Mosaique Views: Asset allocation

JUNE / JULY 2022

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

Our thoughts remain with those hurt by the dreadful conflict still raging, which puts our economic concerns firmly into perspective. Those concerns should perhaps be a little less pressing anyway. The conflict has had less of an impact on the global economy, so far, than it might have done.

Growth may be slowing, but there are no signs yet of the feared recession. Developed economies had momentum going into this geopolitical crisis – not least because of the widespread post-pandemic re-stocking of inventories. In China, the recently-renewed covid-related lockdowns are being eased, promising a rebound in growth there.

Energy costs in real terms are still not as elevated as they appear – real oil prices were higher in 2012 – and even the more extensive shunning of Russian exports by the West might not trigger more dramatic spikes. 

Nor are monetary conditions especially tight. If anything, real interest costs and debt burdens have fallen over the last year, even as policy rates have started to rise, as a result of the surge in inflation.

So, talk of “stagflation” still seems premature to us. That said, the investment climate remains riskier. We hope for a peaceful settlement soon, but escalation is also possible even now: rationality may not prevail. And central banks will not allow policy to stay this loose: 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 again at new multiyear highs, driven recently by that expected rebound in real interest rates.