With escalating tensions in eastern Europe, we’d like to update you on some important developments in and around investment markets and how we are managing risk in our portfolios. Our latest video from Chief Investment Officer Graeme Bibby, linked here, explains this in more detail.
As we have been monitoring in the news, Russia has commenced military action against Ukraine after weeks of preparation and posturing. We believe, based on past geopolitical events, that the overwhelming majority of conflicts cause only temporary concern for markets and lead to swift recoveries. The main difference are those events that materially impact trade and energy flows, and hence are disruptive to many other economies beyond the borders of the conflict of concern.
This is one of those exceptional geopolitical events. It is also one to frame in the context of what has already been in motion in the global economy and markets. The main impact of the Russia-Ukraine conflict is a spike in oil prices that does not subside due to economic sanctions against Russian energy, trade and selected financial assets. We believe this shifts the risk profile for financial markets and investment portfolios materially. A persistent move of oil prices above US $100 per barrel has been enough to prompt a recession in most periods before.
Coming into 2022 we were aware of rising risks from a withdrawal of government spending and a rise of inflation and interest rates. Forecasts we follow from high quality independent researchers, highlighted that late first quarter or into the second quarter of 2022 inflation would likely peak and slowly come down, and growth would peak following a post Omicron bounce. This pattern is projected for the vast majority of countries aside from China which was early into a slowing cycle and was showing signs of rebounding.
At the same time, central banks have clearly signaled their intention to hike short term policy interest rates. They are closely following the data releases of inflation and unemployment and will commence rate hikes this year to curb inflation. The main central banks of importance are the US Federal Reserve who are likely to hike rates at their March meeting. The UK has already hiked cash rates multiple times, as have many emerging market countries. Australia’s Reserve Bank has been slow to acknowledge the growing pressures, mainly due to the low apparent inflation here, however persistent overseas inflation in key imports such as oil and a lower Australian dollar is likely to import additional inflation here.
As central banks are more focused on further rising inflation than falling equity markets, we don’t expect any let up in the path of hiking cash rates. The exception to that rule has been when markets get more dysfunctional where both bond and equity markets suffer volatility. We have seen the Federal Reserve reverse course in December 2018 when equity markets fell around 20%. There is a risk this time that the Fed may not act until equity markets drop further as their bigger issue is inflation.
Our positioning is to rotate to be more defensive, particularly within our equity positions in this environment.
Our plan is well thought out ahead of time coming into this environment, has adapted to new material information in the Russia-Ukraine escalation, and our belief that it changes the trajectory for the rest of the year. We are prepared to manage risks around the events and remain adaptive to the environment as things improve. There will be opportunities to purchase assets at better prices ahead, and there will also be an upturn after this period of uncertainty. We take a measured approach to manage client investment risk and smooth the journey where possible.