3-Minute Market Take

Stalemate

Russia’s invasion of Ukraine in February took the world by surprise, and has moved investors’ attention away from COVID to almost exclusively on geopolitics and inflation.  As well as the enormous humanitarian impact and suffering caused, the war has created major global financial consequences for the world. The situation in Ukraine develops almost hourly, from tentative peace prospects to continued threats of use of illegal weapons, attacks on civilians and the small but highly worrying use of tactical nuclear weapons. Much has been written about Putin’s potential next moves.  Surprised by the efficacy of Ukrainian resistance and the widespread use of anti-tank weaponry the Russian army appears bogged down for now, having lost an unacceptably high number of soldiers, tanks and vehicles.  Morale appears to be low amongst his troops, and despite the propaganda and televised national pro-military rallies back home, popular support is reported to be falling fast.  A continued air assaults seem to be the clear current option for Russia. An attack on Moldova is a plausible escalation; Moldova’s small army and Russia’s support from the break-away state of Transnistria make this feasible. However this situation still averts direct conflict with a NATO member. The worst case would be an attack on a NATO member, possibly Poland to disrupt supply lines, and in turn sucking the US into direct conflict.

On the 15th March markets bottomed out and saw a remarkable rally on hopes of peace talks: +7.36% MSCI ACWI in 4 days to the 18th. A fifteen-point draft deal would involve Kyiv renouncing Nato ambitions in return for security guarantees. Putin must bring home any sort of win. This move may not only be motivated by his ground force’s impasse and waning support back home, but by China quietly distancing itself.

Inflation woes

For now we will continue to see high commodity prices. Oil prices are a result of the Russian sanctions and Saudi’s frosty reluctance to increase supply who, by the way, stand to make 240bn revenues this year. While soft commodities as a result of a sanctioned Russian and a disrupted Ukraine, causing the latter to likely miss both the harvest season and following planting season.  The ramifications of this must be considered; high food prices can create social unrest globally, affecting low to middle income families the most. Already in Italy, a major importer from Ukraine, has seen the price of 1Kg of bread double from EUR 4.25 to 8 EUR in Milan.

Governments are faced with a tough choice between combating inflation and avoiding a growth hit, though so far they remain focused on fighting inflation. US headline inflation is 7.5%, Europe is 5% and in Emerging Markets its reached 10%. The hikes to combat inflation could tip us into another recession. Yield curves are flattening, a potential warning sign; the 2 year U.S. Treasury yields have risen to 1.94% from 0.73% at the end of last year, a 166% increase, while the 10 year yields have gone up to around 2.2% from 1.5%, just a 46% rise.

 

Looking ahead

For now markets need clarity on Ukraine.  But the chapter for the global economy following Ukraine will read very differently from 2021.  A potential recession will likely be met with more stimulus in the form of direct payments.  COVID paved the way for direct monetary handouts, helicopter money, and this trend can be expected to continue. Higher fuel and food prices may also motivate governments to cut taxes. This situation would be good for equities, and when inflation begins to slow, technology and growth stocks may once again continue to lead.

In terms of bonds, longer-dated government bonds can appear quite attractive given the prevailing market risks. As we see from the yield curve, longer dated yields have not moved as fast, and the 30 year US yield is 2.4%, exactly where it was in July 2019. If inflation and interest rates hikes near economic breaking points, and the 30 year sits near 2.4%, this could make an excellent entry point. US government bonds perform well, and act as a negatively correlated portfolio hedge, during a growth shock or severe equity downturn.

Sanctions have repercussions

For every action there is a reaction. The sanctions imposed by the US and its allies like the UK, have been tremendously deep and effective. However it has called into question the fundamental principles of property ownership. What good is holding USD or foreign reserves, if a foreign government can effectively render them useless and inaccessible? Money has become a form of social credit, and government reserves a weapon.  This will likely, over time, drive governments and individuals to hold alternative forms of reserves, whether it be more Gold, a focus Eastward to the Yuan, or greater interest in cryptocurrencies.  Some interesting quotes I read recently, courtesy of GS:

“I do have a number of problems with the sanctions. When we talk about a global economy and then use sanctions within the global economy, then the temptation will be that big countries thinking of their future will try to protect themselves against potential dangers, and as they do, they will create a mercantilist global economy.”

Kissinger, 2014

“It is absurd that Europe pays for 80 percent of its energy import bill – worth 300 billion euros a year – in U.S. dollars when only roughly 2 percent of our energy imports come from the United States. It is absurd, ridiculous, that European companies buy European planes in dollars instead of euro. All this must change.”

Juncker, 2018

Sun 20.02.2022. Article by Marc-Phillipe Davies, Managing Partner at Key Family Partners SA