As financial markets continually move, grow, dip and change, any commentary is offered with a short expiry date – as conditions shift, so do the potential outcomes. Nevertheless, the pace of change within Ukraine over the last few days was enough to leave even the most experienced market observers with whiplash. To say the Russian invasion has caused market volatility is an understatement.
In times like this, activity, analysis, and predictions develop on a minute-by-minute basis. Whilst it may feel as though there is no clear answer on how investments are (and will be) affected, there is a pattern of belief that economists and industry thought-leaders share when it comes to portfolios with a longer-term time horizon; hold steady, don’t take knee-jerk actions, and buckle up for a bumpy ride.
Market Review, 27th February 2022
Today, Tom McGrath (8AM’s CIO and Portfolio Manager for the 8AM CleverMPS range) offered his insights on the war in Ukraine and some unexpected reactions from the markets:
At the time of writing, Russian forces are pushing hard to capture Kyiv and several other major cities in Ukraine while meeting fierce resistance from Ukrainian troops and even civilians. It has become apparent that Putin may have underestimated the desire and unity of Ukrainians to fight for their freedom, mocking his proclamations that he will be greeted as a liberator.
Russian aggression has also succeeded in uniting the Western world and strengthening the NATO alliance. Whilst troops will not be put on the ground, Ukraine is receiving financial, medical, and military support. Germany is even taking the historic step of providing weapons.
Western nations agreed to unleash new sanctions to further isolate Russia’s economy and financial system with a decision to penalise Russia’s central bank and exclude some Russian banks from the SWIFT messaging system (used for trillions of dollars’ worth of transactions around the world). The agreement includes measures to prevent the Russian Central Bank from deploying its international reserves in ways that undermine the impact of our sanctions. While these sanctions will hurt, it will take time for the effects to be felt.
Markets surged on Thursday in the US and followed through on Friday with Europe also joining in. This could reflect several factors: a view that the second round of sanctions packages were perhaps less strict than had been expected (especially with regards to Russia’s energy sector); a belief that the war may end quickly; or simply that some asset prices – notably US equities – had already dropped a long way this year and were due a rebound. Part of this rebound was also technical as ‘short covering’ seemed to be in action with those that had positioned for falling share prices, forced back in to buy as prices moved up.
The US Market
It seems trite to discuss US economics as war rages in Europe, but this will greatly influence the direction of equity and bond markets moving forward. The conflict in Ukraine may well make the Federal Reserve (Fed) more moderated in its upward path of interest rates as global economic growth may be softer as a result. The odds of a 50bps rise by the Fed at its next meeting in March dropped rapidly, yields initially fell but rallied back up to the 2% mark by the close of play on Friday.
Unfortunately, a war with Russia and Ukraine will drive the prices of both energy and food commodities significantly higher in the short term, test supply chains, and further expedite inflation. There is a compelling case that this will impact growth and end up deflationary, but that does not solve the immediate problem for the Fed who must be seen to doing something (having procrastinated for much of last year). Should they tread more gently than planned, then that might result in stickier inflation than hoped for resulting in higher rates for longer.
There is much uncertainty in what will unfold on the ground in Ukraine and at the desks of the central bankers. One thing we know as investors is that markets don’t like uncertainty, so with confidence I can say that both equity and bond markets are likely to be volatile over the coming weeks.
Despite the heightened uncertainty and volatility, equities (outside of Russia) haven’t fallen all that much since the conflict began. So, I would caution any bottom fishers that there is probably limited scope for a “relief rally” should tensions ease.
One can make a case that in a slowing economic growth environment, after an initial inflationary shock, rate increases are less likely and bond yields will gradually adjust downward. This makes for a compelling backdrop for growth companies without inflationary input costs such as technology. But, with near equal compulsion, one can also argue that with inflation now more likely investors are best positioned in value and cyclical plays. Regardless of which investment style plays out, it would seem prudent to remain as diversified as possible and tilt asset allocation towards the defensive end.
In summary, faced by a bleak long term economic outlook of declining prices for fossil fuels as the world decarbonises, Putin has picked his moment to strike with the West seemingly divided and at peak reliance on oil and gas. He will have been surprised by the resilience of the Ukrainian people and the united response from the West, and the latest sanctions are going to hurt. In much the same way that the Soviet-Afghan war was a contributing factor to the fall of the USSR, Ukraine looks likely to mark another case of Russian strategic overreach that will likely generate a social and political backlash in coming years.