Far reaching consequences

Neil Birrell

Premier Miton's Chief Investment Officer

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.

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Risks

The value of investments may fluctuate which will cause fund prices to fall as well as rise and investors may not get back the original amount invested.

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

Alternative investments typically behave differently to traditional investments such as bonds and equities. They can include a range of assets such as specialist lending, private equity, hedge funds and gold. Adding alternative investments to a portfolio can help to make it more diverse but can also make it more volatile.

Commodity prices can fall and rise sharply depending on supply and demand, the economic background and financial market conditions. Exposure will never be direct to any commodity.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Investments are often in large-scale projects whose profitability can be affected by supply problems or rising prices for raw materials or natural resources. Changes in the wider economy and government regulation can also have a significant influence.

Property values can rise and fall sharply depending on the strength of a country’s economy.

Future forecasts are not reliable indictors of future returns.

Glossary

Assets
Different groups of investments such as company shares, bonds, commodities or commercial property.

Bonds (or fixed income)
Types of investments that allow investors to loan money to governments and companies, usually in return for the offer of the pay-out of a regular fixed amount of money until the bond’s maturity date, plus the return of the original value of the bond at a set maturity date. The price of bonds will vary and the investment terms of bonds will also vary.

IMPORTANT INFORMATION:

The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the content of this document, please speak to a financial adviser. The value of stock market investments will fluctuate, which will cause fund prices to fall as well as rise and you may not get back the original amount you invested.

Whilst every effort has been made to ensure the accuracy of the information in this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock or fund does not constitute a recommendation to buy or sell the stock or fund.  Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, we may monitor and record calls for training and quality-assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227.  Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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This section of the website and the content it contains is for professional financial advisers only and should not be relied upon, or circulated to, retail clients. Retail clients should refer to the Private Investor's site.

The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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