A challenging start to the year for investors with concerns over rising inflation and the prospect of higher interest rates, has this week been compounded by the Russian invasion of Ukraine. Clearly this is a fast moving situation which poses geopolitical and economic dangers. It would seem the Russian objective is to replace the Ukrainian government with a more compliant alternative and bring the country into the Russian sphere of influence. How long the conflict will last, the risks of it spreading to other countries and the eventual resolution, are all uncertainties which are expected to see markets impacted by volatility as was evident yesterday with Western European equity markets declining by between 3% and 5%, whereas the US market (S&P500) closed up 1.5% after a selloff in the morning. Meanwhile, the Russian stock market plummeted by 26%.
So far the West’s response has been to impose increasingly severe economic sanctions and Germany has suspended the certification process for the new pipeline intended to carry Russian gas to European consumers, Nord Stream 2. The impact of economic sanctions remains to be seen with Russia having accumulated substantial foreign currency reserves and benefiting from the high gas and oil prices upon which Europe remains heavily dependent. President Biden’s announcement that sanctions will focus on the financial sector, at present and not the energy sector, was a factor in the stronger performance from US markets yesterday.
Economists had been forecasting that a peak in inflation was in sight later this year as the impact of the pandemic wains, however this could be pushed back if oil and gas and other commodity prices, continue to rise or there is interruption in supplies. A scenario of slowing economic growth as a result and high inflation would clearly be unfavourable.
It is worth remembering however, that the longer term economic fundamentals remain unchanged and are supported by sturdy economic growth, particularly in the US and generally robust corporate profits.
History gives some reassurance that markets can shrug off geopolitical concerns relatively quickly as uncertainty in the build up to conflicts diminishes and markets look forward with greater certainty. This was the case after Russia’s annexation of the Crimea in 2014 and has been seen on a number of other occasions including the US led invasion of Iraq in 2003.
With European markets seeing some recovery today the decline in markets has been limited in comparison to other recent influential events including the onset of the pandemic in March 2020. Whilst volatility is likely to remain elevated, the outlook for equities should continue to be relatively positive with high inflation and low interest rates meaning the asset retains its attractions for investors looking to grow the real value of their savings over the longer term.
While the current situation is very concerning, markets are suggesting that medium term disruption will be contained and in such scenarios the right course of action has historically been to remain invested, benefiting from the longer term trend of equity markets delivering returns ahead of other assets particularly cash, fixed income and inflation due to the benefits of participation in longer term economic growth and corporate profits.
The risks and implications of events in Ukraine should clearly not be underestimated but a broad mix of internationally diversified equities alongside diversifying alternative and fixed income investments should see the potential for positive returns when tensions subside.
25 February 2022