The Ukraine conflict, inflationary pressures and supply shortages, as well as the emergence of new Omicron variants, continue to dominate headlines and pose challenges for investors. However, Richard Dunbar, our Head of Multi-Asset Research, explains that while there are obvious short-term risks for markets, there are still valuable opportunities for investors and potential for global growth over the course of the year.
What does the invasion of Ukraine mean for markets?
It’s been a shocking and tragic start to the year. Seeing the terrible events that are taking place within Ukraine and on her borders reminds us that peace should never be taken for granted. And while there’s no certainty what the final outcome will be, we can be sure of two things – human misery and economic calamity for both Russia and Ukraine.
From a global perspective, the immediate threat – and one we’ll all be experiencing in our daily lives – is the surge in energy prices. On top of that, we’re experiencing rising food prices and disrupted supply chains. Taking a longer-term view, issues could come to include a new cold war between Russia and the West, resulting in increased military spending and hindering interaction and integration among companies, and governments worldwide.
There’s no doubt that the war has been an eye-opener for Europe, which now needs to accelerate its transition to more sustainable energy sources, and remove itself from Russian energy dependence.
Is more volatility likely?
It’s difficult to make accurate forecasts when the world is simultaneously dealing with conflict in Europe and a global pandemic. If there’s a quicker resolution to the Ukraine conflict than expected and, in turn, global energy prices stabilise, we should see some improvement to global growth. For now though, the uncertainty caused by the conflict is likely to mean more market volatility in the short term.
What are the other market woes?
Even before the Ukraine conflict, we saw a complex start to the year. We had the Bank of England and the Federal Reserve (Fed) raising interest rates and we saw the impact that continued lockdowns have had on global supply chains and inflation.
There was also an uncharacteristically pessimistic outlook for China, with problems in the property sector, further exacerbated by the zero-tolerance Covid policy and heavy-handed regulation of technology firms. So there was plenty for markets to contend with.
As such, there was a major reassessment of the outlook for the global economy even at the beginning of this year.
Will Covid caution remain?
It looks increasingly likely that the effects of the latest Omicron variants will prove shorter-lived than many people had feared. But the latest major variant is a reminder that the world is only as good as the weakest link in the vaccination chain. This should concentrate the minds of leaders in the year ahead amid the continued re-opening of the global economy.
What’s next for inflation and interest rates?
While energy supply constraints will have some of the biggest impacts on inflation, there’s also a risk from wider disruptions to supply chains. Ultimately, the longer the Ukraine conflict persists, the greater the effect on global inflation. However, it is worth bearing in mind that supply constraints in oil and mining and the impact of weather patterns on the supply of many crops, pre-date the Ukraine crisis. While a resolution will alleviate some of these issues, it will not remove them.
When it comes to interest rates, the Bank of England, Fed and European Central Bank have all voiced increasing concerns about inflation. While markets expect central banks to raise interest rates further in the battle against inflation, they may have to take action in excess of these expectations which could be even less friendly for markets.
It will be a difficult balancing act for them as higher prices and higher interest rates would weigh heavily on consumer spending and industrial activity – a slowing of activity that the central banks believe will weigh down on inflation. However, it also increases the risk of a recession. Meanwhile, prolonged disruption in the supply chain of goods will increase the risk of inflation rising significantly – opening up the risk of both slowing growth and inflation. The central banking community has a difficult needle to thread this time.
How are supply shortages and disruptions affecting the global economy?
Microchip shortages and international shipping delays have been the two most important constraints on the production and supply of goods since the start of the pandemic. These so-called ‘Intermediate goods and services’ feed into the production and supply of a much wider array of products and so affect their prices. For now, the impact across rail and shipping routes is predominantly in Europe but continued supply disruptions to raw materials will start to have a wider impact globally. If the Ukraine crisis is prolonged, this will also have an impact on sectors hardest hit during the pandemic, such as the car and microchip industries. Russia accounts for almost half the global production of palladium, critical to the manufacture of combustion engine vehicles as well as microchips.
When it comes to energy supply, Europe is the most exposed region. This is due to heavy reliance on Russian gas supply through Ukraine. Although other regions and countries have more diversified sources of energy, any higher prices for raw material will still feed into global electricity costs and filter into the prices of core goods, in turn lifting global inflation.
Historically, events like the Ukraine conflict have triggered temporary price spikes in commodities, like oil and gas that then swiftly fall. So there’s scope for some energy price spikes to be offset by the release of oil and gas reserves, by an increase in production by other countries, or indeed by consumers using less. This would all be helpful to central bankers and to the global economy - but there remains a risk that we could see energy prices rise further – prices which users can ill-afford at the moment.
Can China achieve economic growth despite its debt crisis?
Chinese stock and bond markets suffered weakness and volatility at the end of last year, thanks to additional regulations on many (particularly technology) firms. This is in addition to the growing debt crisis in the property sector – with one of China’s biggest property companies, Evergrande, continuing to hit the headlines as the world's most indebted property company – but one having trouble fulfilling these debt obligations, given the downturn in this market.
However, there appears to be some early signs of relief in the Chinese property market. And, despite continuing Covid lockdowns and restrictions, China’s economic growth is likely to continue to outpace the global average – albeit not by the rate that we’ve been used to.
What lies ahead?
It has been, without question, a difficult start to the year, with several headwinds - some foreseen, some not. It seems likely that global markets are likely to remain turbulent in the coming weeks.
Market focus will be on the consumer’s ability to cope with the cost of living crisis, the progression of inflation and the implications for interest rates. Other key areas of focus will be the profitability of the corporate sector, and crucially, developments in Ukraine. At times like these it’s more important than ever to stay the course when it comes to your investments. It can be difficult to watch the value of your investments fall and you may be tempted to take action to avoid further losses. But if history tells us anything, it’s that market volatility caused by events like the Ukraine conflict and some of the economic headwinds should eventually pass.
If you’re not sure how market and economic events may affect your investments, consider getting financial advice. If you don’t already have an adviser, you can book a free, no-obligation call with one of our financial planners.
The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on abrdn’s understanding in April 2022.