The human tragedy unfolding in Ukraine is fast-moving and uppermost in everyone’s minds and our thoughts go out to the brave people who are directly or indirectly caught up in the fighting.
Our role as stewards of your investments often feels secondary to the appalling events but we have to make judgements on the economic impact and how markets are likely to react both now and in the future.
We were already a little cautious prior to the invasion holding higher levels of cash than in normal times and tilting away from richly valued assets. This was primarily due to our concerns over inflation remaining ‘higher for longer’ as global growth in GDP coincided with on-going supply chain shortages. That suggested Central Banks would be more aggressive in raising interest rates than a still fragile recovery from the pandemic perhaps warranted.
Much analysis has centred on Russian sanctions. Clearly, the lighter and less effective the sanctions the greater the short-term relief in markets however wrong that seems. We saw an element of that in Friday’s sharp rally. This week has seen Putin’s bluff called. Sanctions will hit the Russian economy very hard and a consensus has emerged that NATO, and Europe in particular, are prepared to take the hit to their own economies in order to make the sanctions effective. Witness BP taking a massive hit by divesting their stake in Russian Oil producer, Rosneft.
There will be a ‘sanctions cost’, particularly in energy prices, which were already elevated. It is too late to rail against over-reliance on Russia for oil and gas but surely this will and must change in the future. Over 30% of Germany’s oil and gas came from Russia last year. Perhaps surprisingly, Italy is even more reliant on Russian fuel. Warmer weather will help but industry remains the prime user.
The Banking sector is also coming under pressure although it should be said that balance sheets, in general, are very healthy. The adverse impact will be to earnings as sanctions are imposed and as Russia is prevented from using the Swift financial messaging system. The sector is of course benefitting at the same time from rising interest rates that tend to feed through into improved margins for lending.
In the short-term markets will undoubtedly be stressed and liable to react to the latest headlines rather than the longer-term outlook. There will be fresh challenges. More defence spending in NATO countries will need to be funded through a mix of higher taxes, bigger deficits, and cuts to other areas, however unpopular. How frictionless will global trade be in the future?
Like others, we cannot predict Putin’s next move and hope that pressure against him continues to build from within Russia. What we can do is remain very watchful and focus on long term trends that will drive future returns.
As a footnote, the majority of companies in which clients are invested either through their equity or corporate debt are not directly linked to the war and history suggests markets bounce on better news however difficult that is to envisage at the moment.