15 Mar 2022 4 min read

Ukraine conflict: recession risks, long-term scenarios and market sentiment

By Emiel van den Heiligenberg

As the conflict in Ukraine leads to a humanitarian crisis, we consider how the invasion could shape the economic outlook and where market sentiment could go from here.

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The Ukraine war is first and foremost a human tragedy, but it also stretches us to manage risk for our clients to the best of our abilities. The crisis continues to dominate our Asset Allocation team’s morning meetings and investment discussions, and we believe there are three key things to focus on:

  1. How does this impact the probability of a recession across developed markets?
  2. What are the longer-term consequences of the crisis? (As these are usually slow to be priced)
  3. Are we at peak fear? (As that usually represents a tradeable rally in markets)

1. Recession becomes embedded in the popular market narrative

The Ukraine crisis and the massive rally in energy prices increase the risk of recession, especially in Europe. The threats of military escalation and energy sanctions further raise that risk. We believe using Russia’s small share of global GDP to brush off its potential impact on global markets is unwise given its importance to global commodity markets, both in terms of flows and trade finance links. Finally, the enormous volatility and position squeezes add to the risk of unintended consequences from margin calls triggering the default of a commodity trader or bank caught offside.

Before the Ukraine invasion, the economic cycle had progressed even faster than we expected, with unemployment falling below 4% in the US alongside surprisingly strong wage growth. Many labour markets in other countries had also started to look tight. The US had clearly moved late cycle even if 6% core inflation exaggerated the degree of overheating at this stage. Inflation was set to moderate to some extent as disruptions caused by the pandemic began to ease, and growth was expected to remain strong.

The current energy price spike raises the risk of recession, in our view much more in Europe than the US, and the threat of military escalation and energy sanctions further raise that risk. But partially mitigating this is a rapid improvement in the COVID-19 situation in developed economies and strong growth momentum ahead of the invasion. The savings buffer accumulated during the pandemic also offers the potential for a larger-than-normal cushion to the energy-price shock.

2. Taking a long-term view on Ukraine

Now more than ever, the Asset Allocation team is focused on managing risk for our clients over multiple time horizons – not least the near term, given the fast-moving developments in Ukraine and their outsized impact on global markets. But we must also consider the longer-term consequences of this terrible conflict, which has caused a vast humanitarian crisis.

Barring a leadership change in Russia, we see something approximating a new cold war as the most likely outcome. So, all else equal, what could that mean? The following is an inexhaustive list of possible implications:

  • The fragmentation of global commodity markets
  • Further decoupling of supply chains, which already began with the trade wars under the Trump administration
  • The global economy entering stagflation territory (higher inflation, lower trend growth)
  • Higher government spending, e.g. on defence, clean energy and refugees, with energy independence becoming a key strategic goal for Europe
  • An intensification of cyberwarfare, with governments and companies significantly increasing their investments in cyber defence
  • A shift in investor perception of the defence industry’s ESG credentials
  • Greater focus on ESG considerations/political risk for governments
  • A re-think on nuclear energy in traditional holdouts such as Germany and the Netherlands
  • Further integration of the Eurozone, led by Germany
  • Food independence becoming relevant. Note that over a decade ago many emerging economies were convulsed by social unrest triggered by surging food prices
  • Populist leaders, many of whom supported Putin up until a few weeks ago, may lose their lustre
  • A second Trump presidency remains a real possibility even if President Biden’s approval ratings are boosted by the crisis

The role of China is crucial but unclear at this point. We believe the country will continue to try to retain good relations with the West. As such, while China will probably not support sanctions, neither is it likely to undermine them openly. In our view, China will expedite plans to become self-sufficient on strategic industries and technologies.

3. Where next for market sentiment?

Our third question is difficult to answer with much confidence as serious escalations remain possible, but some of the signposts we set ourselves beforehand are starting to send positive signals. These include the spike in priced-in volatility, moves to increase fiscal spending in Europe and the US, NATO remaining risk averse, and equity sentiment being quite negative already.

Deutsche Bank research on equity returns during wars shows some interesting stats: equities typically bottomed early, well before the war ended, and equities typically recouped all their losses and more before the war ended.

So even though we have been sceptics of anyone’s ability to get an edge in assessing a geopolitical crisis, and we very much believe the guiding principle for times of crisis should be ‘prepare, don’t predict’, we now believe the remaining risk of further escalation is starting to be appropriately priced.


Unless otherwise stated, information is sourced from LGIM analysis as at 15 March 2022.

Views expressed are of Legal & General Investment Management Limited as at 15 March 2022. Forward-looking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg