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Russian Roulette

Just as the face masks are coming off and ‘normality’ is finally returning after two extremely hard years, we find ourselves lurching into another external crisis.

The invasion of Ukraine by Russia understandably puts all of us on edge.  We all feel powerless to help and frightened that things will escalate further. The fact is that a terrible war is being forced upon a democratic country, and there is little we can do about it from a military perspective.

I can’t say or do anything that will directly help the poor souls in Ukraine.

My job is to try and steer our clients’ financial plans through any and every event that comes our way. As financial planners, we have to remove emotion from our decision making and my 25 years’ experience has taught me that there is usually a lesson we can draw from history to help us gain some perspective.

To this end, I have written this update to try and show you some positive observations that I have made in amongst all of this terrible suffering and worry. My thoughts are just thoughts. I could be wrong, but here are the key nuggets of information I have gleaned from fund managers and analysts over the past days.

The key to this invasion for Putin appears to be a quick victory. Advised by fellow ex USSR veterans, he and many of his commanders will remember the painful decade lost to the Mujahideen in Afghanistan from 1979-1989. In many ways, that war pre-empted the collapse of the Soviet Union, showing the world that Russia’s military was not be all it was cracked up to be. The USSR was able to keep pouring vast amounts of money into their military machine. The situation for Russia today is very different.

Putin’s Russia of 2022 is financially in trouble and each day in a war costs Russia economically.  The unprecedented move by the West to freeze Russia’s central bank assets should not have technically happened.

There are usually rules that protect central bank assets from attack, making them immune to asset freezing. However, some clever lawyers in the United States found a way around these rules and the West have been able to lock down huge amounts of Putin’s war chest.

The seizing of these assets means that both Putin’s war machine and his economy are likely to be choked financially.

According to fund manager ‘Rathbone’, the average Russian is now 25% poorer than they were just three weeks ago!

But the woe doesn’t stop there for Putin. Many economists are now predicting that Russian banks have literally weeks before they will go completely bust. If this happens, much of the Russian population will be destitute and could turn on their government when they have nothing left to lose.

Putin therefore knows that he has days, not years to get Ukraine under control. This, is a race against time. Every day that Ukraine can hold on, pushes Putin’s government closer to the edge of collapse.

Then there is another consideration. Putin has long mocked social media and the internet, preferring the television for fairly obvious reasons, as he can control it. However, he has overlooked the huge power of social media both at home but mostly in Ukraine.  This is all having far more effect than I think he really expected in drumming up financial support for Ukraine and financial punishment for Russia.

So Russia may be decimating Ukraine’s cities and committing atrocious acts – but they will pay a far higher price for this than they first envisaged.

What does this all mean for your portfolio and how bad is it all likely to get?

Well, Russia accounts for around 12% of the global Oil output. This is a far higher percentage than Iran in the 1970’s or Kuwait in the 1990’s. They also account for around 17% of the global Gas supply. EU countries currently rely upon Russia for around 38% of their Gas needs.  This is why sanctions against Russia have not included Oil and Gas to date. However, it is now a possibility that Oil and Gas may be restricted.

Really this is the key to the problem. The Global economy was pulling itself out of the worst two-year slump in many investors lifetimes. This ‘great reopening’ put massive pressure on Global supply chains – thus temporarily forcing up inflation.

In my January update, I mentioned how used car prices were a strong indicator of inflation. There were some early signs that things were slowing. Gas prices in the EU had also fallen back. It did look as if the inflation storm might be blowing itself out.

However, the massive increase in Oil prices because of the war in Ukraine, has literally poured petrol on the global inflation flames.

This creates anxiety in stock markets, as the prospect of rising interest rates to try and combat this inflation becomes more real.  Weirdly, markets around the world have not fallen that heavily since Russia invaded, because markets are betting on central banks hesitating to put up interest rates during a war.  Nonetheless, rising Oil prices are not helping markets.

Let’s look to history for a moment. I really like the following chart sent to us by Sarasin fund managers. It shows five conflicts from 1964 through to 2014. You can see that the US S&P 500 Index grew over the six months that followed the start of conflict in every single case.  (Forgive the fuzziness!)

Add to this the fact that the ‘great reopening’ is still very much in full swing.

For instance, data reported today from business advisory firm BDO shows employment in the UK is now back to its healthy levels pre-pandemic. I don’t think any of us could have predicted that at this stage!

The optimism index from BDO also shows February recording another increase in the positive outlook for UK citizen’s.

So in conclusion, I am feeling very positive about a rebound for markets at some point in the near future.

There are further unintended positive consequences we can see developing as well.

The West is suddenly realising that it has taken democracy for granted. I think we will see big increases in military spending which should provide further employment and manufacturing opportunities here in the UK.

We also are seeing the EU finally speaking with one assertive voice – something they have been missing for a long time. This may help to bring EU countries closer together – again creating better economic opportunities.

Finally, the West’s reliance upon fossil fuels from Russia has been painfully highlighted. It is very likely that countries such as Germany will start building renewable energy provision with a far greater sense of urgency.

There are, however, longer term unintended potential headwinds for investment growth.

The West is finally having to confront the fact that Globalised supply chains are open to all manner of disruption and corruption. I think we may see manufacturers in the West looking to shorten supply chains to do business locally. This is a good thing for localised production, but it will invariably squeeze profit margins and that in turn will reduce investor dividends.

I believe that we may see a very different ‘20’s’ to the roaring growth many predicted post Brexit.  I do absolutely believe that growth is still achievable, and that investing over the long term is going to be the best solution to counteract the effects of inflation on your capital. However, the dizzy returns of 10% per year are probably behind us for a while as the world adjusts to a new era.

I finally want to talk about Russian influence on portfolios and some recent trends.

We have been carefully checking all of our model portfolios. Exposure to Russia is most commonly found in Oil, Gas and Alcohol. To this end, we have had a fairly easy job with our Ethical portfolios in knowing that there is no exposure to worry about.

We are able to see tiny fractions of exposure to Russia and Belarus within our Mainstream portfolios. However, the fund managers that hold these stocks are jettisoning connections to Russia at a remarkable speed – this is positive to see and it will have an impact.

You will recall that we made changes to all of our model portfolios only a couple of weeks ago. This was because we were concerned about Russia’s intentions. We were also concerned about the impact that inflation is having upon portfolios and our wider society.

I am convinced that we made some really good calls in those reviews, and I am grateful to all of our clients for allowing us to make those critical changes so swiftly.

The picture is ever changing at the moment. We just don’t know which sector of the market will be temporarily out of favour next. We have seen Bonds suffer due to interest rate rises. We have seen growth Equities being sold indiscriminately. Now we are hearing headlines about the Janus Property fund being closed permanently. We don’t hold this fund for our clients – but obviously any sudden shocks in a sector can have a negative impact and I shall be in touch separately with all of our Level One and Two clients to cover our take on the Property sector.

There is so much happening at once that it is actually very hard to report all of this to you in a logical fashion!

My summary advice would be this:

  • Putin has not had it all his own way. The incredibly brave souls in Ukraine are causing his plans to slow. The West has put in place potentially catastrophic sanctions for his country at the same time as investors shun his exports.
  • The West has finally found its voice and we predict huge increases in military spending and renewable energy projects to remove reliance upon fossil fuels in future.
  • You are likely to hear lots of worrying news in the coming weeks and possibly months. Headlines about various funds, sectors and markets will hit the headlines. Please contact us if you are at all worried – that is why we are here!
  • We are watching the portfolios so you don’t have to! My humble advice would be don’t look at your values daily – it’s no good for you!
  • Finally, I believe that we are in for continued volatility, but ultimately we will see a nice recovery in the shorter term. I am predicting slower annual returns in future as the world reset’s – but it will still be worthwhile investing for the long term.

I hope that my somewhat epic ‘update’ has helped. Forgive me for rambling. It is very hard to know where to stop currently.

We are here for you 100% and I am 100% confident that we will come through this period of history in good shape.

My best wishes of peace and prosperity to you all – and my prayers and thoughts to all the brave souls of Ukraine.

Darren

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