I promised to be a bit more upbeat this week – but it is difficult. The movements in markets in the last few days reflect the volatility/uncertainty that a crisis creates. But we have to remember that in the first instance this is a human tragedy.
It is also the recognition that such a great country as Russia, with a rich intellectual and cultural history, has now cut itself off from the western world. The development of an independently minded middle class will be slowed, important cultural and sporting links will be severed, mutual antagonisms will grow. In short, we are entering a new Cold War, but one which will be “hotter” than the previous one; cyber warfare will be the new arena and tactical nuclear weapons a constant undercurrent. An ideological battleground, of capitalism versus communism, has been replaced with one pitching democracy against autocracy, with China firmly aligned to the latter. We must be resolute. And let’s be honest, we have a sorry record here. Britain has been complicit in allowing London to be a centre for Russian money laundering. Weakness and greed: not a great combination.
What are my current thoughts?
- The West will suffer pain through higher energy and food prices. Economically, governments may mitigate some of these impacts in the short term; politically, these costs need to be made clear.
- Countries will re-appraise the post 1989 “peace-dividend”. Germany has already committed itself to the 2% NATO defence spending minimum. The UK will spend more on defence and will move clear of the 2% threshold. This will mean either higher taxes, cuts elsewhere or bigger deficits; none are easy choices. However, we have to recognise that the UK’s frontier, as a NATO member, is the border with Russia / Belarus. We should expect more tensions in Serbia and other areas influenced by Russia.
- Brexit has, so far, been a political failure, badly executed, and a factor in the strategic thinking of President Putin. Economically, Covid has probably disguised a similar story.
- The UK government should recognise the fantastic asset we have in the BBC – and should encourage rather than denigrate. Unbiased news is becoming an increasing rarity.
- Expect more disinvestment from Russian assets (BP, Norwegian Oil Fund); will UK pension funds be willing or able to follow suit?
- There will be an accelerated move away from oil and gas, with greater emphasis on renewables and hydrogen. But this needs to be done strategically. Gestures like the recent decision by the National Portrait Gallery to axe BP as a sponsor, shows a naivety about our current situation.
Government bonds and cash
Markets don’t like war or nuclear threats and safe havens rallied as the rhetoric intensified. Yields on 10-year UK government bonds moved to 1.45% but in truth the rally was half-hearted. It was a similar picture in the euro area and the US – yields lower, but not much. The focus remains on inflation and the impact that the current crisis will have on prices. It is now conceivable that we get a 10% Retail Price Index (RPI) print in the UK this year. This was reflected in implied inflation which moved up in all markets – now 3% in the US and 4% in the UK, at the 20-year tenor. Economic data took second place last week and there is a sense that forecasts will need to be reviewed in the coming weeks as the impact of Russia’s actions become clearer.
Credit markets, understandably, were weaker. Whilst sterling credit markets have little exposure to Russia and Ukraine there was a clear weakening in sentiment. This was reflected in the credit spread premium of non-gilt credits moving above 1.2% for the first time in 15 months. The widening was fairly widespread but did not have any sense of panic. Liquidity was challenging at times – but both as a buyer and seller, with conditions swinging from day to day. Financials were at the epicentre of deterioration, particularly in the subordinated bank and insurance sectors. This has impacted our relative performance a bit but reinforces our consistent message about the importance of spreading risk and getting proper diversification. Yields are attractive in financials but these bonds have high correlations when things get tricky.
High yield markets showed a similar theme with my preferred spread measure moving above 4.5% for the first time since early Q4 2020. Within higher yielding areas, it has clearly been a difficult period for emerging market debt, with returns significantly lagging those in more developed regions. The apparent embargo on foreigners selling Russian securities, imposed by the Russian Central Bank to stop outflows, will only make the situation worse in the short term. But, in the end I do think there will be opportunities – based upon an acceptance of internationally agreed rules and norms of behaviour.
Let’s conclude on a more positive note. The Ukraine invasion has given the West a sizeable kick up the backside. Hopefully, it will jolt us out of our complacency, and let us face the true major global issues without consuming ourselves in petty disputes – hang together or hang separately. Could it be that Ukraine is the issue that heals the Brexit wound?
Past performance is not a reliable indicator of future results. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.