In the second of this two part series, Mark Clubb, Executive Chairman of TEAM plc, discusses the financial implications for investors following Russia’s invasion of Ukraine
In part one of this two part series, we looked at the impact of the invasion on global economies and changing politics. Today, we look at what investors should do.
What should investors do?
Here’s our advice: If you own strong long term growth and financed companies you probably want to fight the urge to sell.
At TEAM we had deployed a more defensive stance for our range of multi-asset strategies coming into 2022. This included significantly dialing-back equity risk to lower-than-average cycle levels (approximately 38% for Balanced and 55% for our Growth strategy). We also significantly increased our exposure to absolute return funds, gold, commodities, and volatility, all of which have performed well year-to-date. Currently, if your portfolio is invested outside the TEAM Multi Asset Models. I would welcome a discussion outlining the benefits of aligning your portfolio to the appropriate and suitable model.
So many times, investors sell in a panic, only to find out that they didn’t really save themselves from anything. They may simply lock in losses. We are currently seeing that behaviour in the equity markets.
Let’s start with the tech or growth market, Nasdaq.
To qualify as a bear market, an index or sector must fall at least 20% from a price peak. Based on that simple definition, no fewer than approximately 66% of the 3,650 Nasdaq shares suffered a bear-market decline during the last 12 months! Plus, more than 50% were 40% or more below their peak levels of the last year.
There is plenty of historic data and research that concludes, that buying the stock market after a correction, such as we have seen, is a great investment strategy for anyone looking to invest for 12 to 36 months and beyond.
If you look at the 25 corrections in the largest stock market of the world, the U.S., since 1950, the average 12-month forward return from the date the S&P 500 (U.S.) entered correction territory is about 5%, while the average three-year forward return is about 27%.
Excluding recessionary periods, the average 12-month and three-year-forward returns are 10% and 32%, respectively for the S&P 500. I would add that looking at the past also suggests that corrections are not necessarily the bottom. Shares often continued to fall but only for a few months.
This is further evidenced when we look at a specific company, such as Amazon. Since the year 2000 the Amazon shares have suffered multiple 30% corrections, a few 30% and even back in 2001 a 90% fall. After every single one, Amazon shares went on to new highs. Why? Because the company itself matters much more than the broad market, the economy, or anything else.
If a business is innovative, provides value to customers, outperforms the competition, has an efficient, scalable business model, and operates in a powerful secular trend, the overwhelming likelihood is it will grow substantially as will the value of its shares.
When we look at the major stock markets we tend to look to the U.S. for guidance.
“America sneezes and the rest of the world catches pneumonia”
The S&P 500 is now valued at circa 18.8 times earnings. That is roughly in line with its five year average forward earnings multiple. Meanwhile, even though the 10-year Treasury yield has shot up, it’s still below 2%.
Put those two facts together and that is a compelling valuation backdrop for shares as long as earnings remain healthy.
In times like these it is easy to lose sight of that fact when you’re watching the stock market fall on a daily or weekly basis. It is easy to want to sell everything and wait until the storm passes.
But that’s not what the great investors do. They stay with high-quality stocks they already own, confident in the long-term growth of the companies they own. That is what we do at TEAM.
Can we predict the future from past experiences?
To return to the Ukrainian conflict, looking back at 54 crisis events since 1907, the Dow Jones Industrial Average has fallen an average of -7.1% during the crisis period, according to global investment research firm Ned Davis Research.
The same research from Ned Davis shows that the Dow gained an average of +9.7% in the six months following a crisis. Similarly, data compiled by BMO shows that the S&P 500 has averaged an +8% return in the 12-months after a geopolitical conflict commences. The fact that stocks rallied on the day of the Russian invasion is not that surprising.
When you look back, the Korean War, Vietnam, the Cuban Missile Crisis, the Iran/Iraq War, two U.S. wars in Iraq, and so on, it was only World War II that resulted in a bear market.
Some may recall that when Russia invaded and annexed Crimea in 2014, the S&P 500 continued to move higher, and did so for years.
I am not for a minute suggesting armed conflict with innocent civilian casualties is a positive or bullish scenario. I am pointing out that it is the uncertainty leading up to a conflict that tends to precipitate market falls. Once the conflict is averted or fighting breaks out, the uncertainty fades and markets can start to price in the effects on corporate earnings, financial markets, and global economic growth.
“Buy to the sound of cannons, sell to the sound of trumpets”
Nathan Mayer Rothschild, founder of NM Rothschild & Sons, is said to have uttered these words during the Napoleonic wars: “Buy to the sound of cannons, sell to the sound of trumpets.” Mr. Rothschild is said to have made ‘a million’ or ‘millions’ out of his early information about the Battle of Waterloo.
We need to stare reality in the face. The world and investment conditions are always changing. Today, they have and the results are:
- Increased volatility in the investing world, which not only will disrupt many businesses, but also will create opportunities
- Increased inflation.
- Increased conflict among international trade partners
- Increased caution among investors.
As written above prior to the Ukraine conflict, the stock markets had already fallen, the cause or concern being rising interest rates to combat surging inflation and the resulting anticipation of the global economy slowing to even going into recession or stagflation.
The U.S. Federal Reserve, alongside most other central banks across the globe, has made it priority number one to fight inflation. Inflation is slow motion theft destroying the value of money.
If inflation continues to accelerates with spiking commodity prices, that could cause Central Banks to move more aggressively in interest rate policy.
This potential for more aggressive tightening is what introduces the risk of a recession. Higher interest rates are a bit like a chemotherapy cancer treatment. Yes, the chemo kills the cancer, but it also kills the surrounding healthy cells too. In a similar way, yes, higher rates can reduce inflation, but they also threaten to kill off business activity and economic growth.
If interest rates rise too much, in a slowing economy, it increases the risk of stagflation and a recession.
The Russian invasion of the Ukraine has created much geopolitical and economic uncertainty, at a time when fears of an economic slowdown were already gathering pace. This may force Central Banks to move much more slowly and cautiously regarding its monetary tightening path in 2022.
As our colleagues at JCap have identified, the market would seem to agree with this. Before the invasion, traders were pricing in a 40% chance that the U.S. would increase interest rates by 0.5% in March, with the consensus belief that they will then make a further six to eight rises over this year.
Now, traders believe there is less than a 5% chance of a 0.5% move in March, while consensus expectations have dropped to five to seven rate hikes for 2022.
JCap expect rates to still increase but the pace of increases is likely to be less aggressive than was thought a couple of weeks ago, however the inflationary implications of higher energy prices means that interest rates may stay elevated for a longer period.
The possibility that either the UK or the US will raise rates by more than 0.25% at their respective meetings in March is now low but successive rate hikes at the next two meetings are still on the cards.
This could be supportive of an equity market recovery.
We don’t think it is time to start stockpiling gold bullion yet and preparing for the end of the world. Although we do have insurance. When it comes to surviving a bear market, no other ‘insurance policy’ is like gold. Across our range of TEAM multi-asset strategies, we currently hold anywhere between 6% and 10% in a physically backed gold security.
Heightened cyber security
Lastly and more specifically, an area that is sure to see heightened demand is cyber security.
This is a part of the market we at TEAM have been bullish on for a long time. In the TEAM International Equity Fund cyber security company Crowdstrike was one of our first purchases and is circa 2.25% of the Fund.
Here’s what the BBC reported recently: ‘Ukraine has been hit by more cyber-attacks, which its government says are ‘on a completely different level’.’ Earlier on Wednesday, the websites of several Ukrainian banks and government departments became inaccessible.
At the same time a new ‘wiper’ attack, which destroys data on infected machines, was discovered being used against Ukrainian organisations. The incident represents the third wave of attacks against Ukraine this year, and the most sophisticated to date.
The reality is that modern warfare isn’t just fought on battlefields between people, guns, missiles and tanks. It is also fought in the cloud between computers.
Many believe that the current Russian invasion of the Ukraine could involve Russia attempting cyberattacks on the U.S. and EU in the coming weeks, if they haven’t already done so.
The threat of such attacks emphasizes the need for next-generation cybersecurity systems to defend government, corporate, personal and intelligence data.
At times like these best to heed the advice of Rudyard Kipling: “Keep your head when all about you are losing theirs.”
The information contained on this website and any resources available are not intended as, and shall not be understood or construed as, financial advice. The publisher is not an attorney, accountant or financial advisor, nor are they holding themselves out to be, and the information contained on this website is not a substitute for financial advice from a professional who is aware of the facts and circumstances of your individual situation.