Understandably we have received lots of questions about how the conflict in Ukraine will impact finances. In this edition of Market Update, I will attempt to answer some of these.
What effect will the conflict in Ukraine have on the recovery from Covid 19?
The world economy, at different rates in different places, has been bouncing back from the falls in economic growth caused by Covid 19. This year was supposed to be the year when the world economy fully recovered from the economic fallout from the pandemic, in the developed nations at least. That was until Russia launched its invasion of Ukraine.
Today’s world is like a giant Hornby train set. From 1990 to 2008 as China, India and Russia joined the global economy, we essentially took every unused piece of track out of the box and joined them all together. The new enlarged circuit turbocharged global trade. Humanity had never lived so well for so long. The problem was that if any piece of the track malfunctioned the global train could derail. There have been a few “derailments”; the rise of Islamic Fundamentalism in the Middle East, the collapse of the US subprime market leading to the Great Financial Crisis and then Covid 19. Now we have Putin’s foreign adventure which is decimating Ukraine and closing off Russia, causing a leap in food and fuel prices.
The effect will be to reduce growth rates. The world economy is still expected to grow in 2022 but at a much slower rate than previously forecast. But it is the long-term implications we should be more concerned about. Blackrock ( the biggest asset manager in the world ) has warned that the war in Ukraine will reshape the world economy and further drive up inflation by prompting companies to pull back from global supply chains. In the words of Blackrock Chief Executive Larry Fink “ The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades”. It will be interesting to see what replaces it.
What effect will the war have on Stock Markets?
It is fair to say that the Russian invasion of Ukraine took the markets by surprise, in the week before the conflict erupted 65% of fund managers believed that there would be no military action at all. The result was predictable, an initial steep drop in share values followed by a gradual recovery. If a peace deal can be found shortly then this will assist markets to recover further. In fact, it looks like investors are already “looking through “current events to see how the world will look post-Ukraine. This is borne out by the fact that all of the” safe haven” assets; gold, the dollar and sovereign bonds have all dropped in value recently having risen a few weeks ago. The Vix – or “fear” index is only just above it’s historical average of 20. To help the process $230 billion will shift from bonds to stocks. As investors, such as US pension funds, seek to rebuild their equity positions consistent with their long-term asset allocation strategies.
But the reality is that the world economy will be affected by the fallout from the conflict in Ukraine. We should also remember that this has added another factor to the growing list of challenges namely; the inflation problem, the commodities price problem, the supply chain problem, and now of course an oil and gas price problem. Most fund managers and observers entered the year with a marginally cautious outlook. Nothing has happened yet to change that sentiment.
What effect will the war have on oil prices?
Some will remember the oil crisis of the early 1970’s. Almost half a century on . the Russian war in Ukraine and the sanctions imposed in retaliation are raising the risk of a new oil shock. The price of oil has already reached $120 a barrel and some forecast it will hit $200 later in the year.
Fortunately, oil is less important to the world economy than it was in 1970 and Russia is far from being the largest producer – other options are available. But sharp drops in real household incomes and some economic slowdown will follow the increase in fuel costs. The west will undoubtedly feel significant pain from the “oil shock”. But in the long run it will drive a speedier adoption of renewables, the “energy of freedom”.
Will the measures in the Chancellors' Spring Statement help the country deal with the coming economic squeeze on households ?
The measures set out by Rishi Sunak have been widely criticised as being insufficient to deal with what the Office for Budget Responsibility has called “the largest single fall ( in disposable incomes ) in a single year since records began in 1956”.
To misquote Shakespeare “alas poor Rishi, in charge of fixing the unfixable”.
He has at his disposal all the apparatus of government and a large money printing machine to feed it with (backed by 30 million taxpayers ), yet appears to be able to resolve almost none of our difficulties. But in fairness, he can’t take much of the blame for where we are today. He can’t be blamed for the long period of low inflation that made our central banks so complacent about inflation. He was not involved in the normalisation of quantitative easing or for an era of low-interest rates that fuelled asset price increases. Nor was he any more to blame than anyone else in government in relation to handling the pandemic (though the eat out to get Covid scheme was probably misjudged), or the fact that by pursuing a zero Covid 19 policy China caused huge interruptions to global supply chains. Finally, he did not choose war – and there is no such thing as a non-inflationary war.
The point is that all the factors that are driving the cost of living up are too global to have anything to do with him. Which is why he has no hope of fixing them. The Spring Statement included some tax reliefs for businesses and some initiatives. Beyond that it was fairly pointless. You got 5p a litre off fuel – which you probably won’t notice given the volatility in the market. You got a rise in the national insurance threshold and an announcement that you might get a cut in income tax in 2024. A date when no one who is worrying about their purchasing power falling 10 percent this year is interested in now.
We are looking at the biggest fall in living standards since records began. We are still treating the young badly, I have no idea why. We are shifting the tax base from income tax, which pensioners pay, to national insurance, which they do not. Meanwhile we are using the soaring RPI instead of the more moderate CPI to calculate student loan repayments. But pensioners do not get off scot-free, they will have to pay more tax on their dividends.
But all this might make some sense. In short, if you know you can’t fix something why try. Instead privately note that the nation’s finances are in better shape than was expected, that the cost of servicing the public debt is low by historic standards and save your fiscal firepower to persuade voters to keep you in your job at the next election. Although why anyone would want a job that mostly involves being expected to fix the unfixable, I have no idea.
How will the Ukraine War end?
The daily images of war flash across our TV screens, as they do so it is difficult to look beyond the horizon and imagine how the war might end. But an end there must be because the imposition of sanctions on Russia demands a solution. Left in place they will slowly asphyxiate the Russian economy and probably the Russian State. The most likely scenario is a stalemate where both sides accept the facts on the ground, more or less as they exist today. This creates huge problems including the movement of people, no Ukrainian would want to live in territory occupied by the Russians. If the opposing sides cannot reach an agreement and the war grinds on only the continuation and gradual tightening of Western sanctions offers a way forward. The endgame would have to come from the destruction of the Russian economy over a period of two to three years. The truth is that the indefinite continuation of the war seems a lot easier to imagine than anything resembling an ending.
It is hard to overstate the tremendous consequences the invasion of Ukraine will have on the world we live in. To quote Lenin, “ there are decades when nothing happens – there are weeks when decades happen”. We have just witnessed some of those weeks.
Written by Mike Haigh, Managing Partner, Domus Financial Services