The ongoing war in Ukraine has resulted, so far, in thousands of unnecessary deaths, millions of people displaced, and soaring prices of energy, corn, wheat and some industrial commodities. Most stock markets have fallen so far this year, though the declines are generally much smaller than in 2008 or early-2020.

However, moderate falls like this are relatively common, occurring on average once every two years. Investors with sufficient willingness and ability to tolerate investment risk in the first place should be able to ride them out. Those who bear the scars of previous market falls will have learned that they also tend to be followed by higher than average returns in subsequent periods.

What if this time is different? Surely, with inflation rates at close to 40-year highs and the war in Ukraine becoming increasingly brutal, we should be recommending that clients take some money out of stock markets?

While we agree that stagflation and recession risks are higher than they were at the end of 2021, recent stock market falls mean that these outcomes are now at least partly priced in. That is not to say that markets cannot fall further, rather that we need to have an even more pessimistic outlook than other investors do to justify selling equities now.

So much is unknowable today. One way or another, this war could be over in a month. Or it could grind on for months or years. In some scenarios, stock markets could rise, in others they could fall.

Considering the options

Within our Investment Research team, we have debated the possible economic consequences of the conflict in Ukraine and considered how we could position portfolios for them. We have also spoken with external experts and listened to the views of our new colleagues at Rathbones. For our March Investment Committee meeting, we undertook broad analysis of our current asset allocation models and the funds selected to construct portfolios. As part of this, we reviewed our recommended positions in light of the different potential outcomes and assessed whether or not to make any further adjustments.

In our assessment, recommended client portfolios are already fairly defensively positioned compared to their target risk profiles. Over the last six months, we have taken steps to dial down the sensitivity of equity allocations to economic shocks, such as sharp declines in business and consumer confidence and disruption to global supply chains as a result of the war in Ukraine. Within equity allocations, we have also increased exposure to the US dollar, which, alongside the Japanese yen, tends to strengthen against the pound during periods of stress in financial markets.

We considered further steps to make portfolios more defensive, notably selling European equities. Our concern was that the European economy, which is more dependent on Russian energy than other regions, would likely suffer more if energy prices remain high or supply is reduced. However, European equities have already fallen more than most other markets, suggesting that this risk is already in the price. We also considered the possibility that European policymakers announce support measures that reduce the economic impact of the war and sanctions, and encourage innovation by European companies. Doing so could enable European stock markets to recoup some of their losses, even if the conflict in Ukraine escalates.

Selling equities now also creates a challenge around deciding when to reinvest the money raised into the market. The speed with which this conflict began warns us that its resolution could also be surprisingly quick and next to impossible to anticipate. If that proves to be the case, investors risk not being able to buy back in at better prices than they sold at. In our view, this is something that must be considered, but often isn’t, when investors decide to sell equities.

We also note that the best times to invest in equities are usually at the points of maximum pessimism, when all of the news and data look dreadful. Some investor sentiment indicators, such as our fear and greed measure, can help us to spot market troughs but it takes a lot of faith for investors to follow them.

At our recent Investment Committee meeting we debated whether this and other contrarian indicators were now deep enough into fear territory to warrant increasing equity allocations. Our conclusion was that this was a buying opportunity only if a recession was not around the corner. Unfortunately, other leading economic indicators we follow left us sufficiently concerned about the possibility of a recession in the next 12 to 18 months to not recommend buying at current levels. As for selling equities, we would prefer to wait for some of the current fear in markets to subside and to gather more evidence that a recession is imminent.

On balance, we believe that the best thing, at the moment, is for clients to hold fast (neither increase or decrease equity weightings). If our ongoing analysis changes our views on the economic and market outlook, we would act quickly to provide recommendations and change portfolios. However, those decisions will always be weighed against the potential benefits or risks of staying put through volatile market conditions.

Finally, we would like to reassure clients, as per our last bulletin (Russia launches invasion of Ukraine, 25 February 2022), that their portfolios already contain some funds with the potential to preserve value, or even make money, in recessionary or inflationary environments. We also confirm that recommended portfolios do not have any direct exposure to Russian equity or debt funds. Some emerging market equity funds do hold shares in some Russian businesses, though these are very small positions and have generally been marked down to zero within the funds. Some bond funds also have a modest amount of exposure to Russian bonds, though these have also been marked down. Across the average client portfolio, we estimate that there is less than 0.1% exposure to Russian securities.

If you would like to talk to us about the views expressed in this note or better understand the Russian exposure within your portfolio, please get in touch with your usual adviser. We have set out why we do not consider it appropriate to reduce equity allocations at this time. However, if you feel differently, please speak to your adviser and we can take action accordingly.


About The Author

Andrew Birt
Andrew is the Investment Director at Saunderson House and manages our team of in-house investment analysts. Andrew joined the ...
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