2022 was expected to be a wild year in financial markets as investors grappled with rising inflation, the end of ultra-cheap money and an economic rebound from the pandemic. Today, as the world watches in shock as Russia invades Ukraine, financial markets are even more uncertain about the way forward.
Investors are being forced to rethink their assumptions about how the global economy will perform this year – and what that means for Australian businesses and a national economy also struggling with devastating floods.
In the days after Russian President Vladimir Putin launched the invasion, the reaction in global markets was dramatic. Investors sold billions of assets exposed to Russia, oil prices jumped above $110 a barrel and money markets bet that central banks would be more cautious about raising interest rates.
“The conflict comes at a time when central banks are at the start of a tightening cycle. This further complicates the picture,” says Anton Tagliaferro, Chief Investment Officer at Investors Mutual. “The markets were pricing in big rate hikes this year. They will still happen, I think, but maybe at a slower pace.
For Australia, which has minimal direct economic ties to the region, the turmoil comes after a generally better-than-expected reporting season for earnings and dividends. Investors trying to understand these conflicting forces face big questions.
With rising oil, gas and coal prices accelerating since the invasion, will this fuel a rise in global inflation, adding to pressures on consumer prices?
Will central banks continue to raise interest rates in the uncertain context of a war?
And what does the highly uncertain environment mean for the great “spin” from higher-growth tech stocks to more traditional cyclical companies?
The earnings season, which ended this week, saw Australian stocks rise 2.1% last month, against a 3% decline in the S&P500. Macquarie strategists attributed the outperformance to strength in banks and miners, but industrials generally had a tougher earnings season as many companies struggled to pass on rising costs, which reduced profits. margins.
In more normal times, earnings season themes such as margins would likely dominate discussion among investors. But not as Europe faces its biggest ground war since World War II. The initial invasion triggered a dramatic sell-off on global exchanges, and by the end of that week the ASX 200 had recovered some of those losses, but was still below its pre-invasion level.
Ophir Asset Management’s senior portfolio manager, Andrew Mitchell, said that since World War II, global stock markets have recovered quickly from military conflicts, primarily because wars have taken place in places that represent a small share of global growth. Russia and Ukraine, for example, account for about 2% of the world’s combined gross domestic product.
“Although you may get sticker shock, the market bounces back,” he says.
UBS strategist Richard Schellbach told clients that through 13 of the biggest geopolitical shocks of the past half-century, the Australian stock market had “largely ignored these events”.
CONFLICTS COULD ADD TO INFLATION AND VOLATILITY
Despite Australia’s minimal exposure to the region, the biggest impact of the war may be its impact on key commodity prices, which could then affect inflation.
Some of the biggest moves have been in energy stocks – with shares in oil, gas and coal companies rising in response to higher oil prices, as buyers scramble for supplies from overseas. outside of Russia, an energy powerhouse.
Tagliaferro says a key question will be whether investors change their oil price assumption used to value companies like BHP, Santos and Woodside
“The long-term price of oil [assumption] for most people was US$50 to US$60. Does this geopolitical risk now mean it may be higher? ” he says.
The broader economic risk is that if the rise in oil prices continues, it could fan the flames of inflation, at a time when central banks were already worried about how quickly consumer prices were rising.
As UBS economists put it this week: “Russia/Ukraine’s impact on the global economy largely depends on where energy prices stabilize.”
Head of Australian equities at Aberdeen Standard Investments, Michelle Lopez, said the war would add to inflationary pressure in the global economy, giving central banks an even more difficult balancing act.
Although central banks such as the US Fed have made it clear that they still intend to raise interest rates, they will be wary that the conflict in Ukraine may also undermine confidence. The end result could be a more volatile backdrop for equity markets.
“We’re talking about volatility — that just makes it worse, and we should also add vulnerability into the equation,” says Lopez, who oversees a roughly $1 billion portfolio.
For all the devastation unfolding in Ukraine, Ophir’s Mitchell also says how the US Fed responds to growing inflationary pressures will have a bigger impact on stock markets than war. “The loss of life is horrific…but what’s going to move the stock market is what the Fed is doing,” Mitchell said.
Expectations for the cash rate for the end of this year have fallen by 30 basis points since mid-February,
David Plank, head of Australian economics at ANZ Bank
Some even speak of the risk of “stagflation” – the combination of high inflation and rising unemployment and weak demand growth. For that to happen, however, there would need to be a sea change in Australia’s labor market, which is expected to see the lowest unemployment rate since the 1970s later this year.
VALUE VERSUS GROWTH
So far, markets are predicting that the Ukraine crisis will make central banks slightly more cautious about raising interest rates – but that won’t stop them from climbing.
Australia’s head of economy at ANZ Bank, David Plank, said the market had delayed expectations for the RBA’s first cash rate hike by about a month, and he expected fewer hikes. this year than before. “Expectations for the cash rate for the end of this year have fallen 30 basis points since mid-February,” Plank said.
Markets also expect fewer rate hikes from the US Fed this year, although it is expected to start raising interest rates again this month.
These changing expectations are important for equities, as the outlook for interest rates has had a huge influence on stock prices over the past few months. In particular, the expectation of higher rates tends to reduce the valuation that investors place on companies that expect to make money in the future, but are not profitable today – many of which are usually tech companies.
Changing interest rate expectations are the main reason for a crucial trend in global markets lately: the “rotation” from “growth” stocks in the tech sector to “value” stocks. with more established cash flows.
Could the more uncertain outlook for interest rates and inflation change this picture?
Ophir’s Mitchell says that in recent days the rotation from growth stocks to value stocks has “paused” in the US, as markets digest the outlook for potential rate changes.
Some investors are wondering if there might be buying opportunities if the war means growth is slower and rates rise more gently than previously thought.
Aberdeen Standard’s Lopez says: “It may be that if you see a significant slowdown in growth, that could have an impact on the type of companies that tend to outperform in those markets.”
For example, Lopez says that for cyclical stocks to outperform, they still need strong economic growth. “We have to rethink what the path is from here, and the path has changed in the last two weeks. [referring to military escalation].“
Given the steep declines in some tech and “growth” stocks this year, Lopez says there could be “buying opportunities” among established tech companies that are making strong profits.
Others, however, see little room for a rebound in tech-based growth stocks whose prices surged during the era of ultra-low interest rates.
Tagliaferro, a well-known value-style investor, doubts growth stocks will make a comeback and says he will remain defensive in his stock picking. “I don’t think that will be the story at all this year,” he says when asked about the possibility of a rebound in growth stocks.
White Funds Management chief executive Angus Gluskie also thinks a resurgence in growth stocks is unlikely, stressing that interest rates are likely to rise further, albeit at a slower pace than previously thought. . ” he says.
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