The weekend brought no respite for the citizens of Ukraine as Russia broadened its attack on the country.
However, whilst the human cost of the war only rises there have been in recent days some tentative signs that there is progress toward peace. Both Ukrainian and Russian negotiators have talked of ‘constructive’ conversations, and it is clear some form of proposal is being drafted. Whilst few of us would welcome any settlement that gave Vladimir Putin any benefit from his attack, a ceasefire would be a blessed relief to Ukrainian citizens.
The response of the market has been to begin to anticipate an eventual settlement. The primary channel by which fear about the Ukraine flows is the oil price. When the oil price has been rising, markets have been falling and vice versa. Investors are acutely aware that the extremely high oil prices touched in recent days would - if they persisted for several months - lead to a likely recession. As of Monday lunchtime, Brent crude oil is trading down 4% at $108 a barrel, a level that investors are hoping could prove more sustainable. This could of course all change in a moment if negotiations collapse. However, for the time being we have seen markets begin a very tentative recovery with riskier shares such as medium-sized companies in the UK starting to edge ahead.
It would be inappropriate for us to attempt to call the low from this market pull-back. Anything could happen in the current situation. However, we can take some comfort that the market does appear to have begun to put a price on the impact of this war and is not continuing to fall.
When we consider the relative positioning of our portfolios, we continue to benefit from our strong exposure to US dollar assets, our holdings in infrastructure and our decision to be short-duration with our bonds. The principle source of relative risk in our portfolios is holding on to our smaller companies in the UK and Europe. We continue to watch this closely but have benefitted significantly from a recovery in this area over the past week.
Finally, we offer a quick Q and A on four stories that have emerged in recent days.
Will China begin to arm Russia?
We consider this unlikely. China is keen to gain the benefits of making Western democracy look weak, and delights in watching the West deal with Putin. However, ultimately its reaction function is entirely rational. It is focused upon achieving the maximum internal economic gains possible. We do not see it embroiling itself in Western sanctions. In reality, we suspect Russia will end up the loser if it continues on its isolationist path and if it believes that China will be its salvation it may find that in fact China becomes its new master, demanding a high price for on-going support.
Will sterling continue to sink?
Portfolios have been helped by the fact that the dollar has risen significantly against sterling in recent weeks. This means that on days when the US market is falling we have a counter-balance in the currency move. We believe that the anticipated 25 basis point rise in US interest rates that most expect this Wednesday will only accelerate the gains made by the US dollar. However, it may well be that the rapid transfers of capital into dollar assets that occurred at the start of this war have now come to an end.
Will central banks continue raising interest rates?
Central banks are facing an incredibly tough call at the current time. On the one hand, headline inflation has been pushed even higher by rising commodity prices. Yet they know that interest rate rises will do little to stem this in the short-term and households are feeling very real pain which could slow economic growth.
We believe that we will still see interest rate rises in the coming months. However, they are not likely to be as aggressive as some had feared in recent weeks. This gives scope for areas of the market like US growth companies and UK small and medium-sized companies to mount something of a recovery in the months ahead.
Will the high oil price crash the stock market?
Many are talking about the 1970's when a higher oil shock led to very sharp stock market falls that persisted for years. That crisis was partly caused by war. However, there are other examples where oil price shocks – such as that seen in 1979-1980 did not lead to falls in the stock market. Likewise following Iraq’s invasion of Kuwait in 1990, markets recovered quickly. Ultimately, we believe that whilst supply-side shocks like this can send equities down, it is not necessarily the case. Sensible action from central banks to support economic growth can contain the problem. We should also point out that whilst many like to hark back to the 1970's and criticise investment managers who did not live through it as ‘naïve’, the world has changed significantly since then. The experience of recent decades might bias investors, but it is also more relevant because it occurred in a more similar reality. Of particular note, is that the oil intensity of the US economy has fallen by 70% since 1965. Oil is simply not what it used to be as a driver of economies or stock markets. Our overall view is that these high oil prices will be negative for stock markets. However, we believe the size of the medium-term economic hit can be contained and so it is unlikely to cause a major market shock.