Russia’s invasion of Ukraine happened just when markets were getting ready for a series of Fed rate hikes, and encouraging signs were emerging that the world was finally moving to an endemic state of Covid.
Prior to this invasion, 2022 had already witnessed a selloff in global equities due to high inflation numbers and central banks worldwide pledged to end the easy liquidity situation. The Fed dot plot indicated around seven rate raises of a quarter-point each this year, followed by a few more rate hikes in 2023.
We were cautious on the markets even before the Russia-Ukraine crisis unfolded. With several sanctions imposed on Russia, we expect further disruption in the global supply chains, and this event will make inflation worse. The euphoria in the consumer confidence that was finally emerging from Covid after two long years may also be curtailed by rising geopolitical tensions.
US Equities and Global Investments
The US economy has very little trade with Russia and is least affected by supply disruptions caused by the ongoing invasion. Furthermore, the US is also a large producer of oil & gas and other commodities and benefit at the margin from their rise.
One can look at a contrarian play within the US market by investing in small-cap growth companies. These companies have dramatically underperformed the market in the last 3+ months as a rising rate environment shall lead to discounted future earnings growth. However, we feel the selloff is overextended. Over the course of the year, we expect supply chain problems to ease and inflation to tame, making investments in these companies a valuable proposition.
Indian Equities Outlook
India has played a balanced approach by not explicitly siding with any of the major powers involved nor speaking up against them. However, the surge in Oil & Gas prices due to global supply disruption poses a problem for the Indian economy. Higher oil prices could cause a rise in retail inflation and impact households’ discretionary spending. Also, it may widen India’s current account deficit due to higher oil import bills. On the positive side, India has massive foreign exchange reserves to tackle any volatility in the currency.
From an equity markets perspective, the ongoing conflict between Russia and Ukraine could cause short-term volatility. The uncertainty around the Uttar Pradesh state election results, IPO of LIC pulling out liquidity from the market, and the Fed’s meeting in mid-March could all have an impact on the markets.
Given these headwinds, we would be cautious on the market and recommend spreading your investments over the next 3-6 months. Most stocks in the mid and small-cap segment have taken some beating due to the recent volatility and are available at cheaper valuations. Systematically adding allocations to the mid and small-cap segments could pay off handsomely over 3-5 years.
Thematic Ideas
The themes we would overweight in this environment are:
1. Companies that produce commodities, particularly oil & gas as well as industrial metals & mining
This theme was already working well this year- the Russia-Ukraine event further bolsters the case for its continuing outperformance
2. Alternative energy companies
Sanctions imposed on Russia will further disrupt the global oil and gas supply and directly impact Europe. The urgent need to develop and fund alternative sources of energy, such as nuclear, wind and solar, and electric, will rise
3. Defense and Aerospace
We posit that the invasion of Ukraine will lead to a big-spending ramp up in this sector, and significant global arms suppliers will be the beneficiary
4. Global shipping companies
The disruption in supply chains and the need for Europe and Asia to increase their LNG shipments will keep shipping rates upward.
5. Cybersecurity companies
Cyberattacks are a big part of modern warfare among global powers. As Ukraine grinds on, the demand for companies that provide Cybersecurity will surge rampantly
6. Banks and other lending institutions
They are the beneficiaries of rising rate environment as the spread between their borrowing and lending rises
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