Exposure rates of the Dorval Asset Management Range – 4th March 2022
The impact of the war along with western sanctions have further fueled the rise in commodities prices, with Brent in particular coming out at $110-120/bbl. Commodities composite indices have broken through their highs of 2008 and 2011 in current dollar terms, while in constant dollars, they still remain far short of figures witnessed in 1973/74 (cf. chart 1). The shock for the world economy is therefore not as severe as initially feared – at least at this stage – both for this reason and due to the fact that the commodity intensity of economic growth has decreased considerably over recent decades. The latest strong job figures out of the US – with 678K new jobs created in February – also reflect western economies’ robust momentum at the time of the Ukraine shock.
Composite commodities price in current dollar and constant dollar terms
_Commodities index (average GSCI and CRB)
Commodities index in constant dollars (=index deflated by US core CPI)_
However, the crucial point is the apparent doubt over the availability of Russia’s commodities exports: not only can Russia trigger shortages at any time by halting its natural gas deliveries to Europe, but US sanctions also currently prevent the country from selling a hefty chunk of its oil. Russia produces 12% of world oil supply – 10 million barrels per day – so this boycott could take some time to get around and may well propel prices considerably beyond $120/bbl. If this turns out to be the case, the shock from the Ukraine conflict would span out to the American and Asian economies. Meanwhile on this side of the pond, the effects of soaring natural gas prices add to this impact (cf. chart 2), making for a potentially greater shock for the old continent.
Natural gas: a disproportionate shock that hits Europe first and foremost
_European natural gas / US natural gas
Base 100 in January 2019_
The financial markets have already priced in the lion’s share of the risks outlined above. The Euro Stoxx 50 has shed 16% YTD and has already retraced close to 40% of its gains since March 2020. Credit spreads have widened again considerably, the euro continues to weaken, and European banks have shed close to 30% since their highs in early February. Lastly, the sharp plunge in P/E multiples and the collapse in real interest rates in the euro area have pushed up the European equity risk premium (Euro Stoxx 300) to the extreme levels witnessed in March 2020.
Risk premium on European equities climbs to March 2020 point
_Forward P/E on Euro Stoxx 300
German real rates
European equity risk premium_
Increasingly attractive valuations and investors’ ultra-defensive positioning imply that an easing in risk aversion – even to a limited degree – would drive a swift surge in share prices, as we have seen time and time again on the markets in the past. This may require hostilities to come to an end, or steps to curb the jump in commodities prices or quite simply market exaggerations triggering short covering. At this stage, we have pursued our cautious positioning in all our flexible funds and have hedged a large portion of European risk in our international funds: however, we stand poised to revisit the market at any time.