Ukraine crisis – What investors need to know

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[Ukraine crisis – What investors need to know]

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[Luc de la Durantaye, Chief Investment Strategist and CIO, CIBC Asset Management]

In our last update, we had mentioned that 2022 would be an eventful year, and so far it has not

disappointed. The events in Ukraine have forced market participants to re-evaluate their global

economic scenario, and the range of possible market outcome has widened in light of Russia's

full military action and also the increased unpredictability of the geopolitical environment, as well

as the rapid and collective response of Western countries. And so, these developments have

naturally translated into higher volatility. So while it remains certainly an understatement that

predicting what Russia's President Putin will do or not do, nevertheless, it's a necessary evil, if

you will, to re-evaluate the environment. Our best take on the conflict at this time so far is that

first, I think NATO is a much stronger opponent than Ukraine. So this suggests that Russia's

invasion will most likely be limited to Ukraine, particularly given the slow progress of Russian

military is making in Ukraine. So that's an important assumption. Second, the extent of the

economic and financial backlash against Russia from G10 countries and a growing contingent

of large multinational corporations suggests that the economic warfare against Russia is very

swift and effective, which means Russia is increasingly isolated. China also is unlikely to come

to its rescue because its economic ties are much, much larger with the West than with Russia.

So this is a new form of economic and financial warfare.

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[Economic implications]

It's still uncertain, but we have both direct and indirect effects of this crisis. The direct effects:

the crisis-related sanctions will negatively affect international trade. That's the direct impact, but

it's likely to be small given that Russia contributes to less than two percent of the global

economy and Russia is not very well integrated with the global economy. The indirect effect is

likely more impactful, but also uncertain. It includes obviously expected negative impact from

higher commodity prices, including energy and food. And Russia is also a major producer and

exporter of many commodities. So that's going to have a negative impact on growth and

inflation and likely affect negatively spending plans of corporations and individuals.

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[Increased inflation risk]

As a result of recent events and the risks they imply for commodity prices and confidence, our

previous growth and inflation forecasts will have to be adjusted. Probably growth will be

adjusted downwards and inflation will be adjusted upwards. So given the starting economic

landscape, the upside risk to inflation outlook is arguably the most relevant for policymakers. So

what we're going to be watching from here also is policymakers’ reaction, and so far they have

demonstrated that they are continuing on their policy renormalization. So the Bank of Canada

recently raised interest rates and gave indications that they would continue to raise interest

rates and so did the Federal Reserve indicated that they will continue or they would start

removing their accommodations.

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[Financial market implications]

The rise in geopolitical events risk confounds what we already see as a complex outlook for the

financial markets. Given the pandemic, given relatively high and broadening inflation, developed

markets, central banks need to remove some of their massive liquidity stimulus since they

injected that since March 2020 after the pandemic. So all this means that in the short term, it

seems likely that we'll experience continued market volatility and a lack of direction in both

equity and fixed income markets as investors continue to evaluate the full impact of the

geopolitical situation. Thereafter I think if we try to lift our eyes on the horizon, a world of higher

commodity prices and receding policy stimulus from central banks could generate a more

pronounced economic slowdown than what we initially expected at the start of the year. This

represents an additional near-term challenge to risky assets, including equity markets, which

had started the year in 2022 at somewhat elevated valuation levels for at least some markets.

Still, I think we do need to keep our eyes on the horizon. Already, some equity markets are in

bear market territory. That creates opportunities, once geopolitical events will calm down.

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[Investor outlook]

Well-diversified portfolios, I think, comprising of government bonds, stable paying dividend

stocks, gold and other commodities in the current environment, as well as cash and some safe

haven currencies should provide more stability to a global portfolio. --So that's number one.

Again, to balance your portfolio with non risky and risky assets is always helpful. And finally,

given the uncertainty, resisting the urge to do something I think is often better than reacting to

daily events that can change on a dime given the current situation. So I think that's another

element that sometimes we feel we need to do something and sometimes not doing anything is

the best thing.

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[Canadian assets]

The prospects for Canadian assets is actually relatively favourable. Canada is very far away

from this whole situation. Exposure to Russia is very low. Yet we are an exporter of commodity.

Our trade balance will benefit from these high commodity prices. Our equity market index has a

favorable composition with high-dividend-paying stocks, energy stocks and commodity stocks in

the index. That's also a favorable composition for our equity markets. And our equity market has

performed relatively well and has outperformed. And our Canadian bonds - Canadian

government bonds - are of highest quality and can be attractive for foreign investors in this type

of environment. And finally, our currency is somewhat undervalued and is supported to a certain

degree by higher commodity prices. So all in all, many mandates that we have, that we run, we

remain overweight Canadian equities, and we have a good portion of our balanced portfolios in

Canadian assets. so that brings some stability in this difficult environment.

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