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Please see article below from Invesco received late yesterday afternoon – 03/03/2022.

Henley European Equities Team Our thoughts on the Ukraine/Russia conflict – February 2022

• The immediate equity market reaction to the Russian invasion last Thursday was risk off.
• There have clearly been inflationary shocks, and so we expect increasing pressure on the ECB to act.
• The introduction of new sanctions over the weekend, namely excluding several Russian banks from SWIFT and restricting the Russian Central bank access to some of their international reserves, has caused a fresh bout of volatility impacting the banking sector in Europe.

How the market responded to rising tensions last week

The immediate equity market reaction to the Russian invasion last Thursday was ‘risk off’. ‘Risk off’ meaning, understandably, selling business with direct exposure to Russia and pending sanctions. However, it also meant selling banks and cyclicals more generally.

When the market has been shocked in recent years: Brexit, Trump, Covid and now Putin, share price reactions are Pavlovian. Banks are financially leveraged and cyclically exposed, so they sell-off with ‘risk-off’, and then quickly the market backfills the fundamental rationale.

Yesterday, the explanation was the risk of slower growth but also less rate potential. And so, whilst banks sold off, long duration equities (‘Quality and Growth’) performed strongly. The risk of higher rates being off the table was fuelled by ECB member Holzmann being quoted as having said, “Ukraine conflict may delay stimulus exit”.

But what he actually said was, “It’s clear that we’re moving toward normalizing monetary policy, it’s possible however that the speed may now be somewhat delayed.” The context of which being that he gave a hawkish speech on Wednesday, and then was asked for an update in the wake of the shocking news of Thursday’s invasion.

What’s undisputable is that looking at the market behaviour, investors were clearly more emboldened post his comments to buy more duration equities as a result.

Is this the right reaction?

We believe this reaction may be short lived. Whilst there is a long list of unknowns resulting from Russian actions this week, one of the few likelihoods is yet more inflationary pressure. Our basic point is ‘transitory inflation’ becomes plain old inflation with longevity and actions in Eastern Europe have again pushed commodity prices higher.

Ahead of the conflict ECB policy was set based on inflation returning to below trend (<2%) in 2023, however, to our minds the assumptions left no more room for inflationary shocks. Given our belief EU wages have upside risk to the ECB’s 3% (and now events in Ukraine), there have clearly been inflationary shocks. So, we expect increasing pressure on the ECB to act: European monetary policy remains a risk to the upside.

Need to think about duration and beta

As we’ve mentioned in previous comments, the impact of higher interest rates is a risk to the valuation of the more expensive parts of the market: European Quality.

Of course, the impact of the Ukraine crisis is also a threat to growth rates – and that impacts cyclicals. Hence, simply buying the ‘Value’ factor becomes more challenging after this week also. We believe the solution lies not in two dimensions of ‘Value vs Growth’, but rather the third dimension of ‘High vs Low Beta’. Whilst we remain nervous of the crowded positioning in high beta Quality (e.g. Technology, Payments, Luxury), where valuations are high, we think there are areas of defensiveness at reasonable valuations: Telecoms, Insurance, Food Retail, Big Pharma and Utilities.

We believe these are the areas to transfer risk to this week and note they sit within the Value factor buckets. Within cyclical value there remain some pockets of defensiveness to the specifics of this week through exposure to Oil and Resources. Where we are incrementally more cautious is consumer discretionary.

The need for a balanced portfolio

Our conclusion is we think balance is key. We think being heavily skewed to the red quartile is risky. Our debate is our weighting to the top half and how much events of this week mean we should move to the low beta side of the allocation.

How to think about banks given the financial sanctions introduced this weekend

The introduction of new sanctions over the weekend, namely excluding several Russian banks from SWIFT and restricting the Russian Central bank access to some of their international reserves, has caused a fresh bout of volatility impacting the banking sector in particular. In the following paragraphs and charts we provide our thoughts on the market’s reaction.

The below chart is from financials specialist research house, Autonomous. They have used the Russian debt crisis in 98 as the basis for impacts when banks lost 60% of their exposures. Note since the late 90s, EU banks exposures to Russia are smaller with, for example, French banks 11% exposed vs 35%. We should also note that assuming 60% of assets are gone is a worse outcome vs walking away from the region – handing Russia back the keys to the assets. However, in this effectively worst-case scenario you can see how much market cap has already been destroyed vs exposure.

Another key point to think about with EU banks is they are long provisions today. Remember, due to the Covid uncertainty, EU banks provisioned their risks aggressively and thankfully because of the extreme fiscal and monetary measures taken, these provisions look overstated. That means banks have a stock of provisions they could be releasing – which can now be redeployed to Russian exposure and thereby absorbing losses for shareholders.

From the list above, the bank with largest risk to Russia is UniCredit. Whilst there is headline risk, we note UniCredit is holding 1yr of normalised provisions in precautionary provisions today (scope 1 & 2). In earnings terms Russia is c3-5% of group only and the assets are well capitalised (18.8% CET1 vs 10% required). Using a 1998 losses analysis means a loss of 90bps CET1 however, walk-away and that loss is estimated at -50bps only (given this would also reduce RWA). This compares to last reported CET1 of 14.1% and co target of 12.5-13% so they have the means to absorb a worst case scenario without fresh equity: this is not a repeat of the GFC.

To that point it’s worth highlighting what’s happening in the debt markets vs equity. German 10Y bond yields have moved lower, but as per the chart below we’re at +20bps yield today vs -40/-60bps for much of 2021. Likewise the 3month Euribor (second below) is far from 2021 levels which is where the European banks have retrenched back to.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke

04/03/2022

Please see the below Daily Investment Bulletin, received by Brooks Macdonald late yesterday afternoon:

What has happened

The risk off theme continued in markets yesterday with higher energy prices weighing on investor risk appetite. 2022 interest rate expectations also fell yesterday as bond markets priced in a more cautious central bank backdrop given the Ukraine crisis.

Bond moves

Europe saw some of the most dramatic shifts in interest rate expectations yesterday with the bond market now pricing in only a c. 20% chance of even one rate hike in 2022. This changing narrative led to further declines in European sovereign bond yields with the 10-year bund yield now back in negative territory after declining by 30bps in the last week. UK markets have seen similar moves with the 10-year gilt yield now at 1.17% after being almost at 1.5% a week ago. Given the inflationary impact of higher energy prices and the second order inflation generated by sanctions reducing trade, the bond market feels on a knife edge but for the time being the risk-off of geopolitics is trumping the inflation hawks. The ECB meeting is next week so we will have official confirmation of how Ukraine is impacting the central bank’s thinking in just a few days. Today sees the first of Fed Chair Powell’s Congressional testimonies so market focus could move from the ECB to the Fed today.

State of the Union

President Biden’s State of the Union address began with a message of support for the Ukrainian people alongside a reiteration that there would be no US military deployment unless a NATO ally was threatened. The speech focused on the administration’s economic plans with a particular focus on easing the current inflationary pressures. Biden detailed a number of policies including supply side expansion, removal of anti-competitive structures, productivity improvements and the release of oil form the Strategic Petroleum Reserves.  The President also outlined his proposals for additional corporate taxes and the closure of tax loopholes for richer Americans.

What does Brooks Macdonald think

The huge swings in the bond market have helped cushion the financial market impact from the Ukraine crisis. Central bank speak over the coming weeks (and the meetings themselves) remain critical however as if the bond market concludes that central banks still side with the hawkish inflationary narrative the fall in bond yields, which has offset some of the severity of the market impact, could reverse.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Andrew Lloyd DipPFS

03/03/2022

Please see below an article from J.P. Morgan which was published on 25/02 and received yesterday (28/02) afternoon and details their views on the Russia/Ukraine conflict and the potential wider impact this could have on the West:

The human toll of any conflict is devastating and events unfolding in Ukraine are deeply upsetting. This note seeks to answer the economic and market questions we are receiving.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Please keep safe and healthy.

Carl Mitchell – Dip PFS

Independent Financial Adviser

01/03/2022

Please see article below from Quilter Investors received late yesterday afternoon – 23/02/2022

Markets tumble as unmarked Russian tanks rumble into Ukraine

Global equity markets recoiled late on Monday (21 February) following Russian President Vladimir Putin’s decision to send armoured divisions into Ukraine.

In the latest round of political brinkmanship in the Ukraine theatre, Mr Putin took advantage of Presidents Day, a federal holiday in the US, to announce on Russian television that the country now officially recognised the two breakaway regions of Donetsk and Luhansk in eastern Ukraine as independent entities.

The leaders of these breakaway regions subsequently appeared alongside Mr Putin in the Kremlin signing a decree recognising their independence. Later that day a number of conspicuously unmarked tanks were reported as rolling through the streets of Donetsk.

Russian markets were still trading when Mr Putin announced his decision following calls to the leaders of Germany and France. The rouble subsequently plummeted north of 3%, while Moscow’s dollar-denominated RTS index plunged more than 13% on Monday with the rouble-based MOEX Russian index suffering its worst day since the March 2014 Crimean annexation, down 10.5%. Elsewhere, the yield on Russian 10- year government bonds (known as OFZs) surged to 10.6% on Monday.

Meanwhile, western markets began to react to the heightened tension on Tuesday morning with oil prices pushing on toward $100 a barrel amid supply fears. After initial ‘softness’ western markets proved quite resilient as investors clearly anticipated limited sanctions at this early stage.

Asian markets fared worse, impacted by both the heightened geopolitical tensions and anxiety over fresh Chinese regulatory scrutiny.

In response to the moves, the US imposed immediate business sanctions on the breakaway regions but held off from imposing the agreed sanctions planned by the US and its European allies in the event of a full-scale invasion of the Ukraine. Even so, more US sanction were expected on Tuesday while Boris Johnson chaired a meeting of the UK’s emergency ‘Cobra’ committee to discuss UK sanctions against Russia.

Likely outcomes…

Coming as it does on the back of a slowly unfurling global energy crisis and record levels of western inflation, driven in no small part by soaring energy prices, Mr Putin’s gambit has succeeded in garnering the political attention he has always sought for his nation.

There now exists a broad spectrum of possible outcomes, each dependent on the Russian president’s next move. The sanctions announced so far entirely lack bite which may have emboldened Russia’s leader. However, the situation will quickly change with potentially harsh international sanctions set to be imposed against Russia in the event of a full invasion.

Even so, Russian boots are now that much closer to Ukraine – which Mr Putin on Monday described as ancient lands of Russia – ratcheting up tensions on the ground and internationally.

Energy worries

In theory, it seems unlikely that an escalation in the conflict will lead to Russia ‘turning off the gas’ to Europe as such exports broadly account for around a third of Russian GDP. But although Russia continued to supply energy to the West throughout the cold war years, the situation is quite different today. Russia is no longer a rickety soviet state dependent on western hard currency.

Mr Putin’s actions have already helped push operating profits for Russia’s primary player, Gazprom, to $90bn this year, more than four times what they were in 2019. Meanwhile, energy sector analysts estimate that (client penalties aside) a complete shutdown of gas piped to Europe might cost up to $230m a day in lost revenues for Gazprom at a time when Russia holds a huge war chest of some $630bn in central bank reserves.

While Russia could afford the lost revenue, the bigger price for Mr Putin might come from jeopardising projects like the Nord Stream 2 gas pipeline which, although completed in September, still requires certification by Germany and the EU – a process that was halted by German Chancellor Olaf Scholz on Tuesday following the recognition of Donetsk and Luhansk. Russia’s still fledgling supply contracts with China might also suffer if it proves to be an unreliable partner.

Whatever Mr Putin decides to do, he’ll need to move fast as Europe’s energy demand drops by 40% or so come spring, which means he loses the added leverage he currently enjoys.

Broader changes

Regardless of the eventual outcome, the latest escalation in the Ukraine suggests that NATO troop numbers in Europe will need to rise in Eastern Europe along with national defence spending budgets, which has potential tax implications down the line.

Meanwhile, it remains to be seen if the rising levels of geopolitical risk in markets cause central banks to re-think the pace of their planned hiking cycles to help support markets. Some analysts are already pricing in more restrained rate rises in Europe this year.

Mr Putin has chosen his opening well with western markets already straining against record inflation and the interest-rate rises that must now quell it. An energy price shock just as central banks are raising interest rates could derail investor sentiment and the outlook for energy-intensive companies in particular.

Although we expect to see the S&P Index re-testing the lows of 24 January, we suspect the disruption caused to equity markets will be relatively brief in line with history (see below). In the meantime, our portfolio managers are looking for opportunities to capitalise on the current volatility, possibly through derivative contracts, which can offer both investment gains and protection against market losses.

A history of conflict

Historically, western markets have always been relatively sanguine towards Russian territorial aggression. As the chart inset illustrates, when Russia annexed the Crimea from Ukraine in 2014, markets were quick to dismiss the interruption.

This time, the political, inflationary and energy supply consequences of further escalation are likely to result in a more pronounced response from markets but they will quickly re-price to the new norm, whatever that might happen to be.

As always, the key message for investors is not to get sucked in by the noise. Over the medium to long term, the broader landscape of company earnings and the strength of economic growth will far outweigh the importance of ‘conflict politics’ for investors. Currently, even including its huge energy bills, total trade with Russia accounts for just 1.5% of EU GDP and only 0.5% of US GDP.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke

24/02/2022

Please see below a special market update from Tatton Investment Management received yesterday – 22/02/2022.

Russia’s aggression towards Ukraine reached a new level overnight after Russia’s president Putin officially recognised the two self-proclaimed separatist ‘republics’ in Ukraine’s Donbas region. Most importantly, he ordered official troops to move in for what he declared to be ‘peacekeeping operations’. This has triggered the West to announce a stepping up of sanctions. Meanwhile Ukraine’s president Volodymyr Zelenskiy said Putin had merely “legalised” troops already present in the republics.

At the time of writing on Tuesday the media reaction to the escalation of the conflict has been more alarmed than that of stock and other asset markets. This ties in with what we published last week about historical observations of the impact of regional wars on stock markets. Price moves tend not to be particularly pronounced once hostilities have actually started. Indeed, downswings occurred when tensions were building up beforehand and hostilities have more often marked the beginning of a medium-term upswing in markets.

The explanation for this apparently uncaring market action is that economic activity beyond the area of conflict usually continues as before. However, in this specific instance, there is a risk of energy supply disruptions to the pan-European region in the form of Russian gas, or at least that energy prices will remain high for longer or rise higher than had been anticipated in 2022’s general economic recovery scenario. This would explain some of the recent weakness in stock markets as they had priced in further increases in the cost of gas and oil putting a dampener on the 2022 economic upswing.

We suspect that if Putin’s latest move had indeed constituted a full-on invasion of Ukraine – as some of the news media seemed to suggest – then the market reaction would not be as benign as it was this Tuesday morning, with only the price of oil and gas in Europe trading notably higher than yesterday.

The subdued market reaction tells us that there is a recognition or at least suspicion that with this latest move, Putin may have revealed his true goals/intentions in this conflict; namely, explicit control of the Russian speaking parts of the Donbas region after Russian supported separatists seized the area in 2014. A military protectorate may not be an outright annexation like the Crimea, but few would draw a distinction. This would be similar to the outcome of the 2008 conflict where Russia succeeded in turning the two Georgian regions of Abkhazia and South Ossetia into such military protectorates.

It also suggests that there is an assumption in markets that Putin has once again been successful in outmanoeuvring western interests and achieved his aim of extending Russia’s area of influence and control at an acceptable cost to his country. This assumption is based on previous indications by the Biden administration that they would not deem a move in the frozen conflict in the Donbas as a trigger for imposing the full force, of what would be very painful sanctions on Russia.

This relative market optimism is heartening, and some may even describe it as wishful thinking, given it is not at all certain that Putin will be content with what he has gained so far. Whether the US and European governments will indeed refrain from imposing significant sanctions and whether the Ukrainian government will accept Russia’s occupation of part of its rightful territory, rather than strike back is unclear. Its basis is the assumption of rational actors on both sides, which at a time when the pressures of the pandemic are easing should want to shy away from risking the economic recovery and contain the economic fallout to what is deemed an acceptable minimum.

Our view is that the above is a possible outcome, but that it is too early to expect this conflict to be beyond its peak. We recall that in the run up to Greece’s 2012 sovereign debt crisis there was also a widespread market expectation that political actors in Greece and the EU would act rationally from an economic point of view, and not let the situation deteriorate to the point where the Greek public no longer had access to their bank accounts. In the end, what was deemed unthinkable was allowed to happen in order to pave the way for a lasting resolution to the debt crisis.

We believe we are faced with a similar situation today, except that one of the main actors in the current conflict – President Putin – is much harder to gauge, even if it has to be said that up to now, in apparently achieving his aims he looks to have been clever and rational, rather than dogmatic or irrational.

As a result of the fluid situation, we are for the time being satisfied that our central investment position, aligned with a continued, albeit more gradual global recovery during 2022 remains sound in the prevailing political and market environment. However, should Russia aim for a significantly bigger landgrab than the already rebel occupied areas of the Donbas and/or the reaction of the Ukraine and the West’s sanctions become more severe, we will re-evaluate our investment portfolio positions. On the other hand, if Russia signals that they are content with what they have achieved, along the lines of ‘we believe our brothers and sisters in the Donbas are now save’ could trigger a genuine relief rally.

The situation remains fluid and uncertain, but as it currently stands, we are seeing an almost equal probability for our next move to be an increase in our pro-cyclical recovery position or a more defensive reduction in our overall risk exposure should the geopolitical situation deteriorate rather than improve from here.

Additional input from J P Morgan yesterday looked at the impact on markets of geopolitical events such as conflicts, war and 9/11. Generally, the impact was short term in nature and recovery typically quick.

In the circumstances you should remain invested and keep on regular monthly funding of pensions and investments. Be patient, look through the short term volatility and focus on your long term objectives.

My thoughts are for the innocent populations involved, hopefully we will still see a peaceful resolution.

Steve Speed

23/02/2022

Please see Brooks Macdonald’s Weekly Market Commentary below published yesterday (21^st February 2022):

Geopolitical risk continues to dominate the near-term investor narrative with the US describing a Russian invasion of Ukraine as imminent.

Equity market volatility continued on Friday as Ukraine risks ratcheted up and geopolitical uncertainty looks set to continue well into this week. Markets are fixated on the geopolitical risk within Ukraine, particularly as it could have, alongside severe human cost, a significant impact on inflationary pressures in continental Europe and the rest of the world. The imminence of US warnings over a Russian invasion of Ukraine gathered pace over the weekend with President Biden saying that significant volumes of intelligence pointed to the invasion starting in a matter of days.

The US and Russia are set to commence high level talks this week after a more constructive call between President Putin and President Macron.

A phone call yesterday between President Macron and President Putin sounded constructive, with both parties agreeing that a diplomatic solution to tensions in Ukraine was preferable. That said, the last set of calls between France and Russia established a Russian commitment to withdraw troops after the ongoing exercises in Belarus which appears to have now been reversed. The US and Russia have in principle agreed to a summit between the leaders but the US has said that such a summit would be conditional on Russia not invading Ukraine in the interim. The content for discussion at the summit will be set between the US secretary of state and Russia’s foreign minister on Thursday, with the implication that the high-level talks will talk place on Friday at the earliest. This likely sets the stage for another week of uncertainty as energy markets attempt to price in a binary outcome.

This week sees the publication of the Federal Reserve’s preferred measure of inflation as well as surveys testing the health of US consumption.

Meanwhile financial markets are also trying to assess the strength of the US economy and whether momentum is sufficiently strong to offset the demand destruction that would be caused by an aggressive tightening of US monetary policy. This week we have the US’s preferred inflation measure, Personal Consumption Expenditures (PCE), released on Friday which will add to the debate over whether the Federal Reserve will raise by 25 or 50bps in March. However, we will be paying as much attention to durable goods orders for a view of current demand for capital outlays and to consumer confidence and sentiment numbers that will help explain the consumer reaction to the inflation pressures of recent months.

Adding Ukraine tensions to a market outlook, which is already wrestling with several inflation and interest rate narratives, sets up a volatile backdrop. This week will give investors a preview of consumer demand in the US which will be an essential consideration for how the economy will react to a more aggressive Federal Reserve hiking cycle. The bond market is currently implying six rate hikes in 2022 – whether that has a major impact on GDP will be highly dependent on US consumption.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Andrew Lloyd DipPFS

22/02/2022