The war in Ukraine and its consequences are overshadowing other factors that drive financial markets at the moment. Yet history shows us that even severe geopolitical conflicts tend to have only a temporary impact. We expect economic fundamentals to reassert themselves over our tactical six to 12 months investment horizon. Equity markets, especially in the euro area, have been quick to price in a lower growth outlook and higher risks. But we think the economic consequences from the war will eventually be limited for other regions.

Our most preferred regions tactically remain the US (via equities) and emerging markets/Asia (via equities and credit). The latest strong signs of financial market support and policy easing are particularly encouraging for Chinese assets. The immediate adverse effect of Russian bonds and stocks losing most of their value is already largely behind us.

Risk aversion temporarily supporting safe havens
We don’t believe a global recession is likely any time soon. Investors remain cautious about risky assets, which means traditional safe havens like gold and the US dollar should remain supported. We still expect the US Federal Reserve to increase rates this year, while the European Central Bank and Bank of England may be more hesitant. Governments may help businesses and households absorb higher energy costs through fiscal relief measures.

The coronavirus pandemic continues to fade around the world, including across most of Asia, which has lagged behind with its vaccination programme. Infection rates are falling sharply from the peaks at the start of the year. Mobility is rising as restrictions are lifted, especially in the euro area and the UK, supporting economic activity. In contrast, China’s cases are still rising, which is testing its ‘zero-tolerance’ policy and may trigger further lockdowns.

The pace of economic growth has moved past the peak and is now beginning to slow. While the market is finding it hard to catch up with this new reality, including the consequences of the escalating Russia/Ukraine conflict, we see this as a normalisation from super-strong rates. We’re not concerned about this as we expect growth to remain above-trend in 2022, even if uncertainties have increased. While equity markets had a bad start to the year, they have recovered from the lows thanks to persistently solid earnings growth, before they came under renewed pressure due to latest geopolitical developments. 
However, we still see a good chance that the end of this cycle has not been reached yet. 

Central banks are now catching up with above-target inflation and are starting to withdraw their emergency stimulus. The Bank of England (BoE) has already raised interest rates and the Fed is expected to follow, with markets expecting several rate increases starting in March. While we continue to monitor the consequences of the latest developments around Russia closely, for now we also expect the European Central Bank (ECB) to hike interest rates before the end of the year, helping the euro to recover against the dollar. While the Russia/Ukraine crisis complicates the near-term market outlook, at this stage we expect any volatility to be relatively short term.

Russia’s invasion of Ukraine is causing a surge in energy costs. This shock comes on top of pandemic-related disruptions, which are easing but not resolved. Europe’s reliance on Russian oil and gas is significantly greater than for the US and the UK. This means the impact on growth (lower) and inflation (higher) is likely to be more significant too. But central banks in Europe will probably turn more dovish relative to the US Federal Reserve and the Bank of England. The odds of EU fiscal support are rising, although we may see measures in the US and the UK too.

Just when we thought things were getting back to normal, a horrific war is raging on the fringes of Europe. The world has been shocked by Russia’s invasion of Ukraine and the humanitarian crisis that is unfolding. Global markets have been unsettled and conditions remain extremely volatile. Rising energy prices are driving inflation even higher, which is making things difficult for central banks to raise interest rates without choking off the post-pandemic recovery.

Our job as investors is to assess how the war is affecting the global economy and markets, and then work out if we need to change our strategy. So what should we do? The first thing to remember is that markets have recovered from falls in the past. History shows that staying invested in a diversified portfolio has been a successful approach through previous geopolitical crises, wars, pandemics and recessions – and is likely to continue to do so.

But at Quintet, we not only seek to create robust multi-asset portfolios that generate competitive investment returns, we also act in our clients’ best interest as holistic and responsible stewards of wealth. By making informed voting decisions and engaging with the companies held in client portfolios, we can help protect and grow client wealth while also benefiting people and planet. Discover more about our objective to be a sustainable company in our 2021 active ownership report.

The devastating conflict in Ukraine and sanctions against Russia are disrupting supplies of oil and gas, and pushing up prices for both businesses and consumers

The energy bill

COUNTERPOINT
APRIL 2022