The kōura market wrap for February

08 March 2022

The kōura market wrap for February

It's all eyes on Ukraine, the impact on the markets, what it means for your KiwiSaver, and possible scenarios of how things will play out

It won't be a shock to anyone that the markets had a tough time with global stock markets falling 7.40% for the month, wiping out all returns for the year. Both January and February were challenging months for the US stock markets, with those discomforts now having spread into Europe as the reality of the Russian invasion in Ukraine struck home. 

Unfortunately, this means KiwiSaver balances have continued to fall in the month taking the year to date losses to almost 8% for a KiwiSaver in a growth fund equivalent. Being an investor during times of market volatility can be tough and stressful, however the most important thing to remember is to stay calm and stick to your investment strategy. Trying to guess where stocks will go from here or changing your strategy to “time the market” is extremely difficult and more often than not you’ll end up missing out because you got the timing wrong. 

One piece of good news is that the New Zealand market held up well during the month and delivered a positive return, one of the only markets in the world to do so over the month. 

And for the first time in almost 12 months, we won’t be repeating our story on interest rates and will instead stick to Russia-Ukraine updates.

 

February market returns


 kōura Growth Fund based on a typical 80:20 mix, NZ Equities 20%, US Equities 35.4%, Emerging Markets 8.4%, Rest of World Equities 16.2%, Fixed Income 20%. The kōura funds are impacted by currency (translation of local currency indices to NZD) and also differences in constituents between the underlying indices and the actual investments that the kōura funds invest in.

 

How did the market react to Russia’s invasion of Ukraine

Amazingly, global stock markets managed to shrug it all off and were in positive territory. Market strategists clearly agreed with Putin’s analysis that the war would be short and sharp accompanied by a very limp international reaction - a week into the invasion, global stock markets were up almost 3% and were still focused on interest rates. 

This was short-lived however and the calculus changed as the international community stepped up and the Ukrainian defences appeared surprisingly robust. The war looks as though it will drag on for a while and we have seen the strongest set of sanctions ever imposed on a large economy (Russia is the world’s 11th largest economy). Surprisingly it appears that European politicians will be willing to put the plight of the Ukrainian people ahead of their own energy supply, something that was unthinkable only a few weeks ago. 

Over the past week, markets have given up all of their gains and are now trading slightly below pre-invasion levels. Unsurprisingly, European markets have fallen sharply, now down 10% since the invasion started - reflecting the fact that they are likely to bear the greater brunt of the economic fallout.

Traditionally market commentators have said “Buy the invasion and sell the peace treaty” implying that markets overreact to the bad news of an invasion and then overreact to the good news of a peace treaty, though it seems this time the market clearly got it wrong and have miscalculated where things might end up.

 

What are the impacts we are starting to see from the Russia-Ukraine conflict?

Whilst the Russian market is smallish in size and not material from a consumption perspective, Russia and Ukraine are still critical suppliers of global commodities:       

  • Russia produces c.17% of global natural gas supplies and c.12% of global oil supplies and
  • Ukraine and Russia combined makeup over 25% of global wheat exports; and
  •  Russia provides over 30% of Europe’s energy supplies through its oil and gas pipelines 

This creates the potential for significant disruption across a number of levels:

1. Higher oil prices

Oil makes up c.3% of global spending so as the cost of oil increases, it means that consumers and companies have less to spend on other things. Traditionally rises in global oil prices have been contributors to global recessions as spending on other things dries up.

The oil market is already in a tight supply and demand position, the very strong global economy is driving up demand for oil while a number of oil wells were shut down in 2020 as a reaction to the covid crash. Oil is currently sitting at $116/ barrel, its highest level since 2014 though it’s likely to go even higher if Russia is fully shut out of the global oil market.

2. A shortage of energy in Europe

Russia provides the majority of Europe’s energy supplies through its network of pipelines. Norwegian and UK oil and gas fields are older and are coming to the end of their lives. Replacing the Russian supplies would require a significant amount of infrastructure to be built (LPG terminals and additional pipelines from the Middle East) which would take years to complete.

Any shut down in supply from Russia would cause significant energy shortages and spikes in energy prices in Europe. Even during the cold war energy was never used as a bargaining tool between Europe and Russia, so has shocked everyone that this is now on the table. It is unlikely that markets have yet priced in (a fancy way of saying investors haven’t yet ‘anticipated’ the future value) a full termination of Russian energy exports.

3. Higher global food prices

Being some of the world’s largest wheat exporters, buyers of those goods now have two big problems. Firstly, many are unsure whether / how they can purchase commodities from Russia given they have been cut out of the banking system, and second, there is a high risk that the Ukrainian crop will be destroyed in the war.

Wheat prices are up over 60% since the start of the year and continue to climb.  The Middle East is one of the largest importers of grains from Russia and is therefore particularly susceptible to higher food prices. Many countries have policies of subsidising bread and other core commodities as a way of keeping people happy, but rising food prices or even worse food shortages almost always lead to civil unrest.

 

Where does all this leave us?

Unlike previous sanctions regimes and penalties placed on authoritarian leaders, this is different, everyday consumers around the world will start to feel the pinch through higher energy and food prices. If energy supplies out of Russia are shut down, it is highly likely that Europe will start facing blackouts as they will not have enough oil and gas to supply their power plants. 

The big question on people’s minds is will politicians have the will and desire to inflict further pain on their own populations to help Ukraine, and for how long will that desire last. 

It is impossible to see what will happen from here, it could get better, or it could get worse. I see three potential scenarios falling out:

  1. Things may escalate further – Putin gets put into a corner and there is nothing more dangerous than a wild animal backed into a corner. Normal political calculations don’t apply to Putin. It also doesn’t help that we have a US President who could use this crisis as a way to rebuild credibility after his economic agenda was bought to a crashing halt last year - which is even greater of a risk given the US is largely insulated from the Russian energy and food markets. Under this scenario markets will fall further.
  2.  Everything gets resolved pretty quickly - you can easily see a situation where the invasion is completed quickly, and European politicians start to worry about the impact of sanctions on their own voters and quickly reverse course and restart the flow of money back into Russia. Under this scenario, we would expect a quick market recovery
  3. We have a long-term stalemate – Russia continues to trade oil with China and other friendly states and Europe continues to import natural gas. Under this final scenario, nothing much changes and everything keeps on bumbling through. This is what markets are currently pricing in

It could be a great time to invest, or it could be a terrible time to invest. It is impossible to tell from here where the market will go and successfully picking the bottom is extremely difficult. KiwiSaver is a long-term investment and therefore the best course of action is to calmly wait it out and see what might happen next.

 

Kōura and Russian holdings

Kōura’s Emerging Markets fund did have a small holding in 4 individual Russian companies. They made up less than 0.5% of the fund. These companies have now been removed from the indices that we invest in and therefore Blackrock is in the process of divesting these holdings. 

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