Humans do horrible things to each other, and war is the worst example of that. What was first announced by Russia earlier last week as a “peacekeeping” force moving into part of eastern Ukraine controlled by Russian separatists quickly morphed into a full-blown attack. This in turn has seen a progressive ramping up in western sanctions on Russia. All of which has contributed to high levels of financial market volatility. This note looks at the current situation, five big picture implications of relevance to investors and the performance of Australian shares.

The current situation

The falls and volatility in global share markets in response to the war reflects a fear of the unknown about how far the conflict will extend and how severe the economic impact will be. The main economic threat is through higher energy prices as Russia supplies around 30% of Europe’s gas and oil imports and accounts for around 11% of world oil production. In short, investors are worried about a stagflationary shock.

If the conflict is limited to Ukraine with Russian gas still flowing to Europe and NATO not getting directly involved (Scenario 1), then the economic fallout will be limited, and further share market falls may be minor or we may have seen the low. But if Russian energy is cut off and NATO military forces get directly involved (Scenario 2) then share markets could have a lot more downside (like another 15% or so). And given the uncertainty investors may fear the latter scenario even if its ultimately avoided. There are several points to make regarding all of this.

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