Jupiter: Ukraine and a world in conflict and flux

An unhappy birthday: Ukraine and a world in conflict and flux

As we arrive today at the first anniversary of Putin’s invasion of Ukraine, there is zero surprise that there has been a flurry of diplomatic activity in the past few days: the February annual Munich Security Conference; meetings of NATO leaders; President Biden’s tour of Kyiv, and his public appeals and rallying calls in Warsaw and Berlin; President Zelensky’s visits to London, Paris and Brussels; China’s top diplomat, Wang Yi, visiting the Kremlin; a resolution in the UN urging Russian withdrawal from Ukraine.

As we have said on many occasions in these columns, even if not strictly World War Three, this is nevertheless a conflict of global proportions and with consequences, whether political and certainly economic, that have been felt in virtually every country. It has had a profound effect on investors.

While the fighting is so far still largely confined within the borders of Ukraine and the military situation has tended towards ossification and attrition (though that will almost certainly change in the Spring fighting season in an attempt by both sides to break the deadlock), the broader geopolitical environment is dynamic and rapidly changing.

Two weeks ago, Jupiter Merlin Investment Director Alastair Irvine published “Anatomy of a Crisis 2: What Next for Ukraine”, a follow-up to his essay a year ago before the invasion analysing how it was possible to be on the brink of a major war in Europe, one protagonist nation (and worse, Russia being a Permanent Member of the United Nations Security Council) about to violate the sanctity of a sovereign neighbour. As an addendum to “Anatomy of a Crisis 2”, while not intending to keep up a running commentary it is worth a look at what has altered since then and what has not.

Biden the Bold?

Biden has been touring Europe projecting himself as leader of the free world. His language has been robust. However, it is important not to lose sight of the political context here. He is still healing the rifts within NATO arising from the disastrous exit from Afghanistan in 2021 when the US unilaterally decided to pull out with little or no reference to its allies; the political humiliation at the hands of the Taliban; the resulting humanitarian disaster from the withdrawal of financial aid to Kabul; Biden’s misguided and uninformed reassessment of the campaign’s intent and his weasel words about the Afghans’ fighting capabilities; the international condemnation of his actions; that episode remains a significant stain on NATO’s copybook and Biden’s own reputation and NATO’s disarray certainly contributed towards Putin feeling emboldened to invade Ukraine. Regarding Ukraine itself, he is also having to slay another of his own personal demons: his public gaffe last January that he wasn’t going to lose any sleep over Putin transgressing Ukrainian sovereignty if it amounted to “a limited incursion”.

Between the war starting and today, Biden has lost the House of Representatives to the Republicans; in a political battle of wills in Washington and with a Presidential election looming, the Republican narrative is that there must be no blank cheque for Zelensky but Biden is publicly couching support in terms of “whatever the cost”. From whichever geographic location he is making his speeches, they all have multiple target audiences.

“Carry on, Comrade Volodymyr! We’re right behind you! Quite a long way behind, actually”

But in a significant change of tack, Biden’s tone has changed while he has been in Europe, literally on the front line. He has markedly upped the ante (or more accurately, the ‘anti’). From being a support to Ukraine, he has now explicitly turned this into a conflict between democracy and autocracy; between freedom and oppression. Good must prevail. Expressed in such terms, the implication to his audience is “you’re either with us or against us”; in the wake of the fractured Munich Security Conference in which a number of countries notably in South America and Africa declared more pressing concerns to their national interests than supporting Ukraine or riling Russia (indeed South Africa has very publicly aligned itself with Russia with its joint military exercises in the Indian Ocean), Biden’s is an oblique declaration to those siding with or sympathetic to Russia, or who abstain from taking sides, that history will judge them to be on the side of oppression and brutality. That exhortation clearly cut no ice in changing opinions in the UN this week calling on Russia to withdraw. A year on from the condemnation resolution the maths stays the same: 141 countries voted in favour, 7 including Russia were against, but critically 32 abstained including China, India and South Africa. They might be a minority of countries, but they account for more than half the world’s population who have effectively said “this is not our problem”.

There is a fundamental weakness in Biden’s position. The rhetoric is strong and laudable but the reality is the words ring hollow. In that battle against oppression, the US is not prepared actively to participate as a direct protagonist in the military conflict in Ukraine, the geographic epicentre where his two cultures of light and dark collide. Biden remains committed to delegating the physical struggle to his proxy, Zelensky. Further, it knows that even if it wanted to, America would not get a UN resolution to evict Russia from Ukraine: Russia and China would almost certainly veto it. Essentially, therefore it remains the case that America pays and the rest of us chip in, Ukraine does the fighting and dying, the political calculus of goodness is relegated to the first derivative at which point it begins to lose its conviction.

Old KGB habits die hard: ‘recollections may vary’

Words matter in such circumstances and inevitably provoke a reaction. While putting backbone behind America’s allies and challenging the waverers and Russia’s supporters, the inevitable consequence is that it also allows Putin to present Biden’s wish to defeat autocrats in general and Putin in particular as an existential threat to Russia and all Russians wherever they might be. In Putinland it’s all the West’s fault. That is precisely how Putin framed it at the staged, televised mass rally at the Luzhniki Stadium in Moscow: however warped his argument when seen through our Western lens, what he did was to turn it into a call for patriotic support for the cause in the struggle against Western aggression towards Russia. If many 21st Century Western countries are embarrassed by the concept of nationalism and national pride, Russia and Russians have no such qualms about patriotism and loyalty to the Motherland; invoking both is Putin’s means of cementing domestic public support, particularly when he needs to demand another round of conscription. And whether bluffing about the use of nuclear weapons or not and upping the ante from his own perspective, he has scrapped Moscow’s participation in the Strategic Arms Reduction Treaty.

An unwelcome further fomenting of relations: Russia and China

The past two weeks have also seen the geopolitical heat turned up in another unwelcome direction: China. Already allies, this week’s reaffirmation not only of shared interests and cooperation but explicit solidarity between Moscow and Beijing, and the warning from the CCP to the West about the quantities and types of military aid being provided to Ukraine is a strong fillip to Putin. Left hanging is whether China will send arms and munitions to Russia: such a move, especially given that Iran, another mutual ally, is already provenly doing so, would mark a considerable escalation in geopolitical tensions. On the other hand, there is speculation that China may act as an interlocutor in a peace deal: while China will do nothing to undermine Russia and Zelensky’s position remains one of no compromise, a deal seems a distant prospect. Time will tell.

Both China and the West (and Europe in particular) are performing the dance of the seven veils around each other. China buying sanctioned surplus Russian conflict oil; Covid blame; Trump’s economic sanctions; the tensions over investment and Chinese appropriation of intellectual property rights; Chinese spy balloons over America; intentions over Taiwan and the militarisation of the Spratley Islands; oppression of minorities in China and the annexation of Hong Kong; all have contributed to a distinct cooling of relations. On the other hand, Western markets are key for China’s economic recovery, and countries such as Germany, Italy and New Zealand are keen to beat a path to Beijing’s door seeking partnership terms in China’s neo-colonial expansion through the infrastructure projects included in the One Belt One Road initiative and its maritime equivalent, the String of Pearls.

And the end-game? Who knows? NATO still does not

If all these elements have been in flux and the ground has shifted, one thing that has not changed in the past two weeks is any progress among NATO members about how to bring the conflict to a quick close. If NATO has moderate agreement (but no unanimity) on the supply of arms, equipment and financial aid to Ukraine, it still has no agreed strategy whatever for a conclusion nor is it able to define what that conclusion should be.

The EU: a lost soul in search of a role

To many around the world, including a significant number of Americans, the war in Ukraine is specifically a European problem. It is a parochial point of view and one with which we do not agree.

However, the conflict’s year-long duration, and more specifically the events of the past fortnight, have revealed just how irrelevant is the European Union. To be clear, not its members but the ‘entity’ of the Union itself.

Ukraine’s bid to join the EU was undoubtedly one of the principal catalysts behind Putin’s invasion, but in terms of averting the conflict or achieving its resolution, the EU has been peripheral at best. Where also members of NATO, EU national governments have focused their energies in that forum rather than through Brussels. Nowhere is that more the case than down NATO’s eastern flank, ranging from the Baltic States to the Balkans. Poland is the focal point for the EU’s difficulties: through Lech Walesa and the Solidarity Union in the Gdansk shipyards Poland was the cradle of dissent against Soviet oppression in the late 1980s; it has a robust defensiveness against the Russians and a healthy paranoia of being overrun; however, it is perennially on the EU’s naughty step and threatened with Article 7, suspension of voting rights, for violation of EU values and ignoring the supremacy of the European Court of Justice (and currently the funds due to it from the EU’s €750bn Covid Recovery Package are being withheld from Poland, despite the significant cost to the Polish economy of taking in millions of Ukrainian refugees); this week, Biden declared Poland a cornerstone ally in NATO and pledged his and NATO’s commitment to the people of Poland as the guarantor of their security under Article 5 of the treaty. Poland will understandably feel that it is in receipt of much greater love, constructive support and respect from Washington than it ever receives from Brussels. But if Poland presents a particular problem of its own for the EU, it is not as though the EU itself has an otherwise unified position (to be fair, nor does NATO). While most EU members are sending aid with varying degrees of enthusiasm or reluctance, three refuse to play at all: Austria (officially neutral) and Croatia wish to maintain pre-invasion ties with Russia (or at least see no reason to antagonise Russia), while Hungary’s Viktor Orban is openly supportive of Putin, and last autumn signed a new gas supply agreement with the Kremlin. With those exceptions, the Frontier Countries are robustly aligned with the UK and the US in confronting Putin, but not with the standpoint of France, Italy, and Germany all three of which see Putin’s/Russia’s total defeat as counterproductive. Last year, when attempting to cut the consumption of Russian gas and the EU attempting to impose a Bloc-wide 15% consumption curtailment, those countries not on the Russian gas ring (e.g. Spain, Portugal and Malta) all refused to comply. So much for unity in the European Union!

Against this backdrop, the EU and its institutions have been largely disintermediated: Charles Michel, President of the Council of Ministers has been supplanted by national leaders and in any case has no unified opinion, policy or solution to represent; Josep Borrell, the EU High Representative for Foreign Affairs has been usurped by national foreign secretaries and to the extent he has played any role at all has proven himself to be woefully inadequate to the task; as the Bloc’s civil service, the EU Commission under Ursula von der Leyen has neither authority nor role without an agreed policy to implement.

EU defence procurement: ample scope for mischief-making

However, not wishing to be left out entirely beyond channelling Ukrainian refugees, Brussels has hit upon a policy area where it feels it can make a concrete contribution: centralisation of defence procurement among EU member states. While sounding superficially attractive, with its propensity to bureaucracy and sclerotic decision-making through needing to accommodate competing national self-interests, it is tempting to suggest that if Brussels is the solution to the rapid procurement of munitions in an emergency, the problem is greater than anticipated. History supports this: thanks to internal divisions and bickering, the EU failed to make any meaningful contribution or to help bring resolution to the Gulf Wars, the Balkans War and the war in Afghanistan. The omens are not good.

However, if it goes ahead, the reality is that the Brussels proposal is a major opportunistic political land-grab by the centre. It would confer significant influence over EU members’ defence strategies and programmes. Politically it is using the Ukrainian situation as a Trojan Horse in the eventual aim of having a single pan-EU defence force with all the knock-on consequences for the stability of NATO.

But there is a geopolitical angle to this proposal too: backed by state-aid cash, it ring-fences the EU defence industry, potentially shutting US and UK contractors out of future supply contracts to EU countries while at the same time risking non-EU participants in joint European programmes being de-prioritised behind EU participants and customers. The Brussels’ plan potentially complicates systems such as Eurofighter Typhoon used by the RAF (the Eurofighter consortium, headquartered in Germany and with assembly sites in the UK, Germany, Italy and Spain comprises BAe Systems, Airbus Defence–formerly EADS– and Leonardo of Italy), and the British Army’s Boxer IFV (the armoured personnel carrier replacement for the Warrior Armoured Fighting Vehicle; Boxer, another multinational system designed by Rheinmetall GmbH, made in Holland and Germany). Cynically/pragmatically, it is a response to Biden’s Inflation Reduction Act passed in to law last year which is equally defensive of the US automotive industry as it transitions from combustion engine vehicles to electric, significantly jeopardising Germany’s biggest export market for cars by value. There is a defence-related war on two fronts here: a proxy fighting war between NATO and the Russians, and a trade war between the Americans and the EU. Welcome to realpolitik 2023.

The investment perspective

There is no sudden new catalyst here today. But it is important to recognise the geopolitical tectonic plates are certainly shifting and the world is a less stable and politically more polarised place than even last month. It is impossible simply to isolate the war from other political and economic forces at work, including China re-opening after its prolonged Covid lockdown. However, the rippling effects of Putin’s malign influence remain pernicious and real: the economic and political effect of inflation and the consequential impact on fiscal and monetary policy; the ongoing debates as to whether national economies will endure or avoid recession; the effect it has on companies, not only on their sales and profits, but for those which are awash with debt there is the significant risk posed by their rising cost of capital. The cost of financing applies to nation states too: a couple of weeks ago we looked in detail at the US Debt Ceiling being breached; in another example of financial stress, Egypt teetering on the brink of default, is currently directing 42% of all government expenditure on servicing its debt.

It matters and affects us all. But it presents opportunities as well as risks! It is our job to find those opportunities and pockets of genuine value, while as far as possible avoiding the investment landmines and torpedoes.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

The value of active minds – independent thinking

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Fund specific risks

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