There is no doubt that the onset of the conflict in the Ukraine led to increased inflationary pressures across the globe, arguably setting the scene for a deeper drawdown on global equity markets than had been experienced up to 24 February, the date of the invasion.
For example, the S&P 500 was down 12.82% on 8 March 2022 from its high this year. Similarly, the MSCI ACWI was down 13.35% from its highest point. The ALSI, on the other hand, was only down 8.82% in rand terms – 7.7% in dollar terms – with this low reached on 15 March.
The Ukraine conflict also caused US bonds to have suffered their worst first quarter in decades, reflecting to some extent, deeper concerns over inflation. However, investors remain wary of investing in shorter-term assets such as cash, given its negative real returns even as policy rates start to normalise.
For now, investors have seemingly ignored systemic risks caused by economic fallout from the conflict and opted to invest in equities (especially during the period of sell-off as a more favourable entry-point) which many analysts and portfolio managers believe would be the best defence against inflation and rising interest rates.
The duration of the war in the Ukraine remains uncertain, with a wide range of possible outcomes. On the one hand, a deteriorating and lasting conflict could add to systemic risks in international markets, predominantly in the form of even higher global inflation, the deglobalisation of trade, and a focus on self-preservation. This would eventually be fully priced into risk assets, posing a potential headwind to the future performance from equities.
On the other hand, a speedy and globally acceptable resolution to the conflict would result in a partial dissipation of systemic risks, promoting a resumption of high single digit earnings growth that was forecast for the S&P 500 index immediately prior to the onset of the war.
There is an apparent irony that, back in South Africa, the domestic economy, equity market and local currency have benefitted from the fear of a systemic fallout from the Ukraine conflict, whereas SA systemic risks, a few of which are highlighted in our Local News section below, are seemingly being ignored.
Should the conflict in the Ukraine be resolved in a way that reduces global systemic risks, the focus for investors in South African asset classes will shift once again to our own homegrown systemic risks. At some stage, local markets will have to account for these risks in the form of a rerating of the pricing of local assets, which would reverse the resilience witnessed this past quarter.
“There may still be vulnerabilities lurking that aren’t immediately evident, and we won’t know their nature until shocks expose them. That’s sometimes how [systemic risk] works.”
– Richard Berner, NYU financial professor
“For something to create problems for a complex system, it has to be integrated into it. Russia just isn’t that integrated into the global financial system.”
– Richard Bookstaber, veteran risk management expert
- Markets have been incredibly resilient in the face of ongoing conflict in Eastern Europe, with only a modest fallout thanks to the west’s financial warfare against Russia. This is despite commodity markets being chaotic, stoking already uncomfortably high inflation. Global economic growth forecasts have been marked down as a result, and many businesses face big hits from their exits from Russia.
- Investors and analysts have been surprised at the remarkably modest fallout of the global financial system, and the lack of broader, more serious reverberations thus far with most major equity indices having recovered beyond their pre-war levels. The Vix volatility index – a proxy for how much fear there is in markets – has slipped below its long-term average, indicating a fall in anxiety.
- With the war pushing up oil prices, Stanlib has determined that a $30/bl sustained increase in the oil price would lower global growth by 0.4% in 2022 and 0.6% in 2023. It says the elasticities of real GDP growth with respect to changes in natural gas prices are more negative for Europe. This, combined with record highs in natural gas and coal prices, would reduce growth in Europe by at least 1.5% of GDP in 2022 and 2023, with most of the adverse impact in 2023.
- Germany has triggered an emergency plan to manage gas supplies that could see it ration power if a standoff over Russia’s demand to pay for fuel with rubles disrupts or halts supplies. Moscow’s insistence on ruble payments for Russian gas, which meets a third of Europe’s annual energy needs, has galvanised others in Europe. Greece called an emergency meeting of suppliers, the Dutch government urged consumers to use less gas, and the French energy regulator told consumers not to panic.
- Russia’s second-largest lender, VTB, hit by Western sanctions against Moscow actions in Ukraine, has sold a ton of gold to customers this month and expects demand to rise.
- In America, gross domestic data was revised earlier in the week to take into account the Eastern European war, as fourth quarter data was initially issued before the conflict. Despite this, there was a big decrease in consumer spending. Lower income US households have spent their pandemic savings, and demand should therefore normalise. The supply of goods to the US hit all-time highs as Korean February production data was stronger than expected, but this excess supply has ended up in US warehouses.
- Afghanistan’s last finance minister, Khalid Payenda – who oversaw a $6 billion budget – is now an Uber driver after fleeing the country. In this Washington Post article, Payenda details his life before and after Afghanistan fell to the Taliban after the US pulled out in August 2021.
- A Bermuda court has ruled that former Georgian prime minister Bidzina Ivanishvili and his family are due damages “substantially in excess of $500 million” from Credit Suisse’s local life insurance arm in a costly setback for the bank. This is because of a long-running fraud committed by a former Credit Suisse adviser, Pascale Lescaudron.
- This week’s news focuses on escalating systemic risks to the domestic economy caused by persistent financial mismanagement, poor policy making, and a lack of structural reform. However, for the time being, these inefficiencies have been papered over with a commodity price boom that has resulted in improved fiscal and debt metrics, together with a stronger rand.
- The country’s largest political party has set a poor example with its own financial mismanagement: The South African Revenue Service slapped the ANC with a R102 million bill for unpaid taxes that had to go to the high court to get paid. The political party has subsequently made payment arrangements to settle R80 million in arrears.
- Financial mismanagement by the ruling party has spilled over into provinces being unable to pay bills. The Public Service Commission’s latest quarterly report shows the Eastern Cape and Gauteng – both led by the ANC – are the leading provinces not paying suppliers on time. The Eastern Cape has shown a sharp rise in unpaid invoices from 4 648 in September 2021, to 24 887 as at 31 December, totalling more than R2.585 billion. The second highest offending province was Gauteng with 5 550 outstanding invoices at the end of December 2021, totalling R1.061 billion. Contrast these numbers with the DA-run Western Cape where there were only five unpaid invoices totalling R930 887 as at year-end.
- Gold production at Sibanye-Stillwater has ground to a halt because of a pay strike by two of the largest unions. Ongoing delays at the mine, one of the world’s leading producers of precious metals, may mean the group misses out on the commodity price boom.
- This comes as the South African coal, chrome, iron-ore and manganese mining sectors lost between R39 billion and R50 billion in export earnings last year, according to chief economist Mike Schussler, as Transnet struggled with capacity to rail bigger volumes of these commodities to ports.
- The long-term future of the Unemployment Insurance Fund is at risk as the short-term financial support system for out-of-work South Africans is paying out more than it brings in. While investment income ensured the fund remained in surplus in the nine months to end-December, the trend – which has never been seen before – has raised enough concerns for its actuaries to compile a report on its long-term sustainability. The size of the surplus has dropped about a fifth in the past two years.
Sources: Dynasty, News24, BusinessLive, Financial Times, Wall Street Journal, Business Day TV, Reuters, Washington Post, Daily Maverick, ITWeb, Engineering News, etc.