Ukraine crisis – what investors need to know
Luc de la Durantaye discusses how a continued lack of direction is likely for both equity and fixed income markets.
Ukraine crisis – What investors need to know
[Ukraine crisis – What investors need to know]
[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.
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.
[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.
[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.
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.
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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