February Issue 2022
30/03/2022
Summary
Almost two weeks after Russian armed forces first invaded Ukraine, the conflict continues to dominate current events. Vladimir Putin has not achieved the swift conquest he had hoped for, and Russia instead finds itself increasingly isolated, both politically and financially.
Equity Snapshot
| United States | • | US equities sold off in February, with volatility remaining elevated. The S&P 500 Index touched its lowest level since June 2021, as sentiment was hurt by fears that the Federal Reserve (Fed) would be more aggressive in raising interest rates and news that Russia had invaded Ukraine. When added to US equity losses in January, the sell-off took the S&P 500 Index into correction territory, defined as a decline of 10% from a recent peak. While large-cap stocks retreated, smaller companies fared better, posting modest gains. Meanwhile, the rotation from growth to value continued. |
| • | Minutes of the latest FOMC meeting highlighted the Fed’s determination to combat stubbornly high inflation, which remains well above the official 2% target. With the jobs market buoyant, investors moved to price in up to six rate hikes in 2022, including the prospect of a 50-basis-point increase in March. Such a move would mark the first half-percentage point hike in rates in more than 20 years. | |
| Europe | • | European equities fell sharply in February, as Russia’s invasion of Ukraine rattled investors. European gas reserves are currently around a five-year low and the region is seen to be vulnerable to supply disruptions, as it relies on Russia for about a quarter of its oil and more than a third of its gas supplies, although dependency varies considerably between countries. The EU announced wide-ranging sanctions targeted at Russia’s banking system and oligarchs, with even Switzerland, a bastion of neutrality, adopting the measures. The sell-off took the EuroStoxx 600 Index into a technical correction, defined as a decline of 10% from a recent peak, with the index hitting its lowest point since May 2021. |
| • | With euro-zone inflation hitting a record high of 5.1% in January, European Central Bank (ECB) president Christine Lagarde acknowledged that inflation risks were “tilted to the upside” and declined to rule out that rates may be raised later this year. The heads of the German and Dutch central banks pressed for the ECB to wind down its bond-buying programme. However, while the ECB’s chief economist noted that euro-zone inflation was unlikely to drop below the 2% target in the next two years, he drew a distinction between likely policy normalization (ending asset purchases and raising rates to zero) and more drastic monetary tightening. | |
| Asia | • | Equity markets in Asia were mixed in February. China equities slid further. Economic data shows that inflationary pressures in China are moderating, with both producer prices and consumer prices decelerating in January, providing favourable conditions for monetary easing. Hong Kong equities also declined, as the territory suffered its worst COVID-19 outbreak to date. With oil prices surging above USD 100 a barrel, commodity exporters, such as Indonesia and Malaysia, rallied, while net oil and gas importers, like Philippines and India lagged. Elsewhere, in Taiwan and South Korea, returns were positive. |
| Bond | • | US bonds sold off in February amid speculation that the Federal Reserve would need to be more aggressive in raising rates to tackle rampant inflation. The 10-year Treasury bond traded above 2.0% for the first time since summer 2019, while the yield on the two-year note briefly rose above 1.6%, a level last seen in late-2019. While news that Russia had invaded Ukraine provided some support for US bonds, as investors sought safe havens, yields still closed the month higher and the yield curve continued to flatten. Treasury Inflation-Protected Securities rallied modestly, outperforming nominal Treasuries. The minutes of the latest FOMC meeting highlighted the Fed’s determination to combat stubbornly high inflation, which remains well above the official 2% target. |
| • | European bonds declined in February as the European Central Bank (ECB) appeared to adopt a slightly more hawkish stance regarding inflation. In Germany, the yield on the 10-year benchmark bond moved decisively back into positive territory and briefly traded above 0.3% for the first time since late-2018. Yields on peripheral euro-zone bonds rose even more: Italian bond yields are particularly sensitive to rising rates due to the country’s high debt burden. | |
| Outlook | • | Almost two weeks after Russian armed forces first invaded Ukraine, the conflict continues to dominate current events. Vladimir Putin has not achieved the swift conquest he had hoped for, and Russia instead finds itself increasingly isolated, both politically and financially. This is in large part due to the resilience and courage of the Ukrainian people, as well as the combined will of various nations to impose sanctions and send aid. |
| • | We can only hope that these measures bring about a swift and peaceful resolution. In the meantime, as investors, it is our job to analyse the consequences of this war as they play out in financial markets. One thing is clear, for as long as the conflict persists, global equity markets are likely to be driven by short-term narratives and sentiment, rather than underlying fundamentals. | |
| • | The primary datapoint currently driving these narratives is inflation. Russia produces around 10% of the world’s oil and supplies 40% of the EU’s natural gas . Ukraine is one of the largest producers of wheat and corn, making up for 12% and 17% of global export supply, respectively . Combined, the two countries also supply large quantities of industrial metals such as copper, nickel and palladium, as well as the noble gas neon. | |
| • | Shortages across such a broad array of natural resources will inevitably drive-up prices and constrict supply chains, increasing the risks to economic growth. Producers of energy and commodities (particularly those with limited exposure to Russia and Ukraine) are likely to be the biggest beneficiaries in the short-term, prolonging a market rotation towards cheaper cyclicals that began in the abeyance of the Omicron variant. Defence names are also seeing strong support, as are traditional safe havens like Health Care and Consumer Staples. | |
| • | Consequently, this earnings season is commanding investors’ attention more than most. However, investors are choosing to focus less on the ability of companies to meet or even beat expectations for the current quarter, and more on their forward looking guidance. Only companies that are able to provide a high degree of visibility around future growth profitability are being consistently rewarded. For example, in the portfolio, Visa raised its growth expectations to pre-pandemic rates and has seen its shares gain significantly. By contrast, Atlas Copco’s more conservative guidance around supply-chain issues – despite rising revenue and earnings – has weighed heavily on the shares since earnings. | |
| • | Our preference for quality growth companies, combined with our exclusion policy, means we have no exposure to either Energy or Defence. However, in the portfolio, names with a more defensive profile like the Cooper Companies (contact lenses and women’s health), Unitedhealth Group (health insurance and managed care) and even Amazon (ecommerce and tech) have proved resilient, delivering positive returns over the month. | |
| • | Perhaps more significantly, names that derated solely due to sentiment continue to post strong underlying fundamentals that are well ahead of expectations. The payments company Visa, for example, recorded revenue and adjusted EPS growth of 25% and 27%, respectively. Assa Abloy, the maker of locks and entry systems, posted a sales and earnings beat thanks to 5% price rises in Q4. This is a common theme across our franchise holdings: while margins may see temporary pressure, the strength and appeal of their offering means they continue to have the pricing power necessary to offset inflationary pressures longer-term. | |
| • | Ultimately, the complex, multi-faceted nature of events in Ukraine means that predicting any outcome with certainty is impossible. This applies as much to the military aggression on the ground as it does to the consequences in financial markets. As a result, in portfolios we are maintaining our focus on fundamentals more so than ever before. We have made no knee-jerk reactions to our holdings and continue to look for quality growth names in which we can invest for a minimum of five years. | |
| • | Our globally diversified approach, with a preference for asset-light business models, strong managements and pricing power, means holdings are well-positioned to deal with crises. Indeed, in the past two years alone, many have shown they can not only endure but thrive during a global pandemic. As companies look to provide ever greater clarity over the coming months, we will remain true to our long-term approach. | |
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Sources: 1 Eurostat 2 Bloomberg 3 Office for National Statistics
Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to revise any information herein at any time without notice.
No offer or solicitation to buy or sell securities, nor investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice. Investment involves risks, in particular, risks associated with investment in emerging and less developed markets. Past performance is not indicative of future performance.
This material has not been reviewed by the SFC in Hong Kong and is published for information only.
Issued by Allianz Global Investors Asia Pacific Limited.
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March Issue 2022
25/04/2022
Summary
Over a month has passed since Russian armed forces first invaded Ukraine. While the initial shock of the invasion has now passed, each day brings new stories of human suffering and courageous defiance.