Given the worrying developments last night, we have pulled the regular market update forward. The update was written yesterday and, as we know, the situation in Ukraine is evolving rapidly. We will keep you updated with any significant market updates as they occur.
Trouble to the East
Much of the market difficulties faced so far in 2022 can be attributed to higher inflation and expectations for a short but relatively aggressive monetary tightening cycle from the Bank of England (BOE) and US Federal Reserve (Fed). Clearly, the rapidly evolving situation in Ukraine is exacerbating market worries and volatility has infiltrated most areas of financial markets.
Bond markets have been struggling as inflation reduces the purchasing power of their fixed income streams, making them less attractive. Thus, prices fall and even the “safest” of bond markets, i.e. government bonds, are down over 5% year to date (based on the UK Gilt All Stocks Index).
A broad measure of the US stock market, the S&P 500, closed in correction territory on Tuesday 22nd February for the first time since the onset of the pandemic in March 2020. As a reminder, a correction is widely accepted to be a fall of 10% from the most recent high point of the index.
A relative bright spot has been the UK stock market but, as our CIO recently pointed out, the relative strength of the UK market has been led by just a few of the largest companies, predominantly energy companies and banks. Looking at the wider market, medium sized companies, as measured by the FTSE 250, are down 10.60% year to date and some of the smallest companies, the FTSE AIM 100 index, are down 18.00%.
What could be the effects of Russian invasion on financial markets?
With many investors seeing drops in their portfolios for the year so far, the natural questions are what are the likely effects on financial markets should the tensions in Ukraine escalate further and what should we do about them?
Firstly, I do not wish to underestimate the human cost of any potential conflict. The situation in Ukraine is clearly very serious and further incursions into Ukraine by the Russians will have a lasting impact on the Ukrainian people.
However, it is worth bearing in mind that geopolitical events have, historically, caused periods of heightened volatility which tend to be relatively short lived. Even after 9/11, the terrorist attack on the World Trade Center in New York, the S&P 500 had recovered into positive territory just six weeks later.
Aside from the inevitable volatility we see a couple of key risks:
- Energy prices – Europe is already reeling in the wake of much higher energy costs and upwards pressure has been evident, particularly in the prices of natural gas. Last night, Germany announced that it would suspend approval of the gas pipeline from Russia into Germany, Nord Stream 2, in an early sanction against Russia. This could raise the prices of Gas even more (Gas and Oil prices are up 20%-25% year to date) which could put further pressure on the consumer.
Furthermore, energy prices, whilst volatile, are a key component of many inflation measures. Therefore, there is a risk that higher prices will force the hand of central bankers into raising interest rates even faster than is already priced into financial markets. In the worst-case scenario, this could result in a policy error. In this context, that would mean interest rates are raised too high and too fast, resulting in a rapidly cooling economy and, potentially, recession.
- Unintended consequences of economic sanctions – Europe, the UK and the US have been quick to impose economic sanctions against Russia. I have already mentioned Nord Stream 2, but the measures already announced in an attempt to inflict economic pain on Russia are wide ranging including targeting individuals, Russian investment banks and even their sovereign debt market, effectively cutting off the Russian Government from Western financing.
President Putin has dismissed the effectiveness of Western sanctions and Russia could turn to allies, such as China, for funding. However, the global economy and financial system is incredibly complex, and the risk of unintended consequences is high. Politicians rarely admit that there is often an economic cost to those imposing the measures as well as those being sanctioned.
What should investors do?
Periods of volatility and falls in the value of portfolios are, whilst deeply uncomfortable, to be expected.
When one sees falls in value, it is all too tempting to make changes. As humans we want to do… something. However, the most successful investors exhibit the following traits:
- They remember that investing is for the long term. If you have agreed a long-term plan with your financial adviser, then it is often best to ride out the volatility and stick with it.
- They don’t get caught up in market noise. Again, investing is for the long term. We invest in funds and companies with a 5 to 10 year investment horizon. Therefore, quarterly results or immediate distractions, (no matter how destructive) shouldn’t influence decision making too much.
- They don’t attempt to market time. Hopefully readers saw the outlook video which Graham Bentley and I recorded a couple of weeks ago. In that video were some excellent charts showing how destructive attempting to market time can be to returns. We also showed a chart from JPM Morgan which demonstrated that, over the past 36 calendar years, the FTSE All Share Index has delivered a positive return in 25 of them. That’s a positive return nearly 70% of the time, despite intra-year falls of anywhere between 4% and 43%.
- They remove emotion from investing. Humans are emotional creatures and, as much as we hate to admit it, fear and greed run through us all. But fear and greed are not good foundations for sound decision making. We believe it is better to rely on fundamental research.
If in doubt, contact a trusted professional
Finally, if you have any questions or are unsure of what to do under the current circumstances, do get in touch with your financial adviser or investment manager. They will always be happy to help and talk through your options.
Until next time, stay well.
Head of Avellemy Private Wealth