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Different scenarios on the evolution of the war in Ukraine and its impact on the markets

Alexandre Gauthy - Economist
In this text we describe four possible scenarios for the war in Ukraine and their impact on the markets. We then outline our baseline scenario and investment strategy in this uncertain environment. However, this paper does not aim to describe the long-term geopolitical consequences of the war.

Four scenarios: from least to most positive for risky assets

1. Escalating conflict, no agreement in sight

In this first scenario, both sides stick to their positions. The Ukrainians do not lay down their arms and the Russian strikes intensify. The Russians use other, more destructive weapons and the collateral damage is significant. Negotiations are continuing, but there are still major differences between Russian demands and what the Ukrainians are prepared to discuss. In this context, we have probably not yet reached the peak of international sanctions against Russia. It is not excluded in this scenario that Europe would impose an embargo on Russian oil and gas exports, causing a further rise in energy prices and plunging Europe into recession. Financial markets would react negatively to these additional sanctions, which would affect European energy imports that have so far escaped sanctions. Risky assets would continue to suffer, the euro would depreciate further, and risk-free rates would fall. In this scenario, investors should favour quality and self-sustaining growth stocks over cyclical and low-value stocks.

2. Status quo in the conflict

The second scenario, the status quo, describes a situation in which the conflict stalls. Moderate additional sanctions remain possible. In this scenario, European economic growth slows down, due to previous increases in commodity prices. Financial markets remain volatile, with no significant further decline in equities materialising. Risk-free rates remain around their current levels and the dollar remains high. In this environment, stocks of quality companies with autonomous growth are to be favoured.

3. Escalation of the conflict with possible agreement

The intensification of the Russian offensive and/or a certain stalling of the Russian army finally allows for progress in the negotiations. In this scenario, the Ukrainians and Russians reach a compromise, and a ceasefire agreement is reached. The withdrawal of Russian troops from Ukraine could lead to a partial lifting of sanctions. Commodity prices fall in response to this agreement and European economic growth slows but remains more resilient overall than in the first two scenarios. Global equities rebound in this scenario and European cyclically sensitive equities rise in price to a greater extent. Risk-free rates rise again, as markets anticipate more rate hikes from central banks in response to this reduced risk.

4. Towards an immediate agreement

This scenario is similar to the third scenario described above, except that the agreement is reached more quickly. In this case, the rise in commodity prices would only be temporary. Its impact on European economic growth would therefore be more limited than if the conflict were to be prolonged. Some of the sanctions are lifted more quickly and economic growth is ultimately only slightly affected by the war. In this context, the value style is to be preferred.

Our four possible scenarios for the evolution of the war in Ukraine:
Différents scénarios sur l’évolution de la guerre en Ukraine et de sa répercussion sur les marchés-table

Our baseline scenario and investment strategy

Although there has been a glimmer of hope in the negotiations in recent days, uncertainty remains high. The evolution of the conflict, its impact on the financial markets and the relevance of our positioning are the subject of daily discussions within our investment committees. That being said, our most likely scenario at the moment is scenario 3 of an escalation of the conflict before a possible agreement. In this context, the markets will probably be volatile in the short term but will remain well oriented in the medium term.

To make the portfolios more resilient if the situation evolves towards the first two scenarios, we have, as a precautionary measure, reduced European equities somewhat. The value style has also been reduced but not abandoned. As a result of these movements, our portfolios now hold more US than European equities and are more oriented towards so-called "quality" stocks, which have good visibility on the future evolution of their cash flows. We believe that these quality stocks will prove more resilient than value stocks in the adverse scenarios (1 and 2). But if we move to the scenario with more positive economic consequences (4), the value style should perform well compared to the quality style.

Despite very low short-term visibility on the aftermath of the war in Ukraine, our fundamental view of equity markets and the value of the productive capital of the private economy they reflect remains positive.

Banque Degroof Petercam S.A., having its registered office at Rue de l'Industrie, 44, 1040 Brussels, is responsible for the drafting and distribution of this document. This document is provided for information purposes only. Its content can in no way be considered as investment advice and does not fall under the category of "investment research" as referred to in the MiFID regulations. The opinions expressed are based on carefully selected public information that is valid at the time of writing. They are subject to change without notice and offer no guarantee for the future. Neither Banque Degroof Petercam, nor its affiliates, directors, representatives or employees can be held responsible for inaccurate, incomplete or missing information, or for any direct or indirect damage, loss, cost, liability or other expenses arising from the use of or reliance on such information, except in the case of intentional misconduct or gross negligence. This document is the property of Degroof Petercam and may under no circumstances be copied, distributed or published, even partially, without the prior express authorisation of Degroof Petercam.
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