The Long and Short of It: War or Peace?

I. The First Year of War

After a year of war, Ukraine is now in a brutal battle of attrition. Mere meters have been fiercely contested, yet there is no sign of de-escalation. If anything, hostilities are intensifying. Western support for Ukraine includes increasingly exquisite, expensive, effective kit and training. Restraint to avoid escalation has been shifting to structurally undercutting Russia’s military threat with large-scale offensive operations. 

The Kremlin is doubling down, not backing down. Russia seems to be preparing a large-scale mobilization and renewed offensive, possibly within months. Sanctions are handicapping Russia’s high-tech military and civilian activity, but the economy is coping and adapting, even though the G7 Oil Price Cap seems to be reducing oil export/fiscal revenue, which suggests the war may drag on. 

Yet markets seem focused on macro factors more than war. Global growth is reaccelerating as China reopens and inflation falls, if unevenly. Europe is coping surprisingly well. Energy subsidies/price controls, conservation, sourcing away from Russia and an unusually warm winter have prevented stagflation. Energy prices have fallen sharply. If the world economy has adjusted, shouldn’t investors move from geopolitics to valuations, fundamentals and upside? 

We wish it were so simple. The energy shocks of 2022 may not repeat even if the war drags on. But if next winter is cold, or there is a Cold War 2.0, commodity prices may be structurally higher in Europe than in the Americas, Asia or Emerging Markets (EM). The “Global South” opposes the war but is not onside with West in isolating Russia – and not even in technological decoupling from China, and so may become a crucial arena of great-power rivalry for influence. 

Thus, the global economy is segmenting in our view, as the war deepens a reconfiguration of the world order underway since the Global Financial Crisis and punctuated by Brexit, Trump’s trade wars, COVID and US-China frictions. Strategic portfolio asset allocation should evolve in response.

II. War or Peace?

Most people did not expect war despite hostilities since the 2014 annexation of Crimea, Russia’s late-2021 mobilisation or early-2022 US warnings. On Day 1 of the invasion, Russia was expected to win quickly. Around Day 365, Ukraine hopes to push Russia back.

War is unpredictable and defining victory or the war/peace distinction is harder than it seems. Accordingly, we consider three possibilities: 1, Ukraine Wins; 2, Russia Wins; 3, Stalemate. We conclude with market views and set out why we think Going Nuclear is unlikely in the appendix.

Ukraine Wins: 

Negotiations after a ceasefire/armistice culminate in a peace treaty largely on Ukraine’s terms, perhaps a return to prewar borders, probably leaving Crimea as Russian territory. Significantly weakened, Russia could turn inward to repair itself, as after the 1991 Soviet collapse. Or it could become even more nationalist and turn eastward, under Putin himself or another hardline leader. 

Ukraine/Europe/West/United States win big. NATO/US military kit, intelligence, diplomacy and coordination conclusively outgunned Russia’s war machine – despite Western restrictions that require weapons to be used only for defense (at least so far), making for a harder-won victory. Pax Americana is boosted, especially in the West, perhaps reducing the risks of instability elsewhere.

Even in winning, Ukraine and the West face uncertainties. Would Ukraine join the EU or NATO and if so, when? If not or for the interim – likely a multi-year process subject to obstruction by any NATO member, and its accession to the EU, Ukraine might need to be armed to the teeth to deter further attacks. Plus, there is perennial risk of US disengagement, crystallized in the Trump era.

Whatever the specifics, there is no return to the ante-bellum status quo. Russia has resurrected the spectre of wars of conquest; economic disruption on a scale not seen since WWII; and perhaps the first of many challenges to Pax Americana in what could be a bipolar or multipolar world but is no longer unipolar, despite Russia’s defeat.

Russia Wins: 

A Pyrrhic victory, huge losses that outweigh gains on any conventional scale, cannot be ruled out. The Kremlin is clearly willing to bear enormous costs to restore control of part of the Soviet Union.

Russia has perhaps the largest natural resource endowment in the world on the largest territory with some 3x Ukraine’s manpower. China and India buy its energy on the cheap, they and others buy its soft or hard commodities. Russia has few allies, but Iran and North Korea supply arms.

Russia could change the course of the war by outlasting Ukraine and the West with men, materiel and mettle, despite Ukraine’s willingness to fight for survival and Western support. On a shorter horizon, a successful Russian offensive may drive the West to reconsider what is achievable and sustainable regarding long-term military support to Ukraine. 

If Russia turns the tide and establishes durable control of part of Ukraine, “Rump Ukraine” would have to be stabilized and armed to the teeth in this scenario too. NATO would have to be even better fortified. Western Europe’s impetus to decouple from Russia would be that much stronger. The risks of other major conflicts elsewhere could rise. National security considerations would become even more important in global economic policy, including in trade/investment barriers.

Stalemate:

Wars can end in negotiation and treaties or remain unresolved: Korea, Indo-Pak/Sino-Indian, Mid-East; “frozen conflicts” on Russia’s doorstep–Georgia, Moldova

With existential risk perceived by Ukraine, Russia, Western Europe, the war drags on. Sanctions undercut Russia’s military capabilities yet do not prevent it from sustaining a destructive, if ineffective war effort. Russia follows in the footsteps of Iran and North Korea, which have continued to develop nuclear weapons despite decades of military/economic sanctions. Russia is a far larger, more capable, resourceful, powerful adversary. Soviet Russia gave the West a strong run for its money in the 20th Century. Russia may be much weaker today, but it can still replace weaponry, mobilise more soldiers and redevelop military/industrial technologies.

Russia has strong motivation to maintain conflict or at least avoid a treaty. Peace would remove a key barrier to Ukrainian NATO membership. NATO cannot accept members involved in armed conflict because of its Article V collective-defense clause — an attack on any member state is an attack on all. In the case of Russia, this could be tantamount to nuclear war.

Furthermore, the traditional path into the West for former Soviet Republics and Warsaw-Pact satellite states was NATO membership, stepwise integration into the EU and ultimately Eurozone entry. Russia’s long-running effort to influence, then destabilize, and now conquer Ukraine implies that the only ironclad guaranty of Ukraine’s security is NATO membership, and that would pave the way for Ukraine’s irreversible westernization.

And that is the heart of the matter: For Russia to be a great power straddling Eurasia, resuming a global role on par with China, the US, Europe or its own history it needs substitutes for China’s economic heft and rising geopolitical power; for the US alliance system, the dominance of the dollar and influence on the global narrative; and Europe’s soft/regulatory power. 

Russia has been restoring influence in the Mid-East and Africa, where the US has been receding, but not in its near-abroad where the US, EU and China are making inroads. There is every reason to think that Russia will keep trying to fend off the West as long as it can – and equally to expect the US/UK/EU to shore up Ukraine and protect the Western system against these threats.

III. War, Peace and Markets

This (in)famous advice has been interpreted literally and figuratively. The Rothschilds made outsized, contrarian returns, lending to sovereigns at war, buying in the carnage of market crashes, investing with an information edge, famously learning first who had won the Battle of Waterloo. 

It clearly matters who wins, and what winning means from all angles — military or geopolitical; economic or financial – both in the theater of war and the wider world. Yet, whoever wins or in a stalemate, the world order is unlikely to return to the status quo ante. 

Instead, we expect increasing state intervention for geopolitical, foreign-policy and national-security aims. The idea that economic interdependence would stop conflict by making war too costly has clearly not worked, so economic and financial globalization will very likely continue to morph. 

The peace dividend, already disappearing, will likely be reversed in many ways. Guardrails are rising to manage the risks of great-power rivalry, friction and conflict. Expect larger budget deficits, greater regulation, more emphasis on tangible, high-intensity capex for resilience; redundancy and reliability of just-in-case supply chains; and much greater insurance in national security, including military hardware and capacity. 

All this means less emphasis on the efficiency, productivity and the profit motive that have underpinned globalisation since the Soviet collapse. Yet, economic integration has progressed so far that decoupling for a Cold-War replay would be disruptive, costly and counterproductive. Isolationism is widely seen to have worsened the Great Depression and WWII.