Equities were sharply lower across the globe following Russia's attack on Ukraine. Risk assets sold off by around 3% and most share markets are today around 10-15% below recent peaks.
Traditional safe havens such as the US dollar and government bonds have rallied. Substantial economic sanctions on Russia from Europe, the United States, Australia and other allies are certain to follow, with the consequences of a protracted conflict in Ukraine still largely unknown. The geopolitical implications of this attack are complex, and the timing unfortunate for markets given strong signs that the global economy is returning to a sustainable growth profile.
Furthermore, the global economy is facing the challenge of post-pandemic inflationary pressures - which are now higher than they have been for 40 years. At the same time, the major central banks are looking to pivot from abnormally low “emergency” interest rates and get back to more “normal” settings while simultaneously reducing the size of their balance sheets by halting the purchasing of government bonds.
Although Russia’s economy is of a similar size to Australia’s, and Ukraine’s economy is far smaller, both are important in energy and food production and distribution. Western Europe imports around 30-40% of its oil and gas needs from the region, and both Russia and Ukraine are significant grain exporters. While question marks remain as to whether oil and gas supplies from Russia will be affected, market prices have already soared, as have grain markets.
The investment implications are wide ranging; higher energy and food prices have the potential to add to inflationary pressures, acting as a tax on consumers. In a period of anticipated rising interest rates, markets have sold off on the fear that a prolonged period of uncertainty could result in a slowing of economic recovery post the pandemic. No one is quite certain how and when this situation will resolve itself – and markets hate uncertainty.
A further complication is that many markets are already stretched in valuation compared with their long-term averages. This is most pronounced in the US market as despite the recent fall, the S&P500 still trades at 18.5x, ahead of its average of 16.1x. In Australia we see valuation as more attractive with the current 1 year forward PE at 15.5 times, 1 PE point above the long-term average. Furthermore, if we look at the spread between the 10 year bond and market yields, Australia’s high dividend yield stands out as increasingly attractive.
Looking through the short term we reiterate there is reason to be “relaxed and confident” about the longer term. Although markets respond to significant events such as this with some degree of alarm, they often recover within a few months. We have carefully constructed our portfolios to be resilient in such circumstances, selecting high quality and well managed companies.
We have also recently moved to a more conservative allocation, with overweights to cash. While we believe short term volatility is likely to persist such periods are utilised to rotate out of lower quality investments into long term growth opportunities for you, our clients. We will be contacting you over the week to make small adjustments.
In general terms, the best advice during periods of crisis is to keep a cool head, re-examine your investment objectives, ensure that your asset allocation remains appropriate. Rest assured that we are doing everything possible to ensure that risks are minimised and where opportunities present themselves, they are acted upon.