Ben Hutton of 7IM provides an update with the political and military situation in Ukraine still deteriorating:
It’s hard to think of the ‘bigger picture’ when bearing witness to the upsetting images we see on our screens. It’s even harder when one thinks of the depressingly inevitable path Russia seems set to take as it approaches Kyiv. We can only hope that it doesn’t come to that. On the investment front, financial markets have remained very volatile. Most global equity markets are down by more than 10% from their peaks this year.
With these fluctuations comes the inevitable increase in news coverage, although during times like this, as during the darker days of COVID, we’d encourage investors to continue to concentrate on their long-term plans, rather than their short-term emotions. That’s how we are approaching the situation (and it’s what we think our clients need from their investment managers at times like this). Whilst that can sound dispassionate, we know from experience that removing emotion from the decision-making process reduces the chance of making a big mistake.
With that in mind, we are focussing on the longer-term and will make any decisions accordingly. Our views can be summarised as below:
Geopolitics – may change significantly
We need to change the way we think about the world. Countries have done what was unthinkable. Putin has turned out to be more reckless, Ukraine has shown more defiance, the EU has been more decisive, Germany has U-turned on its post-war defence policy, and even Switzerland has tempered its neutrality. The scale of economic sanctions – both formal and informal – has been unprecedented. We must accept that any of these could go even further. And the further they go; the more material the social and economic impact could be.
Economics – shouldn’t change too much
Recent events have also been a sharp reminder that fossil fuels are still crucial to the world economy. Combined with the already high inflation in the USA, the oil price shock would, under normal circumstances, be enough to trigger a mild recession – as we saw in the mid-1970’s.
But these are not normal circumstances.
The Russian economy is being crippled. The banking sector is facing collapse, oligarchs have had their lifestyles upended and hardship will soon be felt across the country.
But, turning to the global economy, the picture is different. The two locomotives of global growth, US and China, should be relatively insulated from the worst. The economic boost from the COVID-19 stimulus is still in effect. The US labour market is going strong and there is a huge backlog of hiring, leading to higher wages that can absorb the oil price shock. And the evidence of pent-up new car and homes demand suggest the US economy can ride through the current uncertainty. The same holds for China, which was already embarking on a policy loosening cycle, and is now targeting higher growth.
Europe is more exposed, and its economy will slow in the short-term. But we shouldn’t ignore the potential policy response. Europe will be raising spending on defence, new energy infrastructure and refugee resettlements. All of which point to a material fiscal stimulus in the months ahead. We watch to see what the overall impact will be.
There is of course the chance that as the geopolitics go in unexpected directions, it takes the economics with it. What that would look like is still unclear – the realignment of Europe’s energy infrastructure, a global ramp up of defence spending, adjustments to global supply chains, strategic protection of food exports, the power of financial sanctions, etc. are just some of the long-run implications. These are not changes one should react to, too hastily.
Portfolios – nothing has changed… yet
Proximity to Russia seems to be the driving force for equity market falls. European markets, including the UK, are sharply down. The same is true of some emerging markets. However, it is possible that markets may have been overly concerned with that proximity. For instance, the European financial sector has lost close to 30% since the Russian invasion. It’s one of the most regulated sectors in the world, and the potential for hidden Russian exposure is limited. Does this crisis really mean these businesses have lost a third of their value? We’re asking ourselves this kind of question right now.
Additionally, when we look further away from Russia, the reaction is looking more muted since the invasion. Taking a step back, it is worth remembering that in a globally diversified multi-asset portfolio, there is always scope for gains as well as losses. The aim is to position in a way where the gains offset those losses, delivering a smooth return.
For instance, what would the impact be if Russia was closed off from the world economy indefinitely? Commodity exporters that compete with Russia would have a field day, filling the void where Russian supply once was. Take Brazilian equities which, at double the weight of Russia in the Emerging Market Equity index, are up 25% this year. The long-term ramifications of the Ukraine crisis are not negative for all.
Not to mention non-equity parts of client portfolios that are up nicely since the invasion, such as alternatives and government bonds. In the end, this is what 7IM portfolios are built for: absorb negative news in one place by benefiting from it in another place.
