Drivers of investment performance
- Following sharp declines in January, global sharemarkets fell again in February on rising tensions between Russia and the West, culminating in the invasion of Ukraine by Russia. This occurred against a backdrop of persistently high global inflation data and changing expectations as to when and by how much central banks will increase interest rates in 2022, which negatively impacted financial markets over the first month of the year.
- Global equities fell -2.7% in February and are 7.5% lower compared to the start of the year. Declines were heaviest across Europe over the month. The European sharemarket index fell 6.0%, the Eastern European sharemarket fell more heavily, while the Russian bourse was down over 40%.
- The US and European Union were quick to condemn Russia’s actions and impose sanctions against them. Although initially considered a light touch, sanctions have been ramped up to isolate Russia from the rest of the world. Sanctions include banning transactions with the Russian central bank, freezing assets, excluding some major Russian banks from the SWIFT international payment system, sanctioning some of Russia’s wealthiest elites, and the introduction of export controls. Germany have halted the certification of the Nord Stream 2 gas pipeline from Russia to Germany, putting at risk the potential of large future foreign earnings for Russia.
- These sanctions are expected to negatively impact the Russian economy and to severely limit its access to $600 billion in foreign reserves. In addition to a falling sharemarket, the Russian currency (ruble) has depreciated significantly, plunging to a record low of less than 1 US cent, and Russia’s credit rating has been cut to ‘junk’ status, with default very likely. The Russian central bank has had to increase interest rates from 9.5% to 20% to defend the ruble.
- Rising commodity prices have been a key feature resulting from events in Europe. This not only reflects concern over supply but more recently restrictions on SWIFT payments, rising insurance premiums for shipping, and port closures have added to the uncertainty.
- The commodities impacted are wide ranging, including wheat, aluminium, palladium (Russia exports 40% of the palladium mined globally), gold and corn. Aluminium has reached record prices and the oil price rose to above $100 a barrel. Gold has also moved higher, finishing the month over $1,900 an ounce and recording a 6.2% increase over February. The price of oil increased 11.5% over the month and has risen 43.6% and 66.5% over the last three and 12 months respectively.
- Although it is early days, and it is very difficult to predict geopolitical events, which are likely to get worse before getting better, an initial assessment of the likely global economic impact is for a worsening of the economic growth/inflation mix. Forecasts for inflation are being revised higher and economic growth expectations trimmed. The key factors driving this are higher commodity prices and the tightening of financial conditions, eg rising credit spreads. The impact will vary around the world with Europe most at risk.
- This outlook, and limiting further significant falls in global sharemarkets, is based on two key conditions: the conflict remains confined to the Ukraine, and the supply of gas from Russia to Europe remains open. The US has no appetite nor public support for sending troops to the Ukraine and engaging in a war with Russia, likewise NATO. Nevertheless, they will both continue to supply arms and assistance to Ukraine.
- Both Russia and Europe are highly dependent on the flow of gas from Russia. Russia needs the foreign earnings, particularly now they are at war, and Europe is heavily dependent on Russian gas as a source of energy. To date, the sanctions imposed have been crafted to not impact gas supplies from Russia to Europe.
- Events in Europe have overshadowed an improvement in global economic data and a drop in Omicron cases globally. Manufacturing survey data improved across Europe in January, driven by a larger than anticipated improvement in the services sector with the negative impacts of the high Omicron cases easing. US consumer spending increased by a larger-than-expected amount in January, reflecting a bounce back from the Omicron impact from previous months.
- Global inflation data remains elevated. Both the UK and Canada witnessed higher-than-expected annual inflation increases in January of 5.5% and 5.1% respectively. US core annual inflation has risen to 6.0%, the highest level on record for 40 years.
- The US Federal Reserve (the Fed) is expected to commence increasing the Fed Funds Rate in March 2022 and follow this up with another three or four 0.25% increases over the year. The central banks of England and Canada are also expected to hike interest rates in coming months. The European Central Bank and Reserve Bank of Australia are anticipated to commence interest rate increases by the end of this year. Events in Europe will make central banks more cautious. However, this is expected to only influence the pace at which they raise interest rates.
- The Reserve Bank of New Zealand (RBNZ) increased the Official Cash Rate (OCR) for a third time in February, taking the OCR to 1.0% from 0.75%. In their recent monetary policy statement, the RBNZ indicated a more aggressive track to raising interest rates and lifted the ‘terminal’ cash rate in their projections to 3.35% from 2.60%.
- From the perspective of a balanced fund (60% equities and 40% fixed income), a global balanced fund fell -2.1% in February, and is -5.4% lower since the end of 2021. A domestic balanced fund rose 0.1% over the month, having fallen -5.6% over the last two months.
- In addition to the decline in global sharemarkets (-2.7%), global bond markets fell -1.3%, and have fallen -2.9% so far this year. High and persistent inflation, and central banks beginning to tighten policy positions, placed upward pressure on interest rates around the world despite the events unfolding in Europe.
- Although outperforming global bond markets, New Zealand fixed income indices also declined in value over February. The New Zealand Government Bond Index fell -0.9% over the period.
- Meanwhile, the domestic and Australian sharemarkets outperformed, rising 0.7% and 2.1% respectively. Solid corporate earnings results supported both markets, and Australia benefited from the increase in commodity prices.
- Emerging markets slightly outperformed developed markets, declining -2.5%. The losses across Eastern European markets were offset by solid returns throughout Asia and the Middle East.
- Value stocks outperformed growth stocks by 1.9% in February. This is a continuation of a recent trend, and value has outperformed growth by 14.2% over the last three months.
- Global infrastructure (0.1%) and utilities (-0.9%) outperformed the broader market, reflecting their more defensive characteristics. Global listed property underperformed (-4.1%), which comes after a period of outperformance and reflects greater sensitivity to interest rate movements.
- Reflecting the increase in commodity prices outlined above, the Bloomberg Commodity Index climbed 6.2% in February and has risen 19.5% over the last three months.
- The New Zealand dollar (Kiwi) strengthened in February, recovering some of the losses experienced in January. On a Trade Weighted basis, the Kiwi rose 1.8% over the month, this included a 3.0% gain versus the US dollar. The Kiwi climbed by similar amounts against the euro and British pound but was flat relative to the Australian dollar (0.2%). The New Zealand dollar found some support in February given commodity prices were stronger over the month.
This article has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.