2022 has not been without incident. So far, we’ve experienced; rising rates, breakaway inflation in the United States, and now what has been described by Boris Johnson as the most serious ground war in Europe since 1945 when Russia Invaded Ukraine on Thursday the 24th of February.
Firstly, our thoughts and prayers go to those impacted by conflict.
In summary, we do not see this conflict changing our constructive perspective on equity markets, particularly those outside the US. Portfolio managers will however need to consider their positioning, as volatility looks set to continue, creating significant disparities in performance across stocks, funds and ETFs.
We outline key impacts investors will need to consider when re-evaluating their portfolios.
Impact #1 Higher Commodities Prices
Mr Putin’s timing is partly driven by the US’s sensitivity to rising energy prices. Russia is the US’s second largest exporter of Oil.
Already this year WTI (the US Benchmark) Oil has shot up to near $100 a barrel, its highest level since 2014. This is an especially hard pill to swallow given US inflation is running hot, leaving the Fed no choice but to raise rates aggressively. A high oil price would only add to that pressure.
Tellingly, energy exports have been left off the considerable sanctions levied by the US on the Russian economy, because a further spike in Energy prices will only exacerbate the inflationary dynamic.
Regardless, it seems inevitable that energy prices will rise while war rages.
The key difference between now however and 1974 (Yum Kippur war) or 1979 (Iranian Revolution), is the options for Oil the US has at its disposal; which include, both Shale Oil, which suddenly looks economic at these elevated prices, and a détente with Iran and other oil producing nations.
The pain is not limited to energy commodities.
It should be noted also that Ukraine is a big exporter of grain to countries like Indonesia, where it has secured around 20% of exports. Australia looks set to fill the void, an absolute boon for the local agriculture industry.
Ukraine is a big supplier of inert gases like neon and precious metals like palladium used in device manufacturing. While potentially disruptive, Citi has expressed the opinion from conversations that “We do not see a major disruption in the semiconductor equipment and materials supply chain” (Flash | US Semiconductor Equipment | 24-Feb-2022 (citivelocity.com)).
This should be a relief for anyone looking to purchase a car this year.
The commodities trade will continue to support the Australian equity market will it persists, given our high percentage of global exporters.
Impact #2 Global Economy
It seems unlikely that this conflict alone is likely to derail the substantial re-opening of economies in Europe particularly but also around the globe.
It seems very unlikely that either the US or NATO will be in a position to retaliate, beyond soft approaches such as sanctions.
While Russia is the 11th largest economy in the world, it will open up opportunities for other exporting countries, which we suspect will be only too willing to fill the void.
The principal concern is what this presages for other bellicose authoritarian regimes, who may take heart from Putin’s aggressive example. At this stage however, it would be a long bow to position the portfolio beyond the standard risk management approaches for a second order event, such as, for instance, a Chinese invasion of Taiwan.
This means therefore the earnings recovery in Europe especially looks set to gather pace, in line with the expansionary PMI readings earlier this week.
Corporate earnings on this backdrop will in our view continue to strengthen, especially as the re-opening trade gathers momentum.
Impact #3 Global Interest Rates
The set up of higher than expected US rates in 2022 and 2023 looks more and more likely. Appreciating commodities are likely to keep inflation higher for longer, and the Fed has already communicated its willingness to prioritise inflation over asset prices.
We still see US interest rates as the biggest risk factor on global markets, especially speculative assets, from crypto, to narrative focused tech mid and small caps.
The conflict, and associated impacts on longer term commodities and inflation, still has the capacity to lengthen out the tightening cycle beyond 2.5% (which is where the US bond market sits, as per the chart below), with implications for tech and growth investing.
Pessimism must be tempered however with the fact that a great deal of rate rises are now priced into the equity market. We think a great deal of the more sustainable elements of the equity market, even in tech, is likely to flourish, now that the bulk of the interest rate pain has been dealt.
Feel free to reach out with any questions or queries.