Unsurprising but depressing news this morning that Russia has launched an attack into Eastern Ukraine. Described as an “incursion” by Russia and as a full-scale “invasion” by the US and its allies, this attack has been in the making for some weeks and doesn’t come as a shock to anyone. The reality is that the pressures built up since the signing of the Minsk agreement in 2014, and the ever-bubbling underlying cause of Russian disaffection at being unable to realise its full ambitions in what they view as “Ancient Russian Lands” ensured that this was a likely outcome. Russia is obviously the aggressor in this situation, but outside influences have not been particularly helpful in arriving at a diplomatic solution. Russia feels like it has been backed into a corner by NATO’s growing presence in their “sphere of influence” and at some point, the uneasy peace would break. Today that has happened.

As is always the case in similar situations, you will find that everyone is now a learned expert of the psychology of Vladimir Putin and the politics of the Eastern Ukraine. The reality is that it is impossible to predict what Putin wants to do next, but it would appear to us that he wants to consolidate gains in Eastern Ukraine, allowing those parts of the Ukraine that are basically ethnically Russian to re-join the “Motherland”. One must hope that the Russian tanks stop at the boundaries between the ethnically Russian and Ukrainian parts of the country. As yet, we simply don’t know.

The impact upon markets will be negative at the outset today, compounding what has been a poor start to the year for core equity and bond markets. However, beyond the initial reaction, it is harder to forecast what happens next. Markets have already priced in a lot of negativity and sentiment has become very bearish. In addition, commodity markets and investments have soared in recent weeks, pricing in a geopolitical premium. Credit spreads have finally widened, as across global asset markets the tone has soured. This is what we had been expecting, and it is leading to opportunities for our clients’ investments.

We have used the recent spike higher in bond yields to partially close out our major duration underweight, questioning how far central banks can really push up interest rates. The widening of credit spreads created an opportunity to add defensive income investments at an attractive price. The issues in Eastern Europe could well create an “uncertainty factor” that might not back some of the headiest forecasts for central bank policy, where, as an example, the Federal Reserve is now expected to raise rates six times this year. It might be that rate expectations now start to moderate.
We have also tentatively started to exploit valuation opportunities that had been created by the decimation of growth equities at the start of 2022, including increasing our position in the renewable energy and “environment” sector, which had gone from much-loved to a recent poor performer, further enhancing the return prospects of what we believe is a great long-term opportunity.

Finally, we have just used the spike higher in commodity markets to reduce our position in the asset class, reaping profits from an investment that has gained another 15% this year (to yesterday’s close). Clearly there could well be further to go for commodity markets, as this morning has shown, but we would now have a preference for gold investments at this juncture, not least if the Ukraine situation darkens further: in that case, global growth expectations might have to be lowered, calling into question some of the more recent gains in commodity markets. It is worth remembering that there are many more commodities than just oil. The gold price has shot higher in recent weeks and gold miners have added significant value, as a geopolitical hedge.

There is an old adage in markets that you “buy the war, sell the peace”, broadly suggesting that as markets start to price in a geopolitical or war risk, it creates an opportunity to invest. Will this be the same in this situation? Quite possibly. Asset markets have performed woefully at the start of this year and many of the previous market darlings have been hit terribly hard. This might well allow us the opportunity to reduce our equity underweights and target specific areas of underperformance, such as US equities. We will be exploring such ideas and aiming to act proactively in the coming days. On the negative side of this equation, asset markets are rightly starting to reflect how uncertain global politics have become, how great an issue inflation is and whether near-record equity valuations are justified at a time when corporate profit margins and corporate profit growth (the delta rather than absolute levels of profitability) are peaking.

To conclude, this expected turn of events is tragic for the Ukraine and the Ukrainian people. However, for investors it is not a time to panic. A lot of negativity has already been priced in to asset markets, justifying our defensive stance at the start of this year. Whilst we have been unable to protect against all of the market losses in 2022, we have been reassured by the relatively defensive behaviour of our portfolios. We have now started to modify our views and recalibrate our portfolios. The market volatility is a “friend” of an investor, not an “enemy”, and we will continue to take advantage of the opportunities presented by the shifting and clashing tectonic plates that best signify the “Turbulent Twenties” framework we have outlined for this decade.

Thomas Becket, Chief Investment Officer


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