Page 56 - DIY Investor Magazine | Issue 33
P. 56

    Before the war, Putin’s regime was an irritant with an expansive hybrid foreign policy spanning military operations, influence campaigns and assassinations of opponents on foreign soil.
Nevertheless, Germany appeared reluctant to take the European lead on the kind of sanctions which would have had a material effect on the Russian economy.
As the Russian regime has now revealed its willingness to engage in such a war, economic sanctions are likely to be long-lived, regardless of a supposed ‘win’, loss, or stalemate on the ground in Ukraine.
In some respects, the only remaining uncertainty is to what extent China or India chooses to exploit the situation for its own economic and political advantage.
We therefore expect oil and food prices are likely to remain elevated for the duration of 2022 which will maintain upward pressure on headline measures of inflation. We are however reminded of the oil market’s aphorism that the cure for high oil prices is high oil prices, which similarly applies to agricultural commodities.
Both oil and wheat prices are strongly in backwardation, meaning that prices for delivery in the short term are much higher than prices for deliveries further into the future. Brent crude oil for delivery in 2029 was moving higher prior to the outbreak of war but is little changed at only US$70 since mid- February.
There is a similar story in wheat futures where European prices for 2024 are up only 10% compared to spot prices which have risen by over 40% during the same period.
We expect governments to move swiftly to reconfigure supply chains to avoid major disruption to either energy or food supplies as Russian volumes are reduced or eliminated entirely.
We note the recent agreement between the US and EU for LNG supplies and early signs of a more favourable oil and gas investment climate around the UK. As hydrocarbon- based energy becomes more expensive we also expect further investment in renewable energy which will permanently displace fossil-based fuel.
We also note the EU has proposed relaxing environmental requirements for farmers to set aside land, increasing the acreage available for combinable crops to compensate for both the loss of acreage and likely difficulties exporting grain from Russia and Ukraine.
Supply chain, energy and agricultural themes are likely to benefit from positive earnings momentum in the short term. Nevertheless, investors should be careful not overestimate the duration of the uplift from an essentially transient phenomenon which is likely to become played out within the next 12 months.
We maintain a neutral outlook on global equities with some significant caveats following a hawkish turn in monetary policy in the US and eurozone. Rising US interest rates and tighter than expected monetary policy in the eurozone is likely to prolong the period of underperformance for the most highly valued segments of the equity market whether on a regional and sector basis. These sectors currently account for an unusually large percentage of headline market indices.
Instead, we continue to prefer traditional sectors such as banks, insurers, defence, energy and telecoms over still highly valued technology at this time. We highlight the defence sector as commitments to increased defence spending are likely to outlast any ceasefire in Ukraine. 10-year government bond yields are likely to continue to move higher in the short run with increases in interest rates, but the flattening of the yield curve suggests that the point where long-term rates stop rising in anticipation of growth slowdown is approaching rapidly.
  DIY Investor Magazine · Apr 2022 56

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