2022 has had a very unpredictable start, one that nobody enjoys. Coming from what was meant to be the end of Covid-19 in 2021, we ‘ve jumped straight into a market correction and geopolitical tensions, specifically between Russia and Ukraine.
Endorphin Wealth works with Oreana our investment specialists, to provide the best investment decisions for our clients. Oreana provide insightful market updates on such topics and how they impact investments.
Below is their latest update regarding Russia and Ukraine:
Russia and Ukraine: an update amidst uncertainty
The Russia and Ukraine conflict is a source of significant uncertainty for markets. The Russian
presence along the border has given way to recognition by Russia of two separatist regions.
Russia has sent military support into the regions under the guise of peacekeeping. The West
has responded with sweeping sanctions. The outcome is exceptionally uncertain. In this
blog, we answer some questions and provide some guidance
What are the potential scenarios?
We believe in recognising the limits of our expertise. There is no clear information on the posturing and machinations behind Russian President Putin’s actions. We have no insights into the response from Washington or Brussels. So, we do not aim to build a “most-likely outcome”. Instead, we recognise our lack of expertise and accept that the range of potential outcomes is extraordinarily wide. They range from extremely bad outcomes (e.g a global hot conflict) to much better outcomes (e.g resumption of diplomatic efforts).
Plausible scenarios in the middle of this range include:
- Concessions to Russia to allow them to gracefully stand down.
- Occupation of the separatist regions along the Ukrainian border, with no NATO military involvement.
- Full scale invasion with no or limited NATO military involvement, but significant economic sanctions from the West.
- Invasion with NATO military involvement, and significant sanctions from the West.
- Full scale invasion with NATO military involvement, significant sanctions from the West, and weaponization by Russia of its oil, gas and soft commodity exports.
What are markets pricing in?
Global equity markets have declined almost 8% this year. Over half of that decline has occurred through February. US 10-year Treasury yields are 0.42% higher so far this year. But safe haven flows have knocked that yield 0.11% lower over the past week. Safe-haven flows have also pushed gold higher.
Markets have rushed to increase risk premia in equity and bond markets. Risk premia had already widened as the Fed moved to a more aggressive policy tightening stance.
And as uncertainty persists, and until we have clarity around which scenario we are in, we expect more risk premia will be priced in the near-term. That means potentially further near-term declines in equity markets, and declines in sovereign bond yields.
Has the medium-term outlook changed?
We don’t think so yet. The prevailing narrative remains solid economic growth. Temporarily higher inflation. And increasing cash rates in the major developed economy central banks.
Markets have moved to price as many as seven rate hikes from the US Federal Reserve this year. There was a greater than 50% probability priced for a 0.50% rate hike at the March meeting. The Fed has indicated it will engage in significant balance sheet reduction this year.
We expect that would result in an inverted yield curve – an incontrovertibly negative outcome for the economic outlook. We have pushed back against that rate hike consensus, although we have no quarrel with a pathway for higher cash rates over the coming 24 months.
At the margin, the uncertainty allows the Fed to be more circumspect about their pathway to rate normalisation. That should allow the US yield curve to remain positive over the medium-term. We expect that will allow solid economic growth and solid earnings growth to support equity market returns at attractive levels.
What can investors do?
Periods of episodic extreme uncertainty are not times to make knee-jerk reactions. Markets can move non-linearly, in unexpected directions, aggressively and rapidly. Instead, now is the time to rely on your clear investment philosophy and investment process.
For predominately strategic asset allocation (SAA) investors, that means relying on diversification. Exposures to cash, sovereign debt, high quality fixed interest play an important role in SAA portfolios. That role came under serious challenge through January. Longer-dated bond yields surged and drove capital losses in portfolios. The importance of having some downside protection against uncertain outcomes is highlighted by the recent market movements. As is the critical importance of rebalancing portfolios after significant asset moves such as we saw through 2021.
For dynamic asset allocation (DAA) or active investors, the challenge is to push back against the temptation to make short-term portfolio changes. Instead, it is important to rely on process. For us, that means:
- Review scenarios that could materially change the medium-term outlook.
- Assess the existing medium-term outlook against those scenarios.
- Consider whether the portfolio will need adjusting if those scenarios materialise.
- Adjust the portfolio, if necessary, when we get more clarity about the Russia Ukraine conflict outcome.
Importantly, we recommend being aware of sell-the-rumour, buy-the-fact events. Previous conflicts that have driven episodic widening of risk premia have been followed by rapid narrowing of risk premia after the uncertainty has declined. In other words, as the negative news flow grows, investors may price in ever-more negative outcomes. They may become overly pessimistic. Subsequently, even a relatively bad absolute outcome can be better than market expectations – and result in a perverse increase in equity prices
Contact Endorphin Wealth for more assistance
Your advisor will be able to consider all possible scenarios and factors, all of which should help to ensure that your investment plans have a successful outcome.
For an obligation-free conversation about your financial future, please contact us on 03 9190 8964 or at [email protected].
The team at Endorphin Wealth are passionate about helping people achieve their life goals with great financial planning. We are not licensed or owned by big banks and financial institutions. So the advice and wealth management we provide is always in our client’s best interests.
We have the advantage of being able to access a range of products from different providers. This means that our advice can be tailored to our client’s goals. We have offices located in Sydney and Melbourne, where you can find a financial advisor that is suitable for you.
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