Russia’s invasion of Ukraine and heightened geopolitical tensions have led to steep falls in local assets, sent commodity prices soaring and led many investors to shift to a risk-off stance.
In our multi-asset portfolios, we have reduced our tactical risk positions in European and emerging market equities to neutral and moved into cash, while keeping the option open for further reductions should the situation deteriorate.
We increased our short duration position in US Treasuries given our cautious view on core bonds in the face of strong domestic inflation pressures. Longer maturity bond yields appear much too low to us even as geopolitical risks have pushed real rates lower.
Longer term, we question the role of government bonds as a source of diversification for multi-asset portfolios. Yields at or around 50-year lows offer little as a protective buffer. All the ingredients for higher yields are here including acute labour shortages and an oil price shock on top of the inflation generated from the pandemic.
It is not clear that it is time to buy broader equity risk; further escalation of the conflict will impact earnings considerably, with Europe hardest hit. The longer the conflict continues, the greater the downside risk to growth and earnings. We expect equity analysts to begin to incorporate a more downbeat growth outlook into their forecasts.
Declines in equities this year have primarily been driven by normalising valuations. We will need a stabilisation of the geopolitical situation and a clearer assessment of the earnings outlook before we can determine whether valuations are truly attractive.