7 Minutes on Markets - Q2 2022 Market Update

Ben: Hello everybody, welcome to 7 minutes on markets, the April 2022 edition. I'm Ben Kumar from the Investment Management team and I've got Salim Jaffar with me.

Salim: Hi everyone.

Ben: Now, last quarter, we talked about moving away from the focus on COVID-19 and the impact that was going to have on the global economy. We did not think that we'd be moving so abruptly away from it and focusing on the nasty situation that's escalated and continuing to escalate in Ukraine.

We're not going to spend much time talking about the tragic human impact. We're not going to spend a lot of time talking about the geopolitical impact either; I think it could be decades before that gets untangled. But we are going to think about the economic impact, because what's gone on in the Ukraine has muddied the already muddy waters even further. So, I'm going to let Salim try and clear it up a little bit and talk about, firstly, the impact of the war on potential economic growth in the world. Thanks, Ben.

Salim: Thanks, Ben. So, at the at the start of 2022, before it all kicked off, we were pretty optimistic that growth would get stronger, and that inflation would fall to a post pandemic level of around 3 to 4%. Now, we still think global growth is unlikely to be really stunted by the conflict and the impact of the conflict on growth is very different depending on where you are.

Russia needs the global economic powerhouses much more than they need Russia. Using China as an example, in 2020 China was the single largest importer of Russian goods, representing 15% of all goods that Russia exported. Despite this, less than 2% of Chinese exports were purchased by Russia. So, China clearly has some level of political involvement with Russia, but these figures just illustrate that economically, the countries are very much separate, and this is even more the case in the US. In 2020, less than 0.5% of the US exports were actually bought by Russia.

Unfortunately, Europe’s a bit more sensitive to the situation. Not only does geographical proximity have an impact on sentiment generally but going back to Russia being a gas station, Russia is the biggest gas station in Europe and produces about four to five times more oil than any other European country, and most of this actually gets exported to Europe. So, we don't really expect a synchronised recovery, but we do expect a recovery.

Ben: So, geography very much still matters. The nearer you are, the more likely you are to be affected. It's funny that, isn't it? Even in the modern world, with all its connectivity, how close you are to something is still important.

So, that's the growth side. Still reasonably optimistic, but maybe a gloss come off in Europe. The inflation side, because we're hearing a lot about inflation at the moment, of course. Yeah.

Salim: Inflation, similar to growth, will be impacted differently depending on where you are.
I think looking at the types of inflation helps clear this up. So, you've got ‘demand pull’ and ‘cost push’ inflation both at play.

Ben: Make that a little bit clearer for me, assuming I don't recognise those terms.

Salim: So, ‘demand pull’ inflation is when you've got more money chasing the goods. You're seeing demand being pushed up, more money is the chasing the goods and the price of those goods go up. So, where that's come from was prior to the conflict, it was a COVID stimulus. Massive stimulus packages have put more money into the hands of people, and that money was chasing goods.

Ben: So, is that like when during COVID, the only way to buy a bicycle was to pay thousands of pounds for it because there was just so many people wanting a bike and there weren't enough of them?

Salim: Absolutely. And then recently we've had ‘cost push’ inflation thrown into the mix. So Russia, prior to the conflict, represented around 11% of global crude exports and 15% of natural gas exports, as well as a bunch of other commodities that used as inputs into process. So, when that supplies essentially cut off the price of producing goods increases because you need these raw materials to produce those goods, and that's what we've seen since the invasion.

But what's really important about inflation is that it only really tends to persist when wages get pushed up. And it looks like this is starting to happen. So anecdotally, we've seen Sainsbury's and Tesco’s giving low wage workers big salary increases, and it will be interesting to see how this develops and how it impacts in equality more generally.

Ben: Because that's really the trigger for central banks, isn't it? And that's where interest rate policy changes. Not when there's something going on in the supply side. If there aren't enough T-shirts to go around or there's not enough oil or there aren't enough cars, semiconductors, whatever it is, central banks can't do much. Interest rate policy doesn't affect that.

But when you're talking about wage increases in the spending habits of consumers, that's when the central bank is get interested. And as we've seen over the past few months, interest rate rises are coming.

Now what that means for all investors is a different kind of environment to the one we've been used to over the past, call it 10 years since the financial crisis. A rising rate environment means lots of different things for lots of different assets, but I'll just try and focus on a couple of interesting ones.

In the equity market, we think rising interest rates, and we've been saying this for some time, herald's a change in the leadership in an equity market. The massive tech stocks, usually American, are unlikely to do so well. You've seen them fall already a little bit this year. They're NASDAQ-style stocks. We think the likely winners are going to be banks who turn rising interest rates directly into profit. Industrials who benefit from a, you know, a growing world. And the likes of energy companies and materials who explicitly benefit from higher prices when they're selling their goods.

So, our portfolios are positioned for that shift away from expensive US tech and in other more interesting and cheaper areas of the economy. The FTSE’s a great example. You’ve got lots of miners in there and lots of energy companies in there and lots of banks; One of the reasons the FTSE 100 has been one of the best performing equities markets this year.

In the rest of the portfolio in the bond part of the portfolio, we continue to do the same thing as we've been doing for the last few years: avoiding heavy exposure to fixed income. Bonds lose money when rates rise, so we want to be underweight bonds as much as we as we possibly can. And allocating towards other assets which might be a little bit more defensive and provide a bit of a return, that's our alternatives bucket which you've heard us talk about at length. We still think it's got a place in portfolios.

The first quarter of this year has been incredibly interesting as well as saddening. We hope for better time, certainly in Ukraine, over the rest of the year and for portfolios, we'll keep doing as we have always been doing.

Thank you.