Dented Not Derailed

The Russia-Ukraine war adds to near-term growth risks for the global economy and will likely keep inflation elevated for longer. While uncertainty is high, we believe equity markets are oversold and should recover if tensions ease in the coming months.

Key market themes

Russia’s invasion of Ukraine creates near-term risks for markets, but also casts a shadow over the longer-term outlook. The immediate threat comes from high energy prices, rising food prices and disrupted supply chains. The longer-term issues are a new cold war between Russia and the West, increased military spending and a further blow to globalisation. The war is a defining moment for Europe, which now needs to unwind decades of Russian energy dependence, accelerate its sustainable energy transition and rebuild military capability.
We believe the invasion will lead to lower global growth – with Europe taking the largest hit – as well as higher inflation. Even so, we think global growth could still be above-trend this year, provided the hostilities ease and global energy prices stabilise. While above-trend growth should support equities over bonds and cash, the war in Ukraine has created significant uncertainty, which likely means more market volatility.

We expect the U.S. will be among the most resilient economies to the conflict globally, given its energy independence and lower share of commodity consumption in GDP (gross domestic product). In addition, with interest-rate hikes now priced for every remaining U.S. Federal Reserve (Fed) meeting in 2022, we see this as a maturing risk factor to markets.

In Europe, the invasion of Ukraine has created significant uncertainty, with the main risk coming from energy prices – due to the region’s dependency on Russian natural gas and oil. A decision by Russia to shut down energy exports to Europe, or by European governments to boycott Russian energy, could trigger a recession. In our view, this seems unlikely, given Russia’s need for oil and gas revenues and Europe’s reliance on Russian energy – but we don’t think it can be ruled out. On the other hand, a short-lived shock to energy prices could lead to a recovery in European economies during the second half of 2022. This outlook would likely allow the MSCI EMU Index – which reflects the European Economic and Monetary Union – to recover.

The UK economy began the year with strong momentum, but it is likely to slow due to Bank of England tightening, high energy prices from Russia’s invasion of Ukraine and a planned national insurance levy increase (effectively a tax hike) to help fund the National Health Service. Despite economic concerns, the FTSE 100 Index has been one of the better performing equity markets this year. The index has high exposure to commodity prices and financial stocks that benefit from higher interest rates, and almost no exposure to under- pressure technology stocks.

In China, the government recently announced an above-expectations 5.5% GDP growth target for 2022. The country’s economy, however, continues to face pressures, and we expect that significantly more stimulus will be required to get close to the growth target. In addition, COVID-19 still poses a challenge to the Chinese economy, mainly due to the government’s zero- tolerance approach. While we still expect above-trend growth in Japan, the conflict in Ukraine and China’s recent lockdowns have added to headwinds. As an
importer of energy products and food, Japan is exposed to higher prices from the war.

In Australia, the labour market has tightened over the last three months, but wage growth has remained reasonably contained. This allows the Reserve Bank of Australia (RBA) to be more patient than many of its global counterparts. While we think market pricing for RBA interestrate rises is too aggressive, we do expect the central bank to raise its rates at least once this year.

We believe Canada stands to benefit from rising commodity prices, particularly energy prices. Our 2022 GDP growth forecast is unchanged at 3.8%, although accelerating commodities inflation adds uncertainty to this outlook. We think this will make the Bank of Canada more measured in its approach, potentially hiking an additional three to four times this year.

Slowdown in European growth

We’ve lowered our forecast for Europe’s 2022 GDP growth rate to 2.5%, due to impacts stemming from the war in Ukraine.

U.S. growth forecast

We think the conflict in Ukraine is unlikely to reduce U.S. growth by more than 0.5% this year – and forecast a GDP growth rate of 3.0% in 2022.

Fed rate hikes

Markets are expecting six more Fed rate hikes this year. We agree the Fed will keep hiking policy rates back toward a neutral setting of around 2.25%.

China stimulus

We anticipate there will be more easing measures from the People’s Bank of China in 2022, including an interest rate cut, and more fiscal spending in the form of infrastructure spending.

ECB monetary policy

We believe the European Central Bank will focus on growth risks more than inflation this year. While markets expect two rate hikes in 2022, we think it’s likely that rates will remain unchanged or only rise once as higher energy prices slow economic growth.


Equities: Small preference for non-U.S. developed equities

One of the key things we always do, is to get clients to examine a 360 degree approach to financial planning, to consider things they may have dismissed in the past, or may not be aware of.

In Matt’s case we examined some factors he hadn’t considered. These included changes in his health, possible inheritances for him; and where the £80,000 goal came from and how it was calculated. We also ensured that Matt understood that we were creating a life plan and not something that only covers the next few years. Being used to dealing with shorter term business plans, this was a cultural change to Matt’s thinking, but one that paid off extremely well.

One thing that always concerns us, is that Matt had contacted some larger advisers that had him thinking he would need to use a myriad of products under different jurisdictions. All because they only ever think about how much client’s have to invest, without ever stopping to try to understand what their objectives and goals actually are.

The nitty-gritty

We work net of tax, not gross of tax. Which means that one of our focuses is to always limit the amount of tax you pay on the top line income figure. We’re always surprised how many clients aren’t focused upon this before they come to us. Many people don’t realise just how valuable using all available allowances are and how they can help to preserve wealth, by reducing how much tax is paid.

After the sale of his business and dealing with his divorce, Matt was left with £4M. His main concern was that this wasn’t enough to retire and achieve all the goals he’d set out.

As he had very few investments before retirement, other than his business and pensions, he was ignorant as to what other opportunities were available and what significant returns they could achieve. As this was a new area for Matt, the first thing we suggested was that he immediately set aside two years worth of income, in order to provide him with the psychological safety net of knowing that he was financially stable whilst his chosen investments became established.

Then we turned to his property ambitions. In order to enable him to supercharge his property ambitions, we showed Matt how he could boost his existing pension via his Limited Company, in order to provide significantly more funds for commercial property projects he had in motion and on the horizon.

As far as Inheritance Tax Planning was concerned, it was far easier than Matt had anticipated to ensure that his children avoided a large IHT bill, whilst he still enjoys the benefits of his wealth. Where previously Matt had thought that the only options open to him were to give away money, which he was not prepared to do just now as he wants access to his own capital.

The future is plane sailing

Despite the Ukraine war, we have a small preference for non-U.S. developed equities to U.S. equities. Provided the hostilities subside, above-trend global growth should favor relatively cheaper non-U.S. markets.

Fixed income: Mixed valuations for government bonds

We see government bond valuations as mixed after the recent selloff, with U.S. bonds now fairly valued and Japanese, German and UK bonds still expensive. Yields will face upward pressure from continuing inflation pressure and central bank hawkishness. One positive we see is that markets have fully priced hawkish outlooks for most central banks, which should limit the extent of any further selloff in government bonds.

Currencies: U.S. dollar could weaken if hostilities lessen

The U.S. dollar has made gains this year on Fed hawkishness and safe-haven appeal during the Russia/Ukraine conflict. We think it should weaken if hostilities subside, and if lower inflation outcomes later in the year lead to less Fed tightening than markets currently expect. The main beneficiaries in this scenario are likely to be the euro – which has become more undervalued – and the Japanese yen, which has weakened on commodity price inflation and China growth concerns.