Exposure rates of the Dorval Asset Management Range – 25th February 2022
The Ukraine crisis heightens pressure on energy prices
Brent price / Natural gas prices in Europe
The economic effects of the Russia-Ukraine war are set to be limited judging by the sanctions announced by the United States and Europe. However, this could change if Russia and the West embark on an intensifying sanctions tit-for-tat, leading to commodities supply disruptions in Europe and an even faster uptick in oil prices towards $150 or even $200. However, for now, western sanctions have carefully tiptoed around energy. Meanwhile, Russia has absolutely no reason to pass up the financial bonanza from gas pipelines and oil at a time when the country particularly needs it. If the situation remains in the current state, oil prices would not exceed $110-120/bbl, with a moderate impact of around -0.2% on world growth in 2022 (-0.35% in Europe and -0.15% in the United States, average of current projections). Meanwhile the effect of a possible migration shock from Ukraine to Poland and Germany would take place against a backdrop of full employment in both countries, with a likely feeling of solidarity that will rein in the risk of social crisis, at least initially.
The weighting of the Russian and Ukrainian economies is small, so the shock from the Ukraine crisis will trickle through to the economy primarily via an additional surge in inflation, which will dent some companies – due to a contraction in margins – and hamper consumer confidence. The decline in consumer confidence is already visible in the US and UK, and to a lesser extent in Europe (cf. chart 2), where it is set to keep on dwindling in light of the escalation in inflation (as shown by the sharp surge in inflation in France in February) and growing pressure on commodities prices.
Inflation is hampering consumer confidence
US (Michigan survey) / UK (GfK) / Euro area (Eurostat)
However, the connection between consumer confidence and real consumer spending is often fairly tenuous. Consumer spending in the US has slowed much less than confidence indicators would suggest over the past few months, as reflected by the rebound in household spending in January (+1.5% in volume terms after declining for two months). Labor market momentum partly explains this difference between confidence and actual consumer spending. Additionally, the weeks ahead are set to see a recovery in spending on services as health restrictions are vastly alleviated in almost all countries. Vehicle purchases should also benefit from the gradual easing in electronic component shortages. Lastly, several countries are using fiscal tactics to offset the effects of rising prices on households and companies.
Finally, the shock from the Ukraine situation is ambiguous for the central banks. The outlook for inflation is deteriorating further, but the growth outlook is also weakened, particularly in Europe. This type of shock also particularly tends to make the large central banks especially attentive to financial conditions, as they may fear that risk premiums will increase too quickly on the markets and in the banking system, with the fall-out for the financing of the economy. Risk aversion has significantly increased on the financial markets over the past several weeks (cf. chart 3), and the pace of monetary policy normalization could therefore be slower than expected over the weeks ahead, with the ECB meeting on March 10 and the Fed meeting on March 16.
Risk appetite (Goldman Sachs index)
Recent events have facilitated a stabilization in real interest rates, driving a reversal in the rotation trend out of defensives and pricey stocks: this trend had been under way since December 2021. It is worth remembering that these stocks had already plunged i.e. more than 20% for the Nasdaq, and 40% for biotechs. This share universe will perhaps be unsettled again when long-term yields rise to fresh highs once more, which is likely in the medium term. However, for now they are less vulnerable, which is promoting a stabilization in share indices. Lastly, P/E multiples on the stocks-markets have fallen considerably, particularly in Europe, while real rates remain extremely low, making equities more appealing (cf. chart 4).
Equity valuations have become attractive again in Europe
Forward P/E on the EuroStoxx 300 / German real rates / European equities risk premium
If there is no further change in the shock from Ukraine, upward pressure on long-term yields will end up resuming, which could curb the rally for equities. Our market exposure rates therefore continue to reflect a degree of caution. We maintain our position on the Green Deal theme, which is particularly relevant in the current energy crisis environment.