Special Commentary: Events in Russia

Special Commentary 25 June, 2023

As many of you will be aware, we have been witnessing some extraordinary turn of events in Russia these past 24 hours. The purpose of this quick note is NOT to go over what has happened but, instead, to highlight what we can deduce thus far and, critically, what to keep an eye on in the days/weeks/months ahead.

Look at the map below. That’s how close Yevgeny Prigozhin’s (YP’s) Wagner Group came to a showdown with Moscow! He was on Moscow’s doorstep until the moment that he decided to withdraw.

In terms of what we can surmise from these events of the past 24 hours? Here are some observations:

1. No heavy military presence was implemented in and around Moscow even as YP’s Wagner forces approached. Only some feeble roadblocks and police presence around the city together with some helicopter gunfire on the convoy. This is Moscow, a superpower capital and yet it was left exposed. It is a country with the most nuclear warheads of anyone in the world. Yet a right-wing nationalist got so close to taking control. The Ukraine war has sucked military resources to the extent there wasn’t much left to draw upon. It also leaves one questioning what sort of order and structure remains in the system – the very point YP was making as he vocally lambasted the Defence Minister and others.
2. Putin has maintained a very low profile these past 24 hours – in fact, he has not been seen though there are no suggestions he has fled. He has clearly been shaken by recent events at a time when his popularity has been waning. There is an election next year (2024).
3. Instead, he (Putin) has buckled by clearly pressuring Belarus’s leader, Alexander Lukashenko (a close ally & puppet of Putin), into doing a deal with YP in which YP was given exile in Belarus. This felt desperate and is a feeble attempt at keeping YP off Russian soil – but for how long? His Wagner troops have been granted exemption from any prosecution. Whether these troops are reintegrated into the Russian military, we will have to see. Their loyalty has always been to YP and they remain a loose cannon – as indeed YP does! The notion that they will stay quiet and out of harm’s way is somewhat delusional.
4. An UNCONFIRMED report suggested Alexander Lukashenko fled Belarus - and that his plane was spotted over Turkey – as YP/Wagner were heading towards Moscow. This remains conjecture.
5. So unless all this is some fantastic master plan concocted between Putin, YP and AL, Putin is in a highly embarrassing and severely weakened position. On the one hand he has been full of praise for YP - to the extent there are posters of YP around Moscow and beyond. Now, Putin finds himself publicly condemning him and branding him a traitor. In the eyes of many Russians, YP is a hero. This is the first time the Ukraine war has “come home” to Moscow’s doorstep where, until now, Russians have been somewhat immune from everything that has been going on. They have not encountered any security issues, are still able to buy food and get basic necessities (though more expensive) while the economy has managed to hold up reasonable well. I don’t think, for a moment, Putin thought he would be facing internal military unrest - especially from within senior, military ranks.

What do we look out for next?

1. China. What China does next will be key, not just for Putin’s future but for the rest of the world. If Putin is deposed, the one thing no one wants is for someone from the far-right to come in. I can’t see them being as accommodating towards the Chinese as Putin has been. Look around the world at other states – Iraq, Libya, Afghanistan and see what a mess has been left behind there. None of these have nukes – Russia does! The Chinese will probably be able to prop up Putin for a period of time but everything has an expiry date. Putin’s weakness is not good for China – it puts a roadblock in China’s plans for domination over Asia while the West (through Ukraine and other states) makes a play on the Eastern front.
2. Russia allies are few – one is the Chechen Republic’s leader Ramzan Kadyrov (RK) who is an ally of Putin and even offered to “put down Wagner’s mutiny”. What’s in it for RK? It was Putin who appointed RK’s father to lead the Chechen Republic until his assassination in 2004. RK heads a divided region and needs Putin’s support. It doesn’t end there – Putin faces discontent in Kyrgyzstan and Turkmenistan (these being on China’s border!) while Belarus now becomes an even bigger problem….
3. ….and last, but not least, there’s still Ukraine. If it really is the case that Putin is severely weakened by all that has gone on, then this is as good an opportunity Zelensky will ever have to launch a major counteroffensive.

Let’s see how (1) events unfold and (2) markets react.

Week Ending 23rd June, 2023

First, a quick summary of some of the main economic releases this week:

US housing finally seems to be turning a corner: May’s housing starts surging over 20% m/m while existing home sales also ticked up, something we haven’t seen in a while; new home sales continued its positive trend. If all this continues, the boost to the economy should not be underestimated – it’s another growth engine. The second-half of the year looks promising – raw material prices have dropped back considerably which has given builders a boost. In addition, this pickup in housing implies a more resilient consumer.

UK May inflation proved highly stubborn – though the headline rate was unchanged at 8.7% y/y, the core rate increased to 7.1% y/y, far above expectations. Services inflation was the main driver and has been running at a rate above Q1’s pace.

By a vote of 7 to 2, UK interest rates were raised +0.50% to 5%. This was not expected. This sets the scene for what some are saying will be a further +0.50% hike in August and one more of +0.25% in September taking the terminal rate to 5.75%.

In Europe, both the Swedish and Norwegian Central Banks hiked rates +0.25% and +0.50% respectively taking them to 1.75% (inline) and 3.75% (above consensus) respectively. More hikes are expected.

Also in Europe, unemployment fell again, this time by -0.3% to 13.2%; employment gained +0.6% q/q. Wages remain high in what is still a tight labour market.

Chinese headline inflation notched up a to +0.2% y/y while core inflation edged down to 0.6% y/y – basically, it remains at negligible levels. Inflation also declined in India to 4.3% y/y (a 2y low). In China, it has prompted the CB to cut both the 1yr and 5yr prime rates by -0.10% each to 3.555 and 4.20% respectively. Some expected a deeper cut given how slow the recovery is proving.

Has anything changed out there?

Looking at valuations, the MSCI US regions trades on 19.7X NTM (Next Twelve Month) P/Es. This is at a new high and driven almost entirely by Tech. The latter is trading on 26.7X NTM P/E, a smidgen off its percentile top. By contrast, MSCI Japan is trading on 15.1X, above its median point and certainly a step up from its 12X to 13X range before. MSCI Asia (ex-Japan) is on 13.4X (not massively higher from before). MSCI Developed Europe is on a miserly 12.4X and is below the 12.5X to 13X range we have been accustomed to. MSCI EM is on just 12.2X and other sectors, like MSCI Growth, are on 24.8X (a little above its mid-point percentile range) while MSCI Consumer Discretionary is on 20.9X (half way). At the other extreme, MSCI Energy is on a lowly 9.1X and marks its lowest point. MSCI Value and MSCI Financials are on 12.0X and 11.2X respectively. All other sectors are bunched in the mid to upper teens level.

Overall, risk appetite has returned. Credit spreads (CDX US HY and iTraxx Europe Xover) are down significantly (i.e. bond insurance has cheapened) hovering between 400 and 440. Both are “catching down” to the VIX (S&P500 Volatility Index) which is hovering around 13. Even Bitcoin is up – a sure sign of risk-on!
The 60/40 Equity/Bond portfolio is doing well over the last twelve months with Japan outperforming.

Equity Risk Premia (the Expected Market Return minus the Risk-Free Return) have come down sharply to 4.4% (World), 3.5% (US), 7.3% (Asia Pacific ex. Japan), 4.3% (Europe). These are a clear sign people are not afraid to buy. Meanwhile, more bonds are falling into real return territory (e.g. front end of the US 1m, 1y and 2y Government bonds)

MARKET SUMMARY