The events since 2/24/2022 (when Russia formally invaded Ukraine) have been astonishing and devastating. The resulting conflict, sanctions against Russia, and impact on businesses has become worse than anyone could have expected. The geopolitical intricacies of responses and the details of the economic sanctions remain to be seen, but the damage will likely be worse than most expect.
Throughout this crisis the error of world governments has been an underestimation of the determination of Russia to overtake Ukraine, and the perseverance of Ukraine. As the crisis continues to unfold we will be watching to see how it impacts markets and the balance of global power.
To that end, here are the four investment topics we are focused on right now.
1. Inflation may get worse as energy costs rise
At the time of this writing WTI prices are at $125 and the price for one gallon of gas in the US is averaging $4 (the first time since 2008). With an embargo on Russian oil becoming more likely, and OPEC+ not adjusting production, we expect energy prices will remain elevated in the near-term. These higher costs are likely be a tailwind for more sustained broad inflation and act as a headwind to Fed actions (i.e. rate hikes). The one positive – Spring is around the corner, a time in which energy consumption typically declines.
Concerns over the supply of crude oil have sent WTI prices skyrocketing and pushed gas prices to their highest levels since 2008.
2. Europe (and the US) may face recession
Slowing economic growth in Europe, soaring inflation, and a weakening currency all the have the potential to drive the EU (and neighboring nations) into a recession. While there is spillover effect in the US (and world), the US is less reliant on Russian exports or goods. Within the US the biggest economic drag is likely to come from higher energy costs, which as noted above will impact all aspects of consumer balance sheets.
3. It will be harder for the Fed and ECB to stem inflation
The Fed remains committed to raising rates and scaling back monetary support, but expectations for the number and magnitude of rate hikes have come down. The Fed is now faced with an even more delicate balancing act as it deals with curbing inflation in the midst of an economic headwind.
In Europe the ECB (European Central Bank) is even more challenged as the bank needs to raise rates to combat inflation, but with economic impact of the war may very well push it into recession. The ECB must also contend with the implications of the weakening Euro and declining financial conditions.
In both situations we think the likely near-term outcome is for inflation to remain elevated. The Fed has a better chance of curbing it in the US while in Europe we think inflationary pressures may persist for some time.
Expectations about the magnitude of Fed rate hikes have been volatile. The US 10yr Treasury has been has seen a nearly 30bp move from 2.04% to 1.76%
4. Most major asset classes are experiencing negative performance, limiting the benefits of portfolio diversification
Nearly every major asset class is experiencing negative performance so far in 2022, with the lone outlier being energy and energy-related assets. Similar to other economic-driven sell-offs most major asset classes are moving similar to one another resulting in negative returns in equities, fixed income, and even real assets. And this time it’s happening during a rate hike cycle where the Fed has already exhausted its monetary toolbox.
Looking ahead we think investors should be prepared for a bumpy ride. With rate hikes coming we expect fixed income underperformance may persist. Within a broader portfolio illiquid alternatives (especially venture capital) have held up surprisingly well through this volatility, as have private real estate investments (public REITs have sold-off largely with equity markets). We suggest investors look to Real Assets for near-term portfolio hedging and opportunistic deployment of capital.
Capital markets are experiencing weakness across all asset classes, with the lone outlier being energy prices.
Closing Thoughts
The crisis abroad is likely to get worse before it gets better. Markets will be quick to react to any positive developments, but until a ceasefire is finalized and fighting stops volatility will persist.
We continue to see benefits from owning a diversified portfolio of equity, fixed income, and alternative assets and remain focused helping our clients meet their investment goals. Diversification and hedging can face challenges over short timeframes and to that extent we remind investors that investing is a journey and that there will always be bumps along the way.
Lastly, we continue to remind clients to remain disciplined and follow their long-term investment plans. For strategic investments we suggest investors focus on quality over hype, and companies with hard assets and stable cash flows to support operations. Like all pullbacks and bear markets this one will end, and those that were able to stay invested (and deploy new monies) will see the benefits.
ENDNOTES
Disclosures
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.