Reacting to news of the Russian invasion of Ukraine, Trevor Greetham, RLAM Head of Multi Asset, said:
World leaders were warning there could be a full scale invasion of Ukraine, but the markets were clearly not fully pricing in yesterday's outcome, as evidenced by the 50% drop in Russian stock prices, a bigger crash than that suffered in Russia when Covid first hit.
We're monitoring the situation closely, but not making any asset allocation changes as the multi asset funds we manage were already well positioned for this outcome due to their broad diversification and large overweight in commodities.
Equity markets have borne the brunt of the sell off and volatility is likely to remain high for the next few days or weeks as the situation in Ukraine develops. However, with investor sentiment at its most depressed level since March 2020, the short term risks could soon be to the upside as we reach and pass the period of greatest uncertainty.
As things stand, we’d most likely use a rally in stocks to reduce our position from a small overweight to neutral or underweight. The business cycle is stuck in stagflation with growth slowing and inflation rising. If anything, higher commodity prices could make central bank interest rate rises more urgent. This is a poor backdrop for stocks, especially the more expensive sectors and regions like technology and the US market.
The Ukraine crisis underlines the value of broad diversification as a way to improve resilience to shocks. Our multi asset funds include commodities, commercial property, and a larger allocation to the less expensive UK equity market, all areas performing well or relatively well during this more inflationary period.
Melanie Baker, RLAM’s Senior Economist, added:
The Ukraine situation raises risks to the global economic outlook through the potential impact on markets, business confidence and inflation. Much of course depends on how events unfold from here, but for now, uncertainty on the outlook has risen and the short-term effect looks set to be inflationary.
Two of the key channels of potential impact from the Ukraine situation for major developed economies work through markets. First, via commodity prices - especially through the impact on energy prices and the impact that then has on inflation and, as a result, consumer spending. Second, the potential impact on financial conditions, reflecting overall market movements, and relatedly the impact on business confidence.
There's potentially some two-way tension in terms of what that means for central banks. They might decide to delay monetary policy tightening plans in light of uncertainty around the impact on the economy and markets - and with the path of this crisis unclear from their perspective. Arguably, events work against the case for a 50bp rate rise from the Fed in a few weeks’ time.
If we do see a relatively sustained jump in energy prices, that may mean that central banks need to step up tightening more quickly beyond the near-term. Normally such a supply-driven energy price shock could be considered likely to damage growth and ultimately deflationary. However, it's occurring against a backdrop of already higher inflation expectations and pay pressure making it much harder for some central banks to take a step back.