Mosaique Views: Asset allocation

March / April 2022

Russia’s attack on Ukraine will lower growth and boost inflation

Our thoughts are with those hit by the dreadful conflict still raging as we write. It seems distasteful even to be talking about investment amidst such human hardship: our daily concerns are put suddenly into perspective.

Sanctions, a wider unwillingness to do business with Russia, interruptions and diversions to supply chains –particularly those relating to energy and food –will reduce global growth prospects. The disruptions will also lead to even more inflation.

As yet, we think this will slow global growth, but not arrest or reverse it. The economy had some momentum going into this geopolitical crisis –not least because of the widespread re-stocking of inventories underway as covid finally moves to the economic sidelines (developments in Shanghai permitting, of course).

Energy costs in real terms are not as elevated as they appear –real oil prices were higher in 2012 –and even a more complete shunning of Russian exports by the West might not trigger the more dramatic spikes predicted: other buyers may switch sourcing, and global supply is not completely inelastic.

So, talk of “stagflation” seems premature to us. That said, the investment climate is suddenly riskier. We hope for a peaceful settlement soon, but escalation is also possible even now: rationality may not prevail. And while the initial attack seemed to herald a reduced risk of monetary tightening, as the economic impact has appeared to be less profound than it could have been, interest rate expectations have resumed their pre-crisis upward drift.

We had already reduced our equity weightings in the New Year as it became clear that central banks were indeed planning (rather belatedly) to start normalising monetary conditions that had become needlessly lax. We reduced them further on news of the invasion.

However, our equity holdings have returned to neutral only: we still see corporate profitability staying healthy, and valuations, while stretched, are not outlandish. And the funds released are being held as liquid assets: we stay firmly underweight in fixed income. We did not think the reduction in global risk appetite would be big enough for bonds to rally for long –and indeed, the key government bond yields on both sides of the Atlantic are at multiyear highs as we write, driven by both rising inflation expectations and real yields.