- Russia/Ukraine situation dominates sentiment and exacerbates volatility across markets
- Nasdaq falls into bear market territory, down over 20% from recent highs
- Could fresh uncertainty persuade central banks to hold off or temper expected March rate rises?
After close to two years of the world living under the shadow of a pandemic, the last thing anyone needed was arguably the worst global security threat since the Cuban missile crisis of 1962.
Just as Covid created swathes of amateur epidemiologists in the investment community, events in Ukraine have seen commentators dusting off their copies of Sun Tzu and becoming foreign policy experts, trying to get into the heads of the world’s powerbrokers. As ever, we see little value in focusing on short-term news too much, with the situation shifting by the hour; hard as it may be, we try to keep our focus, and that of our investors, on long-term goals.
Some of the early commentary on these events has talked about a black swan event for markets that ultimately changes the post-Perestroika landscape in Europe. This may well prove to be the case geopolitically but looking at similar situations in the past from an investment perspective, while causing short-term volatility, they have tended not to have too much impact on longer-term performance. With the Second Gulf War, for example, the S&P 500 started to sell-off on 21 March 2003 but this only lasted seven trading days (amounting to a 5.3% fall) and was back to the previous level within 16 days.
More topically, the Soviet invasion of Afghanistan saw the Index start to sell-off on 17 December 1979 but, again, it only fell for 12 days (down 3.8%) and was back to its previous level within six days. The 2014 events in Syria involved a longer sell-off (21 trading days from 18 September) but the 7.4% decline was wiped out in 12 days.
Beyond the threat level (particularly Putin’s ‘greatest consequences in history’ address), the major caveat today is the possible impact on oil prices; they have already climbed above $100 per barrel, the highest since August 2014, and a prolonged spell of energy inflation could mean overall higher inflation takes longer to dissipate. Prices of natural gas and metals, including gold, aluminium and copper, have also spiked; Russia is a key seller of commodities to global customers, with Europe relying on the nation for around a quarter of its oil and a third of its gas.
At headline level, it seems safe to assume the Russia/Ukraine situation will spark a setback to global corporate and consumer confidence. What it also brings is a strong dose of markets’ least favourite tonic in the shape of uncertainty and, already weighed down by impending rate rises, we have seen indices such as the Nasdaq dip into bear territory, down more than 20% from recent peaks, before rebounding slightly at the month end.
We may now see central banks tread more carefully at their March meetings, with a first rate hike currently expected from the Federal Reserve plus a possible third rise in three months from the Bank of England. While the general direction of rates will ultimately be upwards whatever happens in Europe, our view is that the pace of hiking will be slower than consensus has priced in. In the US, for example, we highlight the 10-year/two-year Treasury spread heading swiftly downwards in recent months, with a move into negative territory (so-called inversion) a reliable indicator of imminent recession or at least slowing growth in recent decades. JP Morgan is still pricing in seven 25 basis point rate hikes from the Fed this year, for a total of 175bps of tightening, but there may be some nervous eyes on that indicator in the coming weeks, particularly if markets are also digesting an oil price shock. Will policymakers be willing to act so aggressively if conditions force them to start cutting again in short order?
Earlier in the month, bonds were hit hard by another ‘surprise’ jump in US inflation that stirred hawkish comments from St. Louis Fed Chair James Bullard, who laid out the case for raising rates by a full percentage point by the start of July, including the first half-point hike since 2000. He also raised the possibility of considering a rise between scheduled policy reviews but other Fed officials appeared in no rush to move before their March meeting and a widely expected 50 basis point rise is less certain given how the global axis looks to be shifting.
In the UK, meanwhile, markets have priced in rates rising to 2% by the end of the year but deputy governor Dave Ramsden said tightening will be modest and does not envisage them going to anything like the pre-2007 level of 5% or above.
While current newsflow is broadly negative, equity markets remain attractively valued (apart from the US) and consumer spending continues to pick up as economies open – however people might view the politics behind it, the UK is moving towards a living with Covid strategy, for example. This year may prove to be a test of nerve, however, and we encourage against attempting to move in and out of markets if things do get choppy; ultimately, the best antidote to short-term volatility is diversified portfolios and a resolute focus on long-term outcomes.
Over the month, we completed our quarterly tactical asset allocation (TAA) review and remain positive overall, albeit acknowledging there will be more volatility and uncertainty, and returns are likely to be lower than enjoyed in a stellar 2021 for equity markets.
You can find full details of the latest TAA here, but to summarise, our cash ranking rose from one to two (with one the most bearish and five the most bullish) and investment grade corporate bonds fell from three to two, both moving as a result of rising UK government bond yields in the face of higher interest rates. US small caps also moved down from four to three, as we feel valuations at that end of the market are now closer to highs than in some of the large caps hit by recent sell-offs.
Key Risks
