridge the information gap.”

On average, HNW investors have more than one-fifth of their portfolios, or 22%, invested in alternatives, and 26% say their exposure to alternatives will increase over the next five years by an average of nearly 3 percentage points. About 65% say their level of exposure will remain the same.

Sixty-one percent of those who already invest in this asset class are reallocating from cash and money market accounts; 44% from equities and 22% from fixed income. Three of five HNW investors who are currently using alternatives in their portfolios —have increased their investment over the past year.

The reasons that HNW investors turn to alternatives, the survey finds, are diversification (50%) and investment growth/return potential, 48%. About 60% also view protecting principal as a key role of alternatives. 

Commodities are the most commonly held alternative investment (48%), followed by private equity (39%), long/short equity (36%), hedge funds (34%) and managed futures (30%). The most common method for investing in alternatives is via mutual funds (65%), followed by ETFs (40%) and managed funds (38%). 

Still, concern about risk is the top factor holding HNW investors back from using alternatives more broadly in their portfolios: Nearly half of those who do not invest in alternatives today, 49%, say it’s because they view alternatives as too risky.

Deep Background

While investors and advisors consider their financial options, Europe and the U.S. are mulling the effects of possible economic sanctions.

As to the appropriate strategy to take, Harvard Business Review bloggers Walter Frick and Sarah Green say Russia is vulnerable, since a significant share of Russian exports end up in Europe, but Russia supplies 30% of Europe’s natural gas and is the world’s largest exporter of the commodity.

“But in a sense, Ukraine’s economic tug-of-war mirrors the political and cultural balancing act it faces in deciding how to align itself between Russia and Europe,” they wrote Wednesday. “As an economic matter, it cannot give up access to one without needing much more from the other. And with $16 billion in debt due by the end of 2015, the country needs all the revenues it can get.”

Other Moves to Make

The Wall Street Journal’s take is that the U.S. energy boom could pose a real threat to Russia's oil monopoly, according to columnist John Bussey.

Of course, first, the U.S. would have to get rid of its ban on oil exports, which was put in place after extreme volatility in the ‘70s. “There's money to be made feeding world markets from fields such as the Bakken in North Dakota and Eagle Ford in Texas,” Bussey wrote Thursday.

At the same time, some U.S. companies want to build pipelines and liquefied natural gas facilities to export more gas, thanks to shale production in the Marcellus formation.

There are naysayers, including Dow Chemical, which believes exports would raise energy-feedstock prices at home, and environmental groups that would like to see reductions in fossil-fuel use worldwide.

For its part, the White House has approved “a handful of new natural-gas export projects.” But the Keystone XL pipeline, set to move oil from Western Canada to refineries in the U.S., is stalled.

Back in Europe, Moscow continues to exploit Europe's dependence on Russian oil and natural gas as an economic weapon.

“This dynamic—allies dependent on an unstable supplier—isn't in U.S. interests, business or otherwise,” Bussey argued. “It limits our partners' response during crises. And the instability potentially crimps global economic growth, which isn't good for anyone.”

The more the U.S. can do to shake up this dynamic, the writer says, the better.

“Just the promise of more pressure on Mr. Putin's quasi-monopoly might make him treat his customers better. It might not force him out of Ukraine's Crimea. But it would give Europe more leverage to press the point,” Bussey concluded.

As the Keystone XL pipeline dispute continues, the ruckus in Eastern Europe likely will create more insecurity for global energy markets—and more concerns for investors.

 
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