April 18, 2022
It’s difficult to look away from the tremendous suffering witnessed daily in Ukraine. Beyond the unfolding human catastrophe, the war has also had far-reaching effects on capital markets and the global economy.
Coming into the year, a broad-based recovery in consumer demand, combined with COVID-related supply chain disruptions, was pushing prices higher. Unemployment was plumbing lows last seen in the 1950s and with workers scarce and job openings plentiful, wages were rising at an accelerating pace. Home prices, too, were climbing, with eager home buyers vying for a limited supply of houses.
Then the Russian invasion of Ukraine in late February caused already high fuel and food prices to skyrocket, spurring inflation to its most elevated levels in forty years.
In response, the Federal Reserve has grown more aggressive in its plans to fight the wage-price spiral by making borrowing more expensive. The minutes from the Fed’s March meeting signaled an aggressive campaign of interest rate hikes, as well as an unwinding of the bond-buying program (“quantitative easing”) that has helped keep interest rates low since the pandemic began.
In Europe, economic output is being impacted by the conflict in Ukraine and growth estimates for the region are being cut. Moreover, Ukraine’s fierce resistance to the Russian invasion has upended expectations for a quick resolution, adding to the pervasive climate of uncertainty.
Clouding things further, a resurgence of COVID in China has put tens of millions of people under lockdown and renewed constraints on global manufacturing and supply chains.
Financial markets saw a widespread increase in volatility during the quarter, with large daily price swings. Global stock indices slumped at the outbreak of war, though declines had been trimmed to single digits in most markets by the end of March.
Bond investors, meanwhile, experienced their biggest losses in two decades. Sharp increases in interest rates have reduced the present value of future cash flows, impacting the valuations of bonds, with their fixed interest payments. Longer maturity Treasury and investment-grade securities were hit especially hard.
Investors’ growing risk aversion also hurt growth stocks, particularly tech, and speculative assets such as cryptocurrencies. The sole asset class to generate positive returns during this period was commodities (including precious metals). In the equity market, oil and gas producers, mining companies, and defense contractors were among the few stocks that enjoyed gains.
This environment has been particularly tough for socially responsible investors. ESG portfolios typically avoid fossil fuel and other extractive industries, along with weapons manufacturers. They also tend to have more invested in technology and other growth stocks.
With oil and defense stocks soaring and growth stocks tumbling, major ESG benchmarks such as the MSCI All Country SRI Index and the S&P 500 Sustainability Screened Index lagged the broader market, as did our equity portfolios.
Our bond holdings, on the other hand, benefitted from being defensively positioned in shorter than average maturities, reflecting our concerns about rising interest rates. As a result, they suffered less severe losses than the overall fixed income market.
Alternative Strategy funds are an additional tool in defending our portfolios from inflation. They complement our traditional bond holdings by providing stable returns without the sensitivity to rising interest rates that can be so damaging to bond investors. The Alt funds in our portfolios fully met this mandate, holding their ground as fixed income securities fell in value, and helped to cushion our portfolios from the bond market rout.
Although the global economy continues to rebound from the pandemic-induced recession, early indicators suggest that ongoing supply problems, inflation, and central bank tightening, are hampering the pace of recovery. Some countries will be more affected than others. Nations that rely on Russian oil and gas (Germany and much of the EU) or Ukrainian grain (Africa and the Middle East) are likely to face severe shortages and spiraling prices.
Asia is grappling with renewed COVID outbreaks and a resulting slowdown in manufacturing. In an effort to offset this drag, the People’s Bank of China has announced an easing of monetary policy, but forecasts for Chinese growth are being scaled back.
The near-term outlook for the US is brighter. A tight jobs market, solid consumer and corporate balance sheets, and the lingering effects of fiscal stimulus will support US growth, albeit at a slower pace than last year.
With interest rates moving higher, both bond and stock markets are likely to experience continued volatility. Equity investors will have to rely on company revenue growth rather than rising stock valuations to generate investment returns. Bonds will probably be under pressure until inflation risks diminish.
Much of this has already been factored into securities’ prices and, while we expect the coming months to be challenging, we have learned from experience the futility of trying to time the market. In twenty years of managing portfolios at LongView, and four decades in the investment business, we have found that the most successful approach in times of market turbulence is to stay invested while using downturns as opportunities to rebalance, harvest tax losses, and optimize holdings in order to be positioned for the recovery.
As ESG investors, we face some additional considerations. Low carbon exposure has benefitted ESG funds for much of the past decade, and socially responsible investing has grown rapidly. However, sky-high oil prices and a flourishing military-industrial sector will no doubt test the resolve of many responsible investors. We do not expect elevated fossil fuel prices to last indefinitely, and we believe that companies with strong revenue growth, low environmental risk, and good governance will continue to perform well over time. Whatever choppy waters we face in the short term, we have no doubt that patience and purpose will be rewarded.
Finally, we were struck by the following recent quote from International Monetary Fund Managing Director, Kristalina Georgieva:
“In a world where war in Europe creates hunger in Africa; where a pandemic can circle the globe in days and reverberate for years; where emissions anywhere mean rising sea levels almost everywhere — the threat to our collective prosperity from a breakdown in global cooperation cannot be overstated.”
Global leaders would do well to heed her words.
We wish you peace, good health, and a beautiful Spring.