Rising geopolitical tensions in Ukraine could hit the economic recovery in Europe and lead to a sell-off in emerging markets, according to Luca Paolini, chief strategist at Pictet Asset Management, part of swiss private bank Pictet.

Rising geopolitical tensions in Ukraine could hit the economic recovery in Europe and lead to a sell-off in emerging markets, according to Pictet Asset Management, part of Swiss private bank Pictet.

Luca Paolini, chief strategist at Pictet Asset Management, said that following Russia's intervention in the Crimea, the escalating crisis in Ukraine could potentially slow down economic growth in Europe if the gas supply from Russia to European countries is disrupted.

“Should the situation deteriorate and result in heightened tensions between Russia and the EU, a major casualty could be Europe’s economic recovery, which is vulnerable given that the region imports roughly 25 per cent of its gas from Russia, half of which flows through Ukraine. Under this scenario, the euro would likely weaken sharply against the dollar," said Paolini.

“More broadly, with the recent rally in global stocks showing signs of fatigue, the Ukraine crisis could prove the trigger for a market correction," he added.

A number of wealth management firms have commented on the crisis and its perceived impact on their business. To see an example, click here.

Emerging markets

At the height of the crisis on Monday, the MSCI Emerging Markets Index fell 1.6 per cent to 950.68, the biggest decline since the end of January, and analysts believe an escalation of geopolitical tensions could trigger another sell-off in emerging market assets.

Despite this, Paolini believes this decline may prove contained as not only are emerging market bond and stock valuations attractive, but investor positioning in these assets is extremely bearish.

“Any further fall in emerging market bonds, for instance, would in our view increase the investment appeal of the asset class versus developed market government debt. Ukraine aside, the recent rally has nevertheless pushed equity valuations to levels that look difficult to justify at a time when corporate earnings forecasts continue to be cut," said Paolini.

Paolini continued: "With global economic growth slowing, the picture in emerging markets is a complex one. While exports have recovered, China remains something of an unknown quantity as it struggles to balance the task of deflating a credit bubble with meeting its annual growth target of 7.5 per cent."

“Longer-term, the prospects for riskier asset classes look more encouraging. In Japan, we expect the central bank to increase monetary stimulus as soon as the second quarter of this year. In the euro zone, further monetary easing should also become a reality. Hence, we are confident that global economic growth will recover in the second half of 2014," said Paolini.

Regionally, Paolini favours Japanese and emerging market equities over US and European stocks due to their favourable risk-return profile.

“The recovery in emerging market bonds and currencies looks justified on many fronts. Outflows from the asset class are also moderating. Because of China and various political risks, we remain wary of raising our exposure to emerging assets," said Paolini.

“We prefer high-yield over investment-grade bonds. Speculative-grade debt continues to trade at a yield premium that offers more than sufficient compensation against the threat of default, which remains low by historical standards," Paolini added.