Conflict in Europe: Our stance

Ukraine

The events unfolding in Ukraine first and foremost provoke our deepest sympathies for the human suffering that is being brought about.
 
Although we were all aware of Russia’s military build-up on the Ukraine border over the past couple of months, and we witnessed the frantic last-minute political endeavour by the West to persuade Vladimir Putin to stand down his army, it has still come as a huge shock to see Russia take such aggressive military action on another sovereign state. 
 
Few people really thought the peace between nation states in Europe enjoyed for more than 75 years would be shattered so quickly and easily. We can’t help feel we have been blind to the ongoing reality of geo-political tensions that clearly continue to dominate the underlying motivations of the world’s major powers. 
 
Only recently, I read Tim Marshall’s excellent Prisoners of Geography, published in 2015, which clearly explains how President Putin views the countries on his western border and clarifies his stated intention to face down NATO and EU expansion while re-uniting former USSR territories with Russia.
 
We would have hoped that a diplomatic solution to geo-political tension would have prevailed, in the belief that underlying self-interests for all parties would have ensured rational behaviour.
 
Stay calm and carry on
The simple and obvious truth is that we simply cannot plan for such cataclysmic events. We cannot stay in cash for the long term as this only guarantees that our money loses its purchasing power. We cannot time the market as we don’t have foresight.

All we can do is stay rational in ourselves, try not to panic with knee-jerk reactions, and see how events unfold.
 
We are following events very closely and have now listened to half a dozen webinars since the start of the conflict from the strategists at a number of investment houses. They all prepare a base case for the ‘macro’ situation and consider the likely outcome for the economy and stock markets.
 
The first thing I would say is how fluid the situation is in Ukraine: The narrative is changing daily, with last week’s expected outlook starting at a ‘short war and full annexation of Ukraine within days’ to an ‘unwinnable war lasting many years’ and now to possible ‘rapid de-escalation’ of the conflict as Russia has unveiled its terms for a resolution.
 
As Tim Marshall mused, Putin may wantto take Russia back to the days of the Soviet Empire but is it really his ambition to annexe the whole of Ukraine and maintain a crushing authoritarian regime? More likely he will seek to consolidate the key area of Crimea and stop Ukrainian membership of NATO and the EU.

Putin will be aware of General von Clausewitz’s often quoted military aphorism:
 
“If there must be war, victory lies not in defeating an army but in securing the willing submission of a populace. Stability, not a passing triumph of arms, is the test.”
 
I would humbly suggest Crimea and neutrality of Ukraine are his probable target, not full annexation, and recent Russian statements indicate a willingness to start negotiations, which has to be positive.
 
What can we expect?
It is still too early to make big assumptions on base case macro outcomes. But we can say with certainty that the cost of living is going higher for the obvious reason of energy shortage.

Russia accounts for 12% of all global oil output and 17% of natural gas output. Europe is extremely reliant on Russian energy and cannot easily replace it in short order.
 
Russia and Ukraine together supply 30% of the global output of wheat. Supplies are going to be disrupted, hence the huge increase in prices that have knock-on effects with other goods such as animal feed and fertilisers.
 
Inflation worries were already a concern prior to the outbreak of conflict due to strong consumer demand and supply chain disruptions following the Covid pandemic, so the conflict is adding to pressure on prices. The net effect will impact consumer confidence and therefore demand, potentially curtailing spending, so we are seeing more risk of a recession.
 
The last time we saw an energy crisis-induced recession was in the 1970s. A combination of oil embargoes and higher prices led to what is now referred to as ‘stagflation’ – recession and inflation with resulting higher interest rates to combat rising prices.
 
Two factors mitigate this risk: First, consumer demand remains strong and household balance sheets are generally in a healthy financial position coming out of the Covid pandemic; second, central banks today are far more supportive for the economy than they were 50 years ago. They will be more concerned with demand than inflation, so while interest rates are likely to go up through the year, they will still remain historically very low.
 
We would conclude that while a recession is possible, it is not yet a certainty.
 
It is too soon to say what the eventual economic outcome will be. All we can say is that uncertainty has increased and in this environment markets display a lot of volatility.
 
What are the implications for portfolios?
Our advice continues to be to sit tight with your investments. My experience is that selling in a crisis is the worst decision an investor can make. When the situation appears really bad, history suggests it is a buying opportunity. So I don’t mind sharing with you that I added to my portfolio of UK shares last week. Maybe I have bought too soon but one of the holdings was a brick manufacturer, and I am confident we will still need bricks in my lifetime.
 
Emma Mogford, manager of Premier Miton UK Equity fund, was extremely positive when we spoke to her last month on the long-term outlook for the company and was adding the shares to her fund at higher prices in 2021. The fund consists of good quality large UK companies trading at very reasonable values, with attractive dividend yields. It is funds like Emma’s that we recommend within our portfolios and highly likely that you are holding some of this.
 
We have been allocating to ‘value’ themed funds for the past few years and we believe that buying at the right price is the key to a successful investment, so we are comfortable with the current equity funds.
 
Diversification and long-term value
All our portfolios are diversified, which reduces the exposure to any one asset class. Inflation-linked gilts are another important holding as they have a very good long-term track record as an inflation hedge. We usually include a sizeable allocation to inflation linkers and they are currently enjoying positive returns.
 
We have kept out of long-dated Government bonds which tend to underperform in an environment of rising interest rates. Instead, we have been invested in short-dated and strategic bonds which are less affected and have a better potential to hold their value.
 
Many portfolios will also be benefiting right now from an allocation to ‘real assets’, including commercial property, gold – either directly or through gold mining funds – and commercial forestry. They all add diversification by way of a tangible asset that generally does not correlate with traditional equities and offer a proven inflation hedge over the long term.
 
To summarise, as dreadful as the situation is, it will improve. We don’t advise selling assets, despite the volatility and worry. The history of long term investment proves that asset prices will recover.
 
If you would like to chat through your portfolio or circumstances please do not hesitate to call either David or myself. We would be very pleased to hear from you.