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Article | 13 April 2022 | Investments
After Russian troops withdrew from the area surrounding the Ukrainian capital Kyiv, the focus of military action has switched to the Donbas region. The economic war has continued to escalate, however, with further sanctions on the Russian economy and on certain individuals. Meanwhile Russian oil and gas continue to fuel Europe, despite longer term plans to reduce this dependency.
Prices of energy and raw materials have soared since the invasion began. Monthly inflation reports are rising further, often to multi decade highs. Meanwhile, as the crisis disrupts supply chains and jars consumer confidence, growth forecasts are being trimmed back. Stagflation is once more a real concern. Nonetheless, major central banks are proceeding with planned interest rate hikes or other policy tightening measures. In the words of the US Fed: ‘the upside risk to inflation is judged more significant than the downside risk to growth.’
After initial falls, equity markets largely rebounded to pre-crisis levels. Even in Europe, where the impact of the invasion could be most keenly felt. It’s been a different story for bond markets. Government bonds fell, and yields rose, in anticipation of higher interest rates, with the effect most marked in shorter-dated bonds. In the US Treasury bond market, this has even given rise to an ‘inverted yield curve’, sometimes seen as an indicator of recession. Traditional safe havens, such as the US dollar and gold have performed well.
We now believe that the Ukraine crisis could prove longer lasting than first anticipated. As a result, we are reducing our exposure to equities via a Moderate Underweight in European equities. We expect other regions to be less impacted by these issues and remain more favourable toward US and Asia Pacific equities.
With regard to fixed income, we have not altered our views and remain Underweight on government bonds. We are also negative on investment grade credit, believing spreads could widen further. However, we are less negative on emerging market and high yield debt, which offer attractive yield levels.
Elsewhere, we look to gold, commodities, or US dollar proxies to provide an element of diversification. Overall, we expect quality and defensive growth to provide better performance in the near term, as uncertainty and volatility remain at heightened levels.
Look out for further updates as the situation evolves.