Following the communication sent on Sunday, financial markets have whipsawed this week, with risks peaking as geopolitical tensions between Russia and Ukraine reached boiling point. As mentioned on Sunday, we have taken a more defensive position across the portfolios, holding an overweight cash position whilst we await the outcome of ongoing attempts to diffuse the situation. Given the significant risks to financial markets on a global scale, should Putin’s threats become reality, we firmly believe that if we were to remain fully invested this would not be in the best interests of our clients. When we compare upside potential against downside risks in the short term, the outlook is not positive, and until we get clarity on how much and how fast interest rates are going to increase and the direction of the move in Ukraine, cash is king. Although an invasion is still a worst-case scenario and no one wants to see tensions escalate to a war, it is our view that we cannot remain invested in assets which we see have a potential downside of 20% plus should Russia proceed with military action.
It is also interesting to note that the mighty Goldman Sachs issued a note on Monday confirming that if you can sell to cash and have liquid assets, that you should. A nice endorsement for what we have done to draw a line under what has not been a great quarter whilst we analyse what happens next.
Over the coming weeks, we will continue to monitor the situation closely, with the confidence that the portfolios have greater protection against further knee-jerk reactions in markets as the Russia-Ukraine narrative develops. Although no one wants to see a military escalation, if an invasion is initiated by the Kremlin, we will look to sell all remaining holdings bar those that are in commercial property, within OBI 6, 7 & 8 (the higher risk portfolios) and wait to see how markets react. Depending on the scale of an invasion, we may look to buy longer term government debt should we feel that the situation will impact global growth, however if the situation appears to only affect a smaller area of Ukraine, minimising the global impact, we may look to increase equity exposure. If we do not see further action, holding higher cash levels within the portfolios will shield us from the near-term volatility we are seeing from the uncertainty surrounding the tightening of monetary in the west, and should we see a significant improvement in Russia and evidence of a de-escalation, we will look to re-deploy elevated cash levels back into assets we feel have attractive valuations. As it stands, we are confident that turning to a defensive position is the best course of action in the near-term to avoid taking on unnecessary risk.
We should reiterate that at this stage, our longer-term outlook for 2022 and beyond remains positive, however taking a more defensive approach in the near-term has now become a necessity given the heightened level of downside risk to financial markets.
What is happening in the Financial Markets?
A rapid escalation of tensions has resulted in significant movements in financial markets this week, with European equities being the most sensitive to threats of military action by Russia. Following a selloff of little under 3% in the European benchmark at the start of the week, equity prices rebounded somewhat on Tuesday as uncertainty over Russia’s plans to invade continued to impact asset prices. US Equities underperformed over the week, as a result of ongoing uncertainty surrounding the Federal Reserve’s plan to tackle rising inflation, with the continuing build-up of Russian troops adding to investors’ concerns. The scale of these intraday price movements further confirms the rationale behind our defensive position, noting that the portfolios as of this week are significantly more protected from heightened volatility in markets due higher cash levels.
Over the last two days, markets have continued to decline, and volatility remains for as long as the uncertainty continues. Although we do not hold direct exposure to commodities because we see them as being too volatile in the short term, it is worth noting the effect that tensions are having on crude oil and natural gas prices. Energy prices continue to feel pressure from an increasing threat of invasion, with Russia exporting circa 25% of global gas, 85% of which is routed to Europe. If therefore we did have a conflict this would cause more inflation in Europe as prices would continue to rise rapidly for oil and gas and that in turn means the central banks will have to raise interest rates even further. That risk puts more pressure on us all as regards to limiting our spending and with rising production and staffing costs impacting corporate profitability, the ultimate worst-case scenario of all of this is that it derails the global recovery and triggers a global recession.
Turning to non-equity, US government bond yields remained at the highest levels since 2019, with the 10-year yield remaining above 2% despite a slight fall from its highs of last week, as investors turned towards more safe-haven assets following escalating geopolitical tensions. However, if the view is that interest rates are going to rise further and faster, then even safe haven assets like government debt will fall in value over the coming weeks and month, so all in all “cash is king”.
Overall, rest assured that we are across the risks and monitoring the situation closely, with high cash levels providing protection against near term risks and added flexibility for opportunities should tensions ease significantly from here. As always, we will continue to communicate our views on a regular basis, don’t hesitate to get in touch if you have any questions.
Past performance cannot be used as a guide to future performance and the value of your investment will fall as well as rise in value. You may not get back all of your investment and the final value of your investment will depend on the performance of your portfolio. The actual performance of an individual client’s portfolio may differ due to different funds being used and being restricted in relation to certain asset allocations. Performance figures quoted include fund manager charges but exclude adviser, discretionary, custodian and switch charges. Unless stated, income is reinvested into the portfolio. The information contained in in this document is for information purposes only. It does not constitute advice or a recommendation or an offer or solicitation for investment. OCM Wealth Management Limited is authorised and regulated by the Financial Conduct Authority (FCA Registration No: 418826) OCM Asset Management is a trading name of OCM Wealth Management Limited.
Key Events We Are Watching Over the Coming Weeks:
- Wednesday 23rd: EU Inflation Data
- Thursday 24th: US GDP Data
This Day in History
On this day in 1801, following a tie in the electoral college, the U.S. House of Representatives elected Thomas Jefferson as the 3rd President of the United States.
Thank you for reading,
Jason, Gina & Pete