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Investment implications of Russia’s invasion of Ukraine

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As the Russian invasion of Ukraine continues into its second week, we have spent considerable time talking with asset managers on the CAIS forum about their views on the potential economic and investment impacts from the continuing conflict. He has given the details of the analysis below.

US growth unlikely to be impacted, but economy could be hit by inflation

The risks to the US and its economy for Russia and Ukraine are centered around energy and other commodities such as potash and palladium, as well as agricultural commodities such as wheat, corn and rapeseed.[1] As a major global supplier of these assets, the current situation has driven commodity prices significantly higher, with West Texas Intermediate (WTI) reaching its highest level since 2008. Given energy’s correlation with the Consumer Price Index (CPI), higher global inflation in the Kadam commodity complex is likely to put upward pressure on domestic inflation. From an economic point of view, Russia is currently the 26th largest freight trading partner with a total of $28.0 billion in two-way freight trade.[2] The impact on economic growth is therefore expected to be minimal, if the conflict remains confined to Ukraine and does not drag on for too long. It is generally accepted that the US Federal Reserve (Fed) will focus more on the inflation outlook when setting monetary policy, with the central bank still expected to tighten rates by 25 bps at its March meeting.[3]

European growth could take a hit, with both growth and inflation likely to suffer

Inflation dynamics driven by higher energy and agricultural prices is expected to be broadly global in nature, so the impact on Europe is expected to be the same as above. Additionally, since the US is now the world’s largest producer of oil, it may be able to better absorb higher oil prices with increased production. It is anticipated that Europe as a net energy importer will have a tough time with higher prices.[4] Growth in the region is also expected to slow, given its high dependence on Russia for energy. Europe is dependent on Russia for 40% of natural gas and 25% of oil.[5] Higher energy prices can slow the economy as consumers cut back on spending, contributing to a potential destruction in overall aggregate demand. Holger Schmeeding, chief economist at Berenberg Bank, believes that in this situation the real GDP growth of the eurozone could fall from 4.3% this year to 3.7%.

Returning drivers may look very different in recent times

After nearly 30 years of global deflation, the backdrop of growth and earnings, and several revaluations based on falling rates, according to asset managers on the CAIS platform, took investors off the risk and duration curve. Additionally, they also note that the cost of capital also declined, as did liquid assets such as bonds, corporate credit and private equity, and long-term assets such as venture capital. Over the past 5 years, value-oriented investments have generally not been favored by investors and have underperformed on a relative basis given the performance dispersion between growth and value stocks, as have iShares Russell 1000 Growth (IWF) and iShares Russell 1000. is represented by the value. IWV) ETFs. A potential issue ahead is that the prosperity we have enjoyed in this period could be impacted by higher inflation, which could drive negative real rates and wage growth. As a result, the standard of living may decline as savings are of little value on a real basis. Should we be entering a regime shift, we may see that investors seek exposure to anti-momentum investments that are typically underweight, such as commodities, energy, emerging markets and gold – investments that typically are driven by macro-economic factors.

As concentration increases, so may the need for diversification

Global stock markets are becoming increasingly concentrated. For example, the US stock markets account for over 55% of the global market capitalization.[6] The top 5 stocks in the S&P 500 make up more than 25% of the overall index market capitalization.[7] In a directional market when asset prices are typically moving together, such a concentration should allow investors to enjoy the communal benefit of mutual benefit. However, if we enter a more normalized environment in terms of monetary policy on the back of a shift to a global tightening regime given high inflation, the spread between asset prices could increase. It may be prudent to seek diversification through less concentrated holdings and alternative drivers of returns.

takeaway

Our primary concern in Ukraine is for the people of the country who are caught in the ongoing conflict and we hope that there will be a quick and peaceful solution very soon. However, actions already taken are likely to set in motion events and feedback loops that could drive inflation higher and provide challenges and opportunities for investors. From our discussions with asset managers on our forum, it appears that macro-economic factors and drivers to consider for investors as we enter a more general environment for interest rates, monetary policy, fiscal policy and broader markets. can become increasingly important. In addition, the need for diversification to avoid highly concentrated segments of the markets can be critical to the continued growth of a portfolio and reducing risk. We believe that alternative investments can prove to be valuable tools in such an environment.

For more information on hedge funds and the potential opportunities available on the CAIS platform, Contact CAIS Representative,

  • Washington Post, “Russia and Ukraine are major exporters of food and energy. Will global prices rise?”, 3/2/2022
  • Office of the United States Trade Representative,”Russia”, accessed 3/3/2022
  • Bloomberg, “World Interest Rate Probability”, accessed 3/3/2022
  • Official Monetary and Financial Institutions Forum,”Russia’s invasion had more impact on European central bankers than on the US”, 2/28/2022
  • AP News.”Economic threats from wave of Russian invasion around the world“, 3/2/2022
  • statistics”Distribution of countries with the largest market share”, March 2021
  • Bloomberg, 3/3/2022

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