Investing in times of war

By Peter S. Kim

To add to the woes of financial markets already struggling with red-hot inflation, Vladimir Putin decided to make his presence felt at just the worst possible time. Despite indications of imminent invasion by Russia, investors remained quietly confident that common sense would prevail until last week. The initial complacency was based on decades of the rules-based international order and the harmonious globalization boom.

The threat of being excluded from the global community came with political and economic consequences, which kept most leaders and dictators in line. Even with the latest incursion, there is hope that Russia will eventually yield to growing sanctions. A cost-benefit analysis for Russia indicates irreversible economic damage while galvanizing its opponents, rather than weakening them.

However, I would caution against expecting a positive outcome in current de-globalization and divisive ideology. For those of us in Asia, we can draw lessons from recent history involving China and North Korea.

For many years we witnessed rising geopolitical risks from populism around the world. In particular, we can see the inherent advantage enjoyed by dictators over their democratically elected counterparts. The cost-benefit analysis of a nation or its people is not necessarily aligned with dictators like Putin.

We have learned from China's Xi Jinping and North Korea's Kim Jong-un that personal ambitions often supersede the interests of the country or its people. A rational cost-benefit analysis would have China continue its path to democracy and global trade. Instead, President Xi is reversing 50 years of reform and sacrificing economic wellbeing under the banner of "common prosperity."

Likewise, North Korea's Kim Jong-un has the whole of the world trying to seduce him with promises of riches and liberation for himself and his country. When Kim first came into power, the West pointed to his Western education and young age as the catalyst to open up his hermit kingdom and embrace capitalism and democracy.

North Korea endured decades of harsh sanctions imposed by the global community as it strove to develop its nuclear capability. A decade after assuming power, Kim shows no interest in joining the democratic world. The irrefutable conclusion is that under the rule of dictatorships, economic sanctions are massively overrated.

Ironically, Ukraine is only now paying for its mistake of trusting the leadership of the West. In 1992, Ukraine inherited the world's third-largest arsenal of nuclear warheads when it gained its independence from the Soviet Union. At the time, the Ukrainian army had numerous ICBMs and long-range bombers and held 15 percent of the former Soviet nuclear arsenal, more than the combined atomic weapons of the United Kingdom, France and China combined.

Under diplomatic pressure from Russia and the U.S., Ukraine gave up its nuclear weapons to Russia under the Lisbon Protocol. Ukraine was assured of its territorial integrity and political sovereignty by all five members of the U.N. Security Council. More than 20 years later, Putin's Russia showed total disregard for the Lisbon Protocol and surrounding agreements, with the annexation of Crimea in 2014 and now, the Ukraine invasion.

Since Trump took the White House, the widening divisions between Western allies has been a godsend for totalitarian leaders like Xi, Kim and Putin, who for decades had to struggle with the united front of the world during globalization's heyday. Since Trump was elected, not only has nationalism begun to overwhelm the globalization movement, its champion, the U.S., lost a big chunk of its credibility.

It would seem the world continues to pay for four years of Trump's rule as nations discover the risks of trusting Western leaders with limited terms in power over open-ended terms that dictators enjoy. Putin may be taking significant risks with his incursion into Ukraine, but the greater sacrifice lies with everyday Russians. I do not see the latest U.S.-led sanctions forcing Moscow elites to cut back on their caviar consumption any time soon.

At this juncture, China's stance on the crisis is a critical factor. Will China play the friendly neighbor to Russia as it has done with North Korea in the face of sanctions from the West? China's history of double standards on North Korea's sanctions must be remembered. Many consider the Sino-Russian alliance timely and convenient, but for Asia, it could be a geopolitical shift that could last for decades.

During the panic over the pandemic in March 2020, the Korean stock market crash was met instantly with frenzied buying from Korean retail investors, rescuing the market and eventually driving it to an all-time high. To expect another dramatic recovery could be premature for two reasons. First, unlike 2020, the central banks and governments are busy tackling inflation with tighter policies on both the monetary and fiscal front.

The U.S. central bank is signaling the possibility of seven rate hikes in the coming year, and it has yet to make the first one. Second, the policy response to COVID-19 was coordinated meticulously between governments. Moving forward, governments across the world differ widely on the policy path for the coming years, leading to uncertainty for investors.

A prolonged conflict in Ukraine has broad ramifications for financial markets. Already we are seeing energy prices rise along with other commodities, placing central banks in a policy bind of taming inflationary pressures while supporting global economic growth.

On a brighter note, stock markets are going through a much-needed consolidation period. After the liquidity-driven buying frenzy of the past two years, stocks have become expensive by most historical measures. Many popular growth stocks have fallen with the recent sell-off, making many stocks attractive for long-term investors. Every crisis presents an opportunity, an old saying goes. While it remains valid, investors should brace for the long haul by exercising patience and applying a prudent investment approach.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.