Yesterday, the Australian equity market reeled from the news that Russia had launched an invasion of Ukraine.
The shockwaves are being felt on many levels, including in investment markets. Particularly concerning was that the attack was broad based and included the capital, Kyiv. This event has dominated media headlines and will continue to do so for the foreseeable future. The natural question then arises: what next?
Russia has taken this step to prevent the Ukraine from joining NATO and becoming a partner of the US and its allies. However, it’s speculated that Russia will want to avoid a full-scale global conflict with the US and NATO. The immediate response from NATO aligned nations has been to impose sanctions on Russia.
What are the implications for investors?
Equity markets will continue to experience volatility as they grapple with the uncertainty and risk of a broader conflict between Russia and NATO. It seems that the initial sell-off in global share markets was caused by fear and shock induced selling. However, by the close of US trading, we observed a significant recovery, with the US market finishing in positive territory, and gold falling off its highs.
This suggests that investors see this issue as having only a limited impact on earnings. It appears that while sentiment will be impacted, global growth will remain on track. The expectation is that shares will out-perform bonds over the coming twelve months.
The spike in commodity prices, especially oil, creates a bigger problem for central banks, as they grapple with already high inflation.
The oil supply crisis of the late 1970s is a good example of what can occur when economies experience an exogenous price shock. The key difficulty for central banks occurs when their attempts to control inflation also cause a collapse in future growth, a scenario that would be very negative for equities.
Higher commodity prices have the potential to make this task even harder, albeit initial comments from the US indicate they are well aware of this issue, and as a result – sanctions imposed on Russia are, or will be, targeted at areas that will have limited impact on the global trade of Russian commodities.
While things have certainly just got more complicated, for now our opinion continues to be that we are experiencing a correction rather than the start of a new bear market. Key portfolio construction fundamentals are as important as ever – spread risk through diversification and avoid taking significant bets on unknown outcomes.