Ukraine Crisis (9/03/22 )
Markets had already been falling since the start of the year on inflationary concerns and the ongoing impact of Covid on global supply chains as Omicron heads East. The situation in Ukraine has significantly increased this uncertainty. Whilst investment matters are perhaps less important than the humanitarian crisis unfolding so close to home, we wanted to share with you our thoughts on the impact of recent events on markets and portfolio values.
Unsurprisingly, the last month has been difficult for both equity and bond markets, with expectations for an increasing number of interest rate hikes from the US Federal Reserve, the Bank of England and the European Central Bank prompting concern that efforts to get inflation under control may dampen growth. As fears surrounding the Russian invasion take hold, expectations for rate hikes have subsided, but this has delivered a further hit to growth expectations.
The clearest economic impact of the conflict on developed markets is via food and energy prices. Russia is a significant exporter of commodities, accounting for 13% of global crude oil production, 17% of natural gas production and nearly a tenth of global wheat supplies. Higher energy prices could create higher or at least more persistent inflation, but it is not clear whether this will lead central banks to increase rates further or faster to combat even higher levels of inflation or reduce their pace of tightening to support the economy.
Our current thoughts and discussions are understandably focussed on areas directly affected by the conflict. Should a decision be made to embargo Russian oil, alternative sources will need to be found to satisfy demand, and this will benefit other companies. Western nations have taken advantage of the peace dividend over several decades to reduce military spending, however it now looks likely that budgets will be increased for reasons of defence, and we are looking to identify companies that can contribute to bolstering regional and global security.
The risk of more significant food inflation, coupled with very high fuel prices, will eat into household incomes, impacting consumer confidence and spending levels. Traditionally defensive sectors such as Utilities, Real Estate, Consumer Staples, Communication Services, and Health Care may outperform from here, however, more growth focussed companies, such as the FAANG stocks, have seen significant corrections and may start to look attractive again. This is of course happening when global supply chains remain in a state of disruption, and the impact of the most recent strain of Covid on China and other economies in the Far East which have so far not seen high levels of infection, but with lower levels of vaccination, is yet to be seen. This could further fuel inflation and hold back global growth.
With all of this in mind we are keen to take opportunities of the weakness in markets. The problem is that many of the potential outcomes rest on the decisions made by just a few politicians and central bankers, some of which seem to have abandoned rational thought, making steering a course through this that little bit harder.