Since the start of the year investors have faced an increasingly difficult environment. A backdrop of rising inflation and monetary policy tightening across developed markets has been exacerbated by Vladimir Putin launching the largest conventional warfare operation in Europe since the Second World War. As would be expected in these circumstances, volatility across financial and commodity markets has increased substantially.
Global equities and bonds saw negative returns in February and value outperformed growth stocks for the second consecutive month. UK equities continued to hold up relatively well in comparison to their developed market peers as the natural resources sectors significant weighting in the index gained. Emerging markets underperformed global equities and Russian equities plummeted by over 50% with further substantial losses expected when the Russian stock market reopens.
The outcome of the conflict between Russia and Ukraine is impossible to predict but the economic and market impact has been wide ranging. Russia is the world’s largest exporter of commodities including crude oil and natural gas and together with Ukraine, accounts for around 30% of global wheat exports. With the prospect of supply constraints, Brent Crude oil has risen above $100 a barrel for the first time since September 2014, and agricultural commodities, particularly wheat, have seen sharp price increases. The gold price rose above US$2,000 per ounce approaching its record high, reflecting the safe haven characteristics during periods of uncertainty.
Global equity markets are in negative territory year to date although the UK FTSE 100 has been more resilient. The Bank of England raised interest rates by 0.25% to 0.50% in early February and the market expects interest rates to be around 1.5% by mid-2023. Household energy bills will escalate significantly in April, as increasing energy and food costs are expected to result from the Russia/Ukraine conflict which will add to inflationary pressures. The British Chamber of Commerce downgraded its expectations for UK GDP growth in 2022 to 3.6%, from 4.2% in its previous forecast in December 2021, which largely reflects a deteriorating outlook for consumer spending and a weaker than expected rebound in business investment.
Fixed interest markets have struggled initially against a backdrop of rising interest rates and elevated inflation although developed market government bonds, particularly the safe haven of US treasuries, have reversed some of these losses since the Russian invasion.
In the US, consumer spending has remained robust and the labour market is in a healthy condition as recovery from the pandemic continues. Inflationary pressures have led to the market expecting the US Federal Reserve to increase interest rates at least six times this year. Again, the Russia/Ukraine conflict has raised the possibility of a less aggressive approach. Although the environment remains challenging for most businesses, US companies have reported earnings growth ahead of expectations which is encouraging and provided some degree of insulation from the conflict, which has seen US equities produce relatively strong performance recently.
The European economy has continued to show signs of economic momentum with the unemployment rate falling to 7%, its lowest level in over twenty years. The conflict between Russia and Ukraine has though had a more significant impact on European equity markets and economic prospects. The region and particularly Germany, is heavily reliant on energy supplies from Russia and while there are plans to accelerate a reduction through locally produced renewable energy, this will take several years with the additional risk of disruption to supply from Russian actions. A temporary increase in the use of fossil fuels and extending the life of nuclear power stations are among the options being considered. Inflation in the Eurozone reached its highest level on record mainly due to rising energy prices, but the European Central Bank may be forced to delay the removal of stimulus and an eventual rise in interest rates while the economic implications of the crisis in Ukraine are assessed.
Emerging Market (EM) equities declined overall with sharp falls in eastern European markets and general risk aversion. The Russian market even before its collapse comprised just 1.5% of the global EM index and has therefore had very little direct impact for most investors. Rising energy prices are a headwind for EM oil importers such as India, while China underperformed by a smaller margin. Conversely, stronger metals and energy prices provided a boost for many economies in South America, Africa and the Middle East.
At this stage, it is unclear what stance global central banks will take to account for the impact of higher energy prices on inflation and economic growth. Before Russia’s invasion of the Ukraine, persistently higher inflation would have been expected to have been countered by interest rates increasing at a faster pace, however it seems that a moderated approach may be necessary to support economic growth as consumers come under increasing pressure from rising prices exacerbated by the conflict in Europe. The ECB faces a particularly acute dilemma here due to its reliance on Russian natural gas and oil imports.
A combination of heightened geopolitical tensions, slowing growth and rising inflation is very challenging for investors and may continue for some time in the absence of a decisive resolution to the Russia/Ukraine conflict. Diversification can offset the impact to some extent and in equity markets there are likely to be opportunities to invest in good quality businesses at lower valuations, making individual stock selection important.
|2022 Year to Date|
|FTSE World ex-UK||-6.71%|
|FTSE Actuaries UK Conventional Gilts All Stocks||-5.17%|
|FTSE Actuaries UK Index-Linked All Stocks||-2.93%|
Total returns in GBP to 28/02/2022
|Bank of England Base Rate||0.50%|
|Inflation (Retail Price Index/Consumer Price Index)*||7.80%/5.50%|
* January 2022
Source of data: FE Analytics, www.bankofengland.co.uk, www.ons.gov.uk The content contained in this article represents the opinions of MacIntosh & James Partners Ltd. The commentary in no way constitutes a solicitation of investment advice and should not be relied upon in making investment decisions. Past performance is not a reliable indicator of future results. The value of your investments can fall as well as rise and are not guaranteed.