The current Russia/Ukraine crisis has thrown global financial markets into turmoil. Across the globe it is exacerbating current inflation concerns. And here at home, despite Australia having little direct exposure to exports from Russia and Ukraine, its impacts are real and can’t be ignored.
Given Russia’s significant share in resources production, prices across oil, gas, coal, and precious metals continue to rise, introducing a new, perhaps more complex, level of uncertainty into global markets.
The tensions have contributed to rising volatility in the Australian share market with trading at one point reaching an 18-month low. Markets have recently recovered as expectations of a negotiated settlement emerge. Despite Australia’s abundant energy resources, its fuel reserves are lacking compared to its global counterparts with stockpiles dwindling by the day. Consumers are now experiencing the effects of a commodity price shock, with global oil prices sitting at their highest level in more than a decade.
Ongoing sanctions against Russia have placed further strain on supply chains, already weakened following the pandemic. This will likely result in long-term changes to trade flows, with the impact of increased prices slowing economic growth and contributing to rising inflation.
Macro outlook
As central banks continue to unwind monetary policy and withdraw stimulus, a slowdown in near-term growth is imminent, potentially triggering a stagflationary recession.
For now, central banks are on track to continue their path to tightening, with economists expecting the Reserve Bank of Australia to increase rates in 2022. And, after the Federal Reserve’s rate hike in March, the market is pricing in six more hikes this year. We would expect central banks to retreat on this only if there is a major escalation in the conflict or if evidence of recessionary pressures start to appear.
Overall, it paints an unsettling picture for markets, but despite risk assets falling, there are few signs of panic or liquidity stresses. A short-term resolution, like a ceasefire or evidence that the crisis is not deteriorating further, could result in a rapid rebound for markets.
And though there is no single strategy or market correlation for super funds to rely on, there are some key measures to consider for asset-owners looking to protect their portfolios against increasing volatility.
Keep calm and don’t overreact
While it is possible to test scenarios based on potential outcomes, the reality is that it is difficult to predict how impactful a geopolitical crisis may be at the onset. Despite the crisis significantly increasing downside risks, the growth outlook is still moderate, and the backdrop of strong economic growth heading into the conflict should be enough to avert an outright recession. However, it is likely that inflation will peak later and at much higher levels than anticipated prior to the crisis.
Attempting to position portfolios in response to geopolitical events at this stage in the crisis is more likely to lead to the selling of risk assets after markets have already discounted the event, potentially missing inflection points and resulting in significantly reduced returns.
History has shown us that sell-offs driven by geopolitics can be so short-lived that even clairvoyant investors may struggle to time them. A well-diversified investment strategy, and a restrained approach to responding and reacting to short term events as they occur, rather than reacting and positioning portfolios based on news of the day, can protect funds against potential losses.
And focus on your Fixed Interest portfolio
Most importantly, it will be the robustness of your fixed interest portfolio that will determine how well you will fare through these times. Investment returns for long term asset-owners have been driven by equities for the past couple of years, and volatile markets will expose those strategies that don’t have a diversified approach to their fixed interest portfolios. A blend of traditional strategies for downside protection with high quality credit strategies that keep pace with inflation will add robustness to your portfolio. Consider the use of private markets, low duration and absolute return approaches, emerging markets and higher yielding strategies.
Although much is still unknown, these fundamental shifts in geopolitical order will continue to impact markets and influence investment decisions for some time to come. By adopting a measured approach, combined with due diligence and a robust risk management toolkit, super funds can protect portfolios in the face of volatile markets.
Sue Wang is senior fixed income portfolio manager, Mercer. She will be chairing a session and speaking at Investment Magazine’s Fixed Income and Private Credit Forum on April 6. To register and see the agenda, click HERE.
