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Weekly investment update – Few certainties

Daniel Morris
By DANIEL MORRIS 10.03.2022

In this article:

    One of the few things that can be said with any certainty about the current market outlook is that volatility will remain high (see Exhibit 1). Markets are being whipsawed by new news, old news, fake news and rumours, and ascertaining likely political or military developments is close to impossible.

    Investors can to some degree quantify the economic impact of the sanctions that have already been imposed and the increases in commodity prices. The declines we have seen in equities partly reflect the expected impact on corporate profits. But they also reflect the uncertainty about any further sanctions and the potential for exports of Russian oil and gas to Europe to be blocked.

    High energy prices: Painful, but not crippling

    The known knowns, i.e., corporate sales exposure to Russia, import and export shares, foreign direct investment, even the spike in commodity prices, argue for only a modest decline in equity indices. For example, Russia accounts for just 1.7% of sales for the companies in the MSCI Europe index. Trade and investment shares are mostly in the low single digits (see Exhibit 2).

    Exposure in the banking sector (and therefore the risk of financial contagion) is also limited, with most countries having less than 1% of their assets in Russian counterparties (Austria, at around 3%, is the sole exception).

    The jump in energy prices has been brutal. Brent crude oil rose by as much as two-thirds recently from its level at the beginning of the year; natural gas more than doubled before dropping back recently. This clearly has significant potential to slow economic growth by reducing consumer demand and squeezing corporate profits via shrunken profit margins.

    The European Central Bank has estimated that for each sustained 10% increase in oil prices, GDP growth could decline by 0.24% at the end of three years. The 60% spike in prices we have seen this year, if maintained, could equate to a drop in eurozone growth of 1.4 percentage points.

    While painful, this does not necessarily spell recession. Most major economies are still recovering from the pandemic lockdowns and GDP growth is forecast to be above average this year and next.

    Central bank inertia

    Another determinant of economic growth and market performance will be the reaction of the central banks. We will learn more about the ECB’s plans this week, but so far, the market expects little change in the near-term policy path compared to expectations prior to the conflict (see Exhibit 3).

    This inertia reflects the realisation that central banks have few tools to address supply-side shocks. The current crisis is clearly inflationary, which would argue for accelerating the pace of rate rises and quantitative tightening, while the impact on growth would argue for slowing the pace. The net result of all that is to remain watchful and cautious, but to not change the original diagnosis and remedy.

    EPS: Deceptive stability

    Interestingly, earnings per share (EPS) estimates for major equity indices 2022 have risen over the last few weeks rather than falling as one might expect. The headline figure is deceptive, however. It reflects two things:

    First, the significant increase in commodity sector earnings estimates, which have been so large that they have outweighed the falls in the other sectors (see Exhibit 4).

    Exhibit 4: Change in 2022 earnings per share (EPS) estimates since 18 February 2022

    Second, it is easier for commodity sector analysts to update their estimates as profits depend primarily on the price of the underlying commodity.

    Forecasting the impact on other sectors of input cost increases is more difficult: analysts of those areas will be more cautious and slower to change forecasts. We foresee further earnings downgrades, particularly in Europe. This would lead the current low price-earnings ratios to rise to less attractive levels.


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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