In modern war, short-sellers aren’t on the sidelines

Russia has launched a war against Ukraine, which has unsurprisingly caused Russian stocks and the ruble to plunge. But in truth, companies and investors braced themselves for this prospect months ago. International investors have left Ukraine, and the price to insure against Ukrainian default has risen. Then Russia's stock market began falling dangerously, and when Russia launched its all-out assault on Ukraine on Feb. 24, it nosedived.

Today's globalised private sector is intimately connected to this war: Some companies will suffer badly; others will win. Two countries' economies face devastation. And for the first time in history, Europe faces a land war accompanied by short selling. Perhaps surprisingly, tanks and shorting of the market are an inimical part of 21st-century warfare.

When news of the 100,000 Russian troops positioned on the Ukrainian border emerged late last year, investors paid instant attention. The relatively small cohort that had been brave enough to invest in Ukraine began leaving. The country's sovereign dollar bonds plummeted, and the cost of protection against a Ukrainian default grew. Russia demonstrated that a country can severely weaken another through menace alone.

But Russia's aggression has harmed the Russian economy, too. Yes, it's many times larger than that of Ukraine and less vulnerable to turbulence, but this year its stock market has been among the developed world's worst performers. In the week before the invasion, the value of Russia's five-year credit default swaps skyrocketed by 58 percent. In the past year, it has risen by nearly 300 percent. And during the past six months, the price of insuring against it has exploded, too.

Investors are getting worried that Russia will default. "The Russian economy is likely to suffer more than Ukraine now that it's being sanctioned," Elina Ribakova, the deputy chief economist at the Institute of International Finance, told me on Feb. 23. The following day, the suffering took a far more radical turn. When Russia attacked Ukraine, Russian stocks plummeted by as much as 45 percent.

For the past eight years, both countries have been preparing for a potential invasion. Russia, knowing it could be hit with more sanctions, has radically shifted its assets from a lot of money held in U.S. dollars to a lot of it held in gold. And, Ribakova noted, Ukraine has shifted from "a lot of exports to Russia to much more trading with Europe and North America. Ukraine has made enormous progress in pivoting towards the West."

Alas, such progress clearly doesn't protect a country against war. "Of course, the conflict weighs on investors," Ribakova told me the day before the invasion. For many investors, though, the prospect of war doesn't always mean gloom. Increasingly, investor websites had been highlighting the opportunities that a full-fledged Russian invasion of Ukraine could generate. In an update earlier this month, InvestorIntel directed its readers to companies and thus stocks that are likely to benefit should Russian President Vladimir Putin decide to move his troops into Ukraine: global energy companies, global metal companies, and inevitably arms manufacturers.

As Ukraine's massive grain production and export would be devastated by a war, global agricultural firms stand to benefit, too. "Ukraine is an important supplier of food to the EU and also some of the countries in the Middle East and North Africa," Ribakova noted. "It exports sunflower, corn, and other products." If the world's breadbasket can no longer supply its grains to the world—Ukraine has closed its ports, and insurers had already declared shipping in the Sea of Azov and the Black Sea's Russian and Ukrainian parts an extreme risk—agricultural firms in other countries stand to prosper.

Another opportunity for investors, InvestorIntel noted, was to short Russian stocks. There has been such chatter for months. Last May, the investor website Seeking Alpha highlighted that, as it said in a headline, "Ukraine Is on the Brink of War, Short Russian Shares." It explained that "if the further invasion happens in the foreseeable future, then there's a real chance that the majority of Russian stocks depreciate as they did a few years back. For that reason, we believe that now is a good time to short Russian stocks."

On Feb.  26, key Russian banks were suspended from SWIFT, the financial communications system that powers international transactions. And on the same day, the United States, Europe, and Canada sanctioned Russia's central bank. Both moves will, of course, harm Russian companies. So will the decision by Norway's massive sovereign wealth fund to divest from Russia.

Shorting is an investment strategy where investors borrow stocks that they bet will decline in value. Shorting is not for the fainthearted, given that seemingly doomed stocks can suddenly outperform expectations and a rise in value comes at great cost to the short-sellers. Many observers consider it slightly unethical, but it's not illegal. In fact, it's becoming so common that today many investors consider it a useful addition to the traditional bets on stocks likely to gain value.

"If you're looking to short in the current situation, you're looking at companies that have supply chains in Russia," said Dan David, a shorting specialist who leads the company Wolfpack Research. "Companies that deal with minerals and commodities. If there were a company that exclusively made caviar, I'd short it. Russia's mining companies aren't massive in global mineral supply chains, but even if they're 6 percent total, they're probably 40 percent to some companies out there."

Indeed, many Western firms have a lot of Russian metals and minerals in their supply chains, which they now stand to lose. And because they all stand to lose it, and they won't all manage to instantaneously find alternative suppliers, they could have to suspend production, and their stock price would suffer: an opportunity to short.

Indeed, many short-sellers most likely spotted this opportunity the moment Putin started amassing Russian troops on the Ukrainian border, especially considering that sanctions are a favourite tool of the West. Short-sellers also know Russia's Norilsk Nickel is the world's leading producer of palladium and nickel, that Rusal makes more aluminium than any other company outside China, and that large amounts of the uranium used in global supply chains come from Russia and Russian-controlled companies. Among the likely beneficiaries: Brazil's Vale, Switzerland's Glencore, and not a few Chinese firms.

Short-sellers are also likely to home in on oil and gas. "If you think this incursion will be prolonged, buy oil," David said. "But if you think it will be resolved soon, a short may be in order. Either way, as oil approaches $150, that's a screaming short." In other words, a no-brainer, as $150 per barrel is an unsustainable price.

Indeed, Russia's invasion of Ukraine is taking place in an economic environment fundamentally different from that of any previous war fought on European soil. It's an environment where insurers and short-sellers pay as close attention to Putin's actions as government officials and journalists. And it's an environment where their actions, based on their interpretation of events and statements, have dramatic effects.

Days before the invasion, when it was still unclear whether it would happen, many airlines and their insurers decided it was no longer safe to fly to Ukraine, which left the country largely cut off from international air travel. The insurance industry had, of course, already placed the Sea of Azov and the Russian and Ukrainian parts of the Black Sea in its highest-risk category.

On Feb. 25, in retaliation for a U.K. ban on the Russian airline Aeroflot, Russia banned all British airlines from using its airports and flying through its airspace—no small matter given that almost all European flights to East Asia generally cross Russia. Short-sellers, who are not just indefatigable researchers but skilled geopolitics watchers as well, had no doubt predicted this development and shorted British airlines. (Indeed, I predicted last month that Russia would suspend Western airlines' overflight rights.)

The last time a land war was fought in Europe, countries mostly grew their own grains. Neither companies nor citizens had much insight into "quarrel in a faraway country, between people of whom we know nothing," as Britain's then-prime minister, Neville Chamberlain, described Nazi Germany's annexation of the Sudetenland. In today's globalised economy, insurers and other companies will swiftly draw their own conclusions from Putin's attack. Indeed, they drew their conclusions long before Feb. 24.

This precedent is a warning that companies in countries that are at risk of invasion or other geopolitical mayhem will face stock price turbulence and potential economic damage. Indeed, enough betting against a country's companies could severely harm that country. Imagine if Chinese short-sellers were to collectively act on predictions of a Chinese assault on Taiwan.

Had Russia not invaded, the short-sellers betting on war would have lost. Alas, Putin decided otherwise.

Elisabeth Braw is a columnist at Foreign Policy and a fellow at the American Enterprise Institute. Twitter: @elisabethbraw

Elisabeth Braw

Disclaimer: This article first appeared on Foreign Policy, and is published by special syndication arrangement.