1 March 2022 Do not tell me to calm down! - By Dr. Francois Stofberg, Managing Director: Efficient Private Clients
Most of us have a negative response when told to calm down. This is especially true when headlines of war and despair dominate the news. While US markets came under pressure in January over interest rate concerns, European and other markets have been dragged lower over fears of contagion, prompted by sanctions against Russia.
It’s important to consider the numbers for some perspective. Combined, the Russian and Ukrainian economies make up about three percent of the global economy, roughly the same percentage as Texas. The invasion’s impact on commodity prices could result in an increased build-up of inflationary pressures. A third of Europe’s oil and 40% of its natural gas imports come from Russia. Moreover, a quarter of global wheat exports and most exported sunflower seeds come from the two warring nations. Russia is also a leading exporter of precious metals, especially platinum group metals. Concerns relating to palladium supply have supported our local PGM players, and to some extent insulated the South African market.
While Russia’s current strategy remains unclear, it has fortified its economy against sanctions in recent times. The Russian Central Bank holds approximately $360 billion in reserves, and the country exports more than it imports, creating a balance of payments surplus. While The West has not involved itself militarily in the conflict, judging by Russia’s response to Western sanctions over the weekend, it appears that the imposed sanctions are damaging. The West limited the Russian Central Bank’s ability to intervene in the economy, and the impact has been material. The Russian ruble is under immense pressure, trade on its stock market has been halted, global indices of the Russian market have almost halved, and interest rates were doubled to 20%.
History has taught us that the greatest risks from crises like this come from overreactions. So how do we stay calm?
In short, diversify, hedge, stay the course, hold some cash, and take advantage of opportunities. Drawdowns driven by geopolitical stress events are typically short-lived. We diversify our global portfolios by investing in companies across geographies and sectors, in order to limit sector- and country-specific risks. Geopolitical risks have been increasing over the past decade and we have positioned our portfolios accordingly, by investing in sectors that benefit from a rise in geopolitical uncertainty, such as defence contractors and energy counters.
Some dry powder is also useful, we raised cash in our portfolios at the beginning of the year, as we were of the view that valuations across the world were lofty and that we would get better entry points. More recently we started to allocate capital to interest-rate sensitive names.
It has not all been smooth sailing. We held the view that Europe would outperform the US, given differentials in planned interest rate hikes, expected GDP growth, and valuations. While we remain of the view that most of the market dynamics we are currently experiencing are sentiment-driven, and that equities will rebound as the dust settles, the war has hurt the European exposure in the portfolios. It is also important to note that the biggest risk to markets, a monetary policy error, still looms. The situation remains fluid and we will continue to monitor the impact of the invasion and will make changes where appropriate.
Crises typically accelerate existing trends, and we need to be mindful and ensure that we position portfolios optimally for long-term growth. For instance, one such example is online security and cyberwar, a field in which Russia is a prominent player, and on which The West will increase spending to ensure security as we all live work, and play, more remotely.
As always, if you require any of our economists or portfolio managers to speak to your clients, please let us know. We will continue to actively manage our clients’ portfolios and invest in excellent businesses when they trade at attractive valuations.