“There’s an east wind coming all the same, such a wind as never blew on England yet. It will be cold and bitter, Watson, and a good many of us may wither before its blast.” – Sherlock Holmes, ‘His Last Bow’
Outside the British Embassy in Moscow stands a statue of Sherlock Holmes. While the quote above is in reference to the outbreak of the First World War, it is perhaps fitting to describe the current crisis in Europe. Russia’s invasion of Ukraine is horrific, and we can but hope for a swift return to peace. But even if that happens, it is likely that the war has marked a long-lasting realignment of political and economic relationships across the world.
Until last month, investors were concerned with whether stubborn inflation, due to ongoing disruption from the pandemic, would bring about an end to the business cycle. Thanks to Putin we will never know if inflation would have turned out to be transitory. In the circumstances that could not matter less. Inflation is now running at its highest level in 30 years and is expected to rise further. Even an immediate peace deal would not resolve the disruption caused to the commodity markets in the near-term.
The impact of this disruption will be felt globally, but most acutely in Europe as it is so dependent on Russian resources. Higher energy costs, higher food prices and higher interest rates should undermine consumer sentiment and reduce economic growth in Europe. Whether this results in a recession or not remains to be seen. But European stock markets recovering to the level prior to Russia’s invasion seems premature.
In the Endeavour Fund, we have been concerned about the prospect of higher inflation for some time and have been overweight energy and mining sectors accordingly. Long-term investments, such as Shell and Anglo-American, will not only benefit from higher oil and metals prices but will also play a crucial role in the energy transition in the long-term thanks to their exposure to natural gas and copper. More recent additions, Freeport-McMoran and Norsk Hydro, are more explicitly exposed to the disruption in supply from Russia.
The US remains relatively better insulated than Europe from the economic impact of war in Ukraine. Despite an increasingly hawkish Federal Reserve ready to sacrifice growth to bring down inflation, there are sectors that are attractive to investors. For example, capital equipment companies offer exposure to a likely investment impulse in the energy and mining sectors; financial stocks, like Bank of America and Charles Schwab, can benefit from higher interest rates; and the healthcare sector should be less prone to consumer sentiment and inflation.
Risks to the business cycle from an aggressive interest rate hiking cycle now under way are considerable. But the resilience of the US economy, supported by strong household and corporate balance sheets and a tight labour market, has much to recommend it at this juncture.
With regards to geopolitics, I would not be so bold as to make predictions. However, after the strains caused by the Iraq war, the Trump presidency and Brexit, now is surely an opportunity for the West to galvanise, and trade agreements are one way to do that. And while the BRICS nations are worryingly silent in their condemnation of Russia’s actions, the West’s economic response to Putin’s aggression may serve as a reminder to them of the strength of the Western economies.
Our duty to our clients is to generate the best possible risk-adjusted returns for their investment. It follows that this means not only investing to protect from the fallout caused by this war, but also to deploy where economic and corporate activity have the best chances to prosper. And in so doing we hope that the second part of Sherlock Holmes’ quote may also be relevant to the situation we find ourselves in:
“But it’s God’s own wind none the less and a cleaner, better stronger land will lie in the sunshine when the storm has cleared.”
