Summary

• Russia’s invasion of Ukraine has exacerbated a risk off environment. The FTSE All- World Index declined 2.5%, the FTSE All-World High Dividend Index declined 1.4% and the Global Equity Income Portfolio fell 0.6%.
• Inflation expectations are now expected to decline less fast due to sanctions that will be imposed on Russia. All else equal this likely means that central banks continue with their plans to reduce global money supply by raising interest rates and reversing quantitative easing.
• Oil and defence sectors performed strongly.

Markets reacted negatively to the invasion of Ukraine by Russia. Ukraine, formally part of the Soviet Union, gained independence in 1991. Russia annexed the Crimean Peninsula from the country in 2014. Russia has made clear their displeasure at what they regard as NATO’s creep towards their borders. With troop build ups on the border and western governments pulling citizens out of the country in January and early February, we had envisaged that Russia looked likely to annex some further modestly sized, and ethnically Russian, regions of Ukraine’s Eastern front. Full invasion of Ukraine was unexpected. With Ukraine not being part of NATO, and Russia being a nuclear power, direct escalation seems unlikely. We do not expect the war in Ukraine to extend westwards, nor for the USA or NATO to become directly involved in the conflict.  The world has however reacted to condemn the actions of Russia and is in the process of implementing a swathe of sanctions targeted against the country.

During the month the portfolio’s best performing holdings were BAE Systems (+24.7%), Shell (+5.2%) and National Grid (+4.7%). Future expectations for defence spending seem likely to increase given Russia’s aggression. Russia and Ukraine supply a substantial proportion of the world’s hydrocarbons resulting in a higher oil price. Sanctions will result in further increasing inflation expectations. With National Grid providing a large element of inflation, pass through and highly non-cyclical earnings the company’s shares benefited in a flight to safety.

At the other end of the portfolio Hannover Re (7.3%), AT&T (-7.1%) and Merck (-6.0%) were the disappointments. Hannover provided an update to their January 1st reinsurance renewal rates which, along with annual guidance was in line with market expectations. The firm did reduce retrocession coverage, in other words the amount of insurance they buy from other insurance companies to help cover very large loss events, which theoretically increases their risk exposures. However later in the month the company was involved in placing some catastrophe bonds, presumably these provide a cheaper way to obtain the same sorts of coverage. Following on from the disappointing earnings in January, the AT&T share price fell further. We anticipate that March’s investor day will shed further light on the spin-off of Warner Media, and prospects for what we believe to be promising multi-year growth expectations. Merck’s results were ahead of consensus estimates and the mid stage pipeline looks encouraging. Guidance was a little mixed and the lack of late-stage pipeline products resulted in speculation that the firm may indulge in M&A to fill this gap.

War in Europe has had immediate impacts for markets. With both inflation and employment levels both high, central banks would seem obliged to follow through on their plans to reduce global liquidity. Reducing money supply by raising interest rates and actively quantitative tightening ought to reduce asset prices. We remain cautious on equities trading on high multiples.

Written as at 4 March 2022. Commentary covering 01 February to 28 February 2022.