Asset Allocation – Should you shift out of risky assets?
Let’s bring it down to the point: there are three ways the Russian/Ukrainian crisis will unfold:
- A rapid de-escalation,
- An entrenched conflict over time, or
- A wide-spread crisis with other countries being involved.
Here is our take on the issue. As of last Friday close, equities haven’t really suffered much. In fact, they continued their slow correction towards a strong support line. As we all know, a support line is just a technical indicator. In this particular case, it doesn’t really apply, as the past conditions were different from what we are going to see going forward.
On the other hand, very classic assets such as commodities (oil, gas, corn, maize, and minerals, amongst others) have experienced a massive price hike.
As of now, ‘stagflationary’ risks are predominant. The most likely scenario is an EPS and Sales Growth reduction. This occurs on the back of a higher and lasting rate of inflation. The fact that input prices (oil, gas, materials, corn, etc.) have taken the elevator doesn’t spell any rapid harmonization. Based on standard valuation models, equity markets could be considered “fairly valued”, but with the crisis unfolding, they are most likely still somehow overpriced.
Statistics show that each time energy prices surged by more than 50 percent above the long-term moving average, a recession followed. While the world is less dependent on oil and gas than in the past, crude oil still accounts for approximately 3 percent of global GDP and is one of the most important commodities in the world. Petroleum products can be found in everything from protective equipment, plastics, chemicals, and fertilizers through to healthcare products such as aspirin, consumer staples, discretionary such as luxury products and clothing, as well as alternative energy enablers like solar panels.
Yet, statistics clearly also pinpoint that geopolitical shocks tend to be short-lived and trigger average market corrections of around 10 percent. Also, markets tend to strongly rebound from the sell-off level once a resolution has taken shape.
Let’s look at the possible macroeconomic impact of scenarios that can unfold in the coming weeks:
| De-Escalation | Entrenched conflict | Wide-spread Crisis | |
| Probability | 40 % | 40 % | 20 % |
| Key identifier 1 | Ceasefire | War of attrition | Spillover to EU countries |
| Key identifier 2 | Commitment to negotiations | Heavy causalities on both sides | Full scale disrupted energy supplies |
| Key identifier 3 | End to some punitive sanctions | Sanctions on Russia to remain in place | |
| Growth | Above trend | Recession in Europe | Global recession |
| Inflation | Inflation declining | Inflation to stay high for longer | Lacking consumption to an oversupply of goods, which in turn leads to lower prices |
| CB Policies | Stay on course | ECB to stay on hold FED to process as planned | Renewed QE and other facilitating policies |
| Market expectations | EY: +10 to +15 % | EY: 0 to -5 % | EY: -30 % |
| EPS expectations | EPS Growth: +10 % | EPS Growth: -5 % | EPS Growth: -25 % |
| Interest rates | UST 10Y: ~2.2 % | UST 10Y: ~1.5 % | UST 10Y: ~0.25 % |
| Key performer 1 | Equities | Commodities | 30Y Government Bonds |
| Key performer 2 | Cyclical stocks | Quality stocks | Government Bonds (Australia, Japan, Southeast Asia / ex China) |
| Key performer 3 | US, EMA | US Equities | Swiss Franc |
| Currencies | Euro | USD | Swiss Franc |
With the probability ratio being between de-escalation and entrenched conflict equally, taking the right investment approach is close to a binary call. Given this, it is opportune to revisit the maximum expected risk one can stomach. We, however, would not recommend panic and taking steps to adhere to a black-swan scenario.
Looking through the conflict, one can expect the following:
- While the pandemic is “managed” as of now, the present crisis might impact, in the short-run, consumption especially in leisure, travel, and entertainment. The shift from above average consumption of durable goods back to services should tough continue,
- The impact of higher energy prices will have a negative impact on discretionary spending, and regional recessions should be expected,
- Economic growth will decelerate over time,
- Inflation will stay high; we estimate that the peak in US-inflation is behind us, while the rate of inflation in the EU will peak in Q3/2022,
- Equities are expected re-rally and to deliver positive returns over 12 months,
- Asian markets should remain mostly unaffected. Regional markets are still benefiting from pandemic benefits,
- Commodities are expected to trade higher for most of the year.
Over to top!
It is too soon to grasp what the long-term repercussions will be for Europe. But, in the near and medium term, all this looks to reinforce the European Union and its internal collaboration in an ever-faster manner. After all, it looks as if the Union can only make progress during times of crises. While in the short-term any ramifications are negative, medium term, we clearly see a rebound and a stronger market in Europe.
Short-term investment stance
The effects of sanctions, both directly and through consumer and business confidence, will make it difficult for economic growth to re-accelerate and corporate earnings to rise as rapidly as they did through the COVID pandemic.
Our original view was an assumption of an ongoing economic growth as the latter was progressing from products to services. The most recent events have diminished the probability of further economic progression. This occurs on the back of limited Central Bank action. Yet, once again we want to highlight the fact that most geopolitical shocks are rather short-lived, and any sign in resolution is expected to make markets rebound massively.
Given this, while we are not committing to any new engagements, we continue to monitor new elements and how they unfold. Only a spillover into Europe would make us to disengage step-by-step from risky assets.