Market Update - March 2022
- Shunil Roy-Chaudhuri
- 08 April 2022
- 10 mins reading time
On 10th March, we hosted a webinar in which we assessed the tragic developments in Ukraine and discussed the investment and economic outlook for the months ahead. This briefing is based on that content.
You can view the slides from the webinar here.
Events since the end of January have been overshadowed by Russia’s invasion of Ukraine, which began in the final week of February. This has created terrible human suffering and a refugee crisis, with millions of people leaving the country. At this troubled time our thoughts are above all with the people of Ukraine.
These tragic events have, unsurprisingly, had a significant economic impact. In particular, the oil price has risen and inflationary pressures have increased. In Russia itself, which now faces robust sanctions on banking transactions and restrictions on trade and travel, interest rates have gone up to 20% and the rouble has plunged in value.
While Western nations have started to implement sanctions against Russia, uncertainty remains about China’s position. Some commentators believe China will ally strongly with Russia but this could lead to Western sanctions against China. In our view, China won’t provide significant support to Russia. Most Chinese exports go to Europe and the US and we believe China’s leaders won’t want to jeopardise these trading relations.
It is difficult to make economic forecasts given the terrible current events, but we have cut our forecasts for economic growth and raised our inflation forecasts for all the economies we monitor. Even before the Ukraine crisis, the global economy had been experiencing high inflation. This was partly driven by unprecedented delays in the supply of goods due to the impact of pandemic lockdowns.
Read more: The ups and downs of inflation
Rise in the price of oil
The Russian invasion has led to an oil price shock, with the oil price recently peaking at nearly $130 (£99) per barrel. This is due to concerns about the possibility of supply cutbacks from Russia and reduced global purchases of Russian oil.
Russia is the world’s second largest supplier of oil and this supply shock has had a stagflationary effect. In other words, we are experiencing a combination of high inflation alongside comparatively lower economic growth. We estimate that US and UK inflation, as measured by Consumer Price Indices, could reach up to 9%, while European inflation could reach 7%. This would be a big economic shock to both consumers and businesses.
Even so, Russia is not a large part of the global economy, apart from oil and gas. We believe Russia will be excluded from the world economy for many years and the current tragic situation creates geopolitical and economic uncertainty. Some businesses are waiting to see what happens in Ukraine and how it might affect economic demand, which is creating a pause in economic activity. Moreover, as consumers absorb higher prices, we could see a short-term slowdown in economic activity, with a risk of recession.
Central bank responses
So what will central banks do in this stagflationary environment? We don’t think the European Central Bank will raise interest rates until 2023. But we believe they will soon rise again in the UK and US but, after that, they will rise more slowly than investors generally seem to expect.
We are, though, always alert to the risk of central banks panicking and imposing excessively high interest rate rises in an effort to control inflation. Significant rate rises could potentially choke off economic growth and we are watching this closely.
We see scope for Saudi Arabia to increase its oil supply. It could do this quite quickly and it would make up for at least some of the shortfall in Russian oil. But US-Saudi relations will need to improve for Saudi to turn on the taps. Oil supply could also be boosted if a deal is struck with Iran.
In our view, it could take some time for oil output to increase. And we believe today’s high oil price will lead people to cut back on energy consumption and this will bring the oil price down by the end of the year. In any case, market expectations are for a lower oil price in the future.
Increased price of gas
Gas prices have also risen, as around 40% of European natural gas supplies com from Russia. Russia has reduced gas supplies in recent months and Europe has already begun to limit Russian gas consumption following the Ukraine invasion. Supplies from US liquified natural gas tankers are helping to make up the shortfall, but this is a more expensive option. The result is that gas prices are rising globally, which also contributes to higher inflation.
Moreover, Ukraine and Russia supply around a third of global grain, so prices of many food items are rising sharply as supply from these countries dwindles. There could be a six-month lag before this hits the supermarkets, but it adds to inflationary pressures.
The UK Government has introduced council tax rebates to help people cope with energy price rises. This programme could be extended more broadly and we could indeed see a global fiscal response to help households through this difficult period. Demand for energy in the UK should fall back as we move into spring. But more government support may be required if energy prices remain high by October; this could lead the government to borrow more.
Renewed focus on renewables
The International Energy Agency (IEA) has published a paper on weaning Europe off Russian energy by building natural gas terminals and focusing on renewables and nuclear power. So we could see a bigger shift away from fossil fuels. But, in the short term, we expect to see a strong reliance on carbon burning fuels, as Germany turns to coal to replace Russian gas.
We currently forecast global economic growth of 3.7% for 2022, but could well reduce our expectations to around 3%, which is still quite good by historical standards. Manufacturing and service sector trends are improving and the impact of the Omicron variant is diminishing. Even so, markets are worried about the increase in inflation and its impact on demand.
Against the current tragic backdrop, equities (shares) have had a very turbulent performance so far this year, with European equities down by 18% . But many investors’ portfolios include bonds as well as equities, and the value of government bonds has held up well and is virtually unchanged in 2022 . This reminds us of the benefits of holding a diverse range of assets in a portfolio. For different assets can respond in different ways to particular events and so can cushion portfolios against declines in one asset class.
Opportunities for active investing
We’ve currently positioned our portfolios for an environment of lower economic growth. We note that banks and oil companies have performed well since the start of the year and in the wake of the pandemic. In contrast, technology companies, many of which performed strongly in the pandemic, have generally faced falls in their share price so far this year. In this environment, we believe we need to actively identify those sectors with the potential to perform well and have made some changes to company selection.
Overall, we have adopted a cautious approach to equities, which had strong returns last year that we don’t expect to be repeated this year. And we believe they will generally struggle to perform against the background of the tragic events in Ukraine.
Even so, we note that in the past, when the Vix index has risen above 30, as it has done this month, there were strong equity returns in the following 12 months . This suggests there could at least be tactical opportunities for equity investment in the year ahead. The Vix is popularly known as the ‘fear index’. It measures the amount of turbulence market participants expect from the US S&P500 index during the following 30 days. To give some context, the index has averaged around 19 since 1990 and, during the Great Financial Crisis, it hit levels of around 80. On average, the S&P500 has generated an average 12-month return of more than 15% when the Vix was between 28.7 and 33.5 and an average 12-month return of more than 26% when it rose above 33.5. It hit 36.4 on 7 March this year.
We also note that equities can perform strongly 12 months after geopolitical crises. As the table below shows, the S&P500 rose by an average of 8.6% in the 12 months following past crises. And positive returns were achieved 75% of the time.
How the S&P performed after geopolitical events
Source: Truist IAG, FactSet. Lighter blue rows represent down markets where the economy was in recession at some point during the measurement period.
Our preferences in fixed income assets
We currently have a negative view on bonds issued by companies. Higher inflation can lead to higher interest rates, which can make the income payments (yields) from bonds look less attractive and drive down bond prices as a result. But short-dated bonds (those with up to five years until they expire) often have less sensitivity to interest rate changes than long-dated bonds. So we’ve increased our exposure to short-dated bonds. We have also increased our exposure to government bonds, as we consider these low risk and believe they can function as an investment safe haven when equity markets are turbulent.
Favourable outlook for commodities
At present, we have a positive view on commodities and have increased our exposure to this class of assets. First, they can act as a buffer against inflation: as economic activity picks up there should be more demand for raw materials, which we believe could lead to a rise in their prices. Second, the price of oil, gas and grain has become more variable against the backdrop of the terrible events in Ukraine. By owning these assets, we gain some protection from any rises in their prices.
At Schroders Personal Wealth, we believe in investing for the long term, meaning for periods of at least five years but preferably ten or more. This enables you to hopefully ride out the peaks and troughs that markets undergo. Our view is that it is very difficult to try to time the markets, perhaps by attempting to buy investments when markets are low and then sell them when markets are high.
We also believe in the benefits of holding a diverse range of investments appropriate to your level of risk and that a financial adviser can help you determine your level of risk.
Finally, we would like to point out we have a very small amount of exposure to Russian assets in our funds, of less than a quarter of one percent. We are trying to reduce this to as close to zero as possible, although it can be hard to find buyers in the current environment. We have no plans to make additional investments in Russia in the near future.
 FactSet: MSCI Europe ex UK total returns 31/12/2021 to 08/03/2022.
 FactSet: BBG Barclays Global Aggregate Treasuries 31/12/2021 to 08/03/2022.
 Schroders, ‘Ukraine crisis: how does the stock market perform when the Vix fear gauge surges?’, 25 February 2022.
Past performance is not a reliable indicator of future results. The value of investments and the income from them can fall as well as rise and are not guaranteed.
Any views expressed are our in-house views as at the time of publishing.
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