February 2022

February Investment Summary

The dismal start to 2022 for capital markets continued in February. The Russian invasion of Ukraine, in a premeditated and unprovoked attack, has added a terrible human tragedy and a myriad of economic side effects to the investment world. Major equity markets were down 3% to 6% for the month in sterling terms. Only the Chinese CSI 300 index managed a small gain. Fixed income did not offer any help as the modest fall in yields late in the month could not overcome the rise in yields from the first three weeks of the month. We now have both equities and fixed income returns negative for the year. Not a good place to be as an investor.

Concerns over inflation have been overshadowed by the shocking events in Ukraine. As Russia now appears to be targeting civilians, killing innocent people destroying hospitals, schools and critical infrastructure like running water and electricity, it becomes ever more difficult to see how this conflict ends. We won’t begin to guess. We certainly know how we would like it to end with the removal of President Putin as the leader of Russia, but we can offer no guidance on when that might happen. So as the conflict drags on the economic side effects will continue.

The economic isolation of Russia by the West has essentially cut them off from any commerce with the outside world. Despite carve outs in the sanction’s regime imposed on Russia by the US, UK and the EU to allow energy exports from Russia to continue, energy prices have risen significantly. Shippers are unwilling or unable to pick up Russian cargoes bound for the West. Banks and insurers are unwilling or unable to finance and insure those cargoes. The result has seen oil jump to nearly $120 per barrel, at the time of writing, and many other commodity prices surge higher.

Both Russia and Ukraine are big producers of many gases used in semiconductors, electric vehicles and smartphones. By way of an example, Ukraine is responsible for over 50% of global neon gas supplies. Gas mixtures that include neon are used to power lasers for etching patterns into semiconductors and with inventory levels in the industry typically lasting only 3 – 4 weeks, we could see even more supply constraints for chips and the subsequent knock-on impact for other sectors such as autos and smartphone producers. The Russian invasion of Crimea in 2014, saw neon prices increase by over 600%. Already tight commodity markets are seeing supply further reduced. This of course is adding to inflation pressures that were already making central banks nervous and governments and consumers angry.

What will the central banks do? FOMC Chair Powell delivered his semi-annual monetary policy report to the US congress last week and indicated that he was expecting a 25-basis point hike in rates to be announced at their meeting later this month. He didn’t rule out hiking faster, if necessary, to bring down inflation. He was asked by one Republican Senator if he (Powell) could be as firm and determined as Federal Reserve Chair Paul Volker was in the late 70’s and early 80’s in fighting inflation – Volker took the radical step of switching Fed policy from targeting interest rates to targeting money supply - Powell responded “Yes”.

In March of 2020, the Fed cut rates essentially to zero and began buying $120 billion a month to offset the effects of the Covid-19 pandemic. Now, two years later, rates are still essentially zero, unemployment is back to pre-Covid levels and the Fed is only now halting their purchase of bonds. Oh, and inflation is 7.5%.

To a lesser degree, this same challenge faces the Bank of England and the European Central Bank (ECB). The ECB hinted in early February that they might have to become less accommodative with monetary policy as inflation keeps rising. The surge in energy prices is only going to make inflation worse and leave the ECB in a very unenviable position. At some point the rise in energy prices will slow activity as higher energy costs take away from discretionary spending. We just don’t know at what level of oil and gas prices that is. That said, history tells us that in the past 50 years every time oil prices (adjusted for inflation) have risen 50% above trend, a recession followed.

In our view, the outlook for capital markets will continue to be challenging. First and foremost, we need to see a peaceful end to the war in Ukraine. We need to see inflation ease and the process of central bank tightening not become too disruptive for activity. We believe that all of this will happen. However, Russia's invasion of Ukraine has shattered the relative peace we have enjoyed in Europe post the end of the Cold War. The ramifications from an investment perspective will ripple across the globe as sanctions start to bite. Indeed, authoritarian regimes may look to diversify away from the US Dollar in an attempt to circumvent any future sanctions. These are questions for another day. For now, our thoughts and prayers are with the people of Ukraine.

Jeffrey Brummette

Chief Investment Strategist

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