This update should not be taken as advice. If you are unsure about any of the content please contact your financial adviser. Please remember that the value of stock market investments will fluctuate and investors may not get back the original amount invested. To assist, where appropriate, a glossary explaining some of the terms used has been provided at the end of this update.
I don’t intend to turn this update note into a running commentary on events as it became through the early stages of the COVID crisis. However, as the horrors of the invasion unfold it is worth providing a brief update on the global economic and financial market consequences.
First things first
The aggressive military invasion of one country by another is difficult to justify at the best of times, but the actions of Russia against Ukraine call into question the concept of sovereign nations and democracy. As we are seeing now, the human tragedy is heart breaking and is impacting materially on the region, not just the country.
The economic reality is that the impact is global and substantial. I will look at potential long term consequences in a moment, but there are immediate and meaningful ramifications. The obvious one is inflation. The moves in the prices of commodities have been considerable. You will have experienced first-hand the impact on petrol prices and the cost of heating and lighting your homes. Oil and gas prices were already at high levels and have jumped sharply higher as a result of the invasion. Similarly, Ukraine is a big producer of agricultural products which had led to corn, wheat and soybean prices jumping as well. This has only one effect; higher inflation.
Just as importantly though, it does call into question the actual supply of products as well. Russia supplies around one third of Europe’s gas. If it decides to stop the supply or a pipeline gets bombed, the lights will, literally, be going out in Europe. The same could be said for agricultural products, if supply is cut; how will it be replaced?
German car manufacturers have had to stop production of certain models because they cannot get supplies of key components that are made in Ukraine; although if Porsche can’t meet delivery dates, that is not a great hardship.
The point of that is simple; supply problems and price rises mean inflation, but they can also mean that products will not be available. Some of those matter, some don’t. This is an immediate result of the war.
How much does it matter?
One outcome will be that economic growth will slow, maybe sharply, and recession is a clear possibility.
At the start of the year, central banks were struggling with rising inflation and how to deal with it without damaging economic growth. Today, they have the same conundrum except the issues have been amplified many-fold by the war. You can also throw in financial market stress and risks in Europe of commercial banks being hurt by bad loans, not just in Russia and Eastern Europe, but more widely in the region.
All eyes are focused on what central bank policy will be, the European Central Bank met on 10 March. It had previously been reasonably sanguine about interest rate increases and other policy change, and it stuck with that approach, allowing for some wiggle room in case the backdrop worsens. The US Federal Reserve meets during the week of 14 March and by the time you read this, it may well have announced a 0.25% increase in interest rates and flagged more through the course of this year. It will be similar for the Bank of England and others; manage inflation without hurting growth too much.
In short; it matters. The near term outlook for the world economy is uncertain. However, it is clear that we will be living with higher prices for some time. It was happening already, but as a consequence of Russia’s actions, it has gone to a new level and one we have to accept; we are paying the price, unless we decide to remove sanctions, buy their oil and gas and bring them back into the world economy. That cannot happen. We should worry more about what the medium and long term implications are.
Fundamental change is likely
There are many interesting long term changes to think about; too many to detail here and fundamental enough that any one would take pages to discuss. There are a couple that we could consider briefly.
Firstly, the obvious one; energy transition. We knew we had to move away from fossil fuels, either to renewable energy or nuclear, over time and the process was underway. Simply, that now has to accelerate. Governments, companies and individuals must push the process faster, this will mean greater spend sooner and it will still take a long time until we are where we need to be. We have the technology, we now need the will and the money, but where will that money come from? Governments cannot fund it all, so we will have to put our hands in our pockets again through taxes and private corporate or investor funding will be crucial.
Countries will want to be more self-sufficient in energy production and the move to renewables and away from imported oil and gas facilitates that, essentially a move back from globalisation. The point I made above about car manufacturing also makes you think about the future of globalisation; will companies want to have their suppliers more local, maybe in their own country?
Russia and Ukraine are not large economies, but they are important for energy and food, which they export; look at the impact that is having. Then imagine if this conflict was China and Taiwan instead. The economic consequences of that would be on a different level entirely.
Of course, there is a simple answer; no more conflict like this. However, decision makers will look at the current and potential risks and seek to mitigate them; that is unlikely to lead to more globalisation and energy transition means it will reduce.
The impact on financial markets
Not much of what I have written above makes easy or positive reading, but you should not assume it is bad news for your investments!
Firstly, markets have fallen a considerable amount already and secondly prices take into account future prospects, so the direction from today is not just down. It is very likely that markets will remain volatile, however, as uncertainty abounds.
To quickly look at the main asset classes. Bond markets are unlikely to make such headway in the short term, not until there is more clarity on how high inflation and interest rates are going. Government bonds could benefit from safe haven status if the war escalates.
Stock markets have reflected the troubled times and as we are active investors, we are able to find interesting companies to invest in, in all geographic regions and industries. We can avoid those companies whose prospects are less good and focus on positive outlooks. Overall, though, there is obviously still risk to market levels, and prices will remain volatile, which also provides opportunity.
Elsewhere, oil, gas, other energy sources and agricultural goods are likely to stay firm. Property could well be a beneficiary of higher inflation as could infrastructure and there are other specialist asset classes that can provide good opportunities.
Whilst the economic and geo-political outlook makes financial markets difficult to navigate; we can find plenty to do. We focus on the long term and try to take advantage of short term moves.