When I drew attention a few weeks ago to the fund’s high cash holding as its greatest strength under current conditions, I was thinking of the need to rein in inflation and the likelihood of further monetary tightening by the main central banks of advanced countries.
A few days later, the specter of war began to scare the markets – and the world.
Vladimir Putin’s decision to tear up the rules of international behavior and launch a full-scale invasion naturally shocked many of us. This has resulted in markets falling as the extent of the damage to Ukraine, Russia and the rest of the world becomes clearer.
There have been far-reaching and extreme market reactions, with energy, grains and some other commodities much higher as investors assess the impact of sanctions imposed on Russia and supply disruptions .
These events will lead to both higher inflation and slower growth in advanced economies.
High inflation erodes purchasing power and reduces discretionary buying as people face a sharp drop in their real incomes. As home heating bills, fuel costs and supermarket food prices rise, many people will need to get their other expenses under control.
Stock markets have generally fallen as the outlook deteriorates. Russian asset prices have collapsed as they are no longer supported by Western buyers. Chinese stocks also suffered a significant drop. This reflects both the new Covid surge in China resulting in more lockdowns and growing US pressure on Beijing to change its stance on Russia. China runs the risk of its much larger trade being punished if it overly supports its Russian ally.
The FT portfolio was helped by the past exit from direct exposure to China, by the large portfolio of indexed bonds offering some protection against inflation and by liquidity.
Global equities and specialized energy transition and digital indices fell along with the rest, as there were few safe havens against the consequences of inflation and war.
Central banks now have to accept a worse outcome in terms of the trade-off between inflation and output. They must recognize that higher energy prices for longer are a kind of tax on consumers, slowing demand and therefore production. The war curtailed air travel, disrupted trade, and shattered confidence. Companies with assets in Russia or trading with Russia experience significant write-offs and loss of revenue.
While the length and intensity of the war is the biggest influence on events, much now depends on how the Fed, European Central Bank, Bank of Japan and Bank of England react to the situation much more difficult.
If they tighten their monetary policy too much with several rate hikes and some reduction in their balance sheets, they will increase the risks of recession, thus reinforcing the impact on incomes that will be felt.
It seems more likely that they will scale back their growing hawkish stance a bit despite continuing to rise in inflation, as they seek to fulfill their mandate of enabling jobs and growth as well as controlling rising prices. .
It is a bad fund for investors. Overall, markets will be lower the longer the war lasts. There will always be highly volatile moves in the prices of everything from oil to defense stocks as news swirls around the prospects of truce or peace and traders begin to sort through a reliable supply of energy and metals and commodities crucial foods.
The West’s response will hurt the Russian economy. Russia will look to Asia and particularly China to replace the market access it is losing due to Western sanctions.
The world will see an accelerated retreat from globalization with more countries and regional blocs seeking domestic or friendly supplies of energy, other commodities and important technologies.
Governments are likely to spend more on energy changes, expanding their armies, and cushioning the effects of inflation. Part will be financed by additional borrowing and part by tax increases. It is also likely that there will be more price controls, state involvement in business and regulations to try to tame unruly markets.
Energy will remain at the center of global concerns. This decade was always going to be a decade of heavy reliance on fossil fuels, with major emerging economies expanding their use and advanced countries taking time to replace domestic gas heating systems, gasoline and diesel vehicles and industry with gas. by renewable electricity.
There will be new efforts to accelerate the electric revolution, but pulling Russia out of the West’s oil, gas and coal supply will lead to tensions.
In due course, a new energy trading pattern and more realistic prices will reappear, which will help calm the stock markets.
The road to net zero requires more ways to store renewable energy to handle days when the wind is not blowing. A combination of hydrogen, pump storage, large batteries and other methods will be deployed to make this possible.
Germany will have to rethink its attitude towards nuclear power and accelerate its transition from Russian gas. The United States will benefit from gas self-sufficiency and significantly lower domestic gas prices.
I will keep running with cash and indexed bonds until we see how central banks react to the twin problems of slowing growth and rising inflation, and as the war continues to do so much damage. The difficult balance that central banks must achieve has become much more difficult to achieve. The sooner the war ends, the better for the people involved and for the markets.
Sir John Redwood is Charles Stanley’s chief global strategist. The FT fund is a fictional portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global equity markets while reducing investment costs. [email protected]