On February 24th, Russia launched a brutal and unprovoked invasion of Ukraine. Except for China and a few Russian allies, the world has condemned this attack.
The Russian strategy, harkening back to the Chechen and Syrian conflicts of bombing civilian as well as military targets, has resulted in a humanitarian crisis in Europe not seen since World War II. This is deeply troubling on both an individual and socioeconomic level as European nations bordering Ukraine have already absorbed over 4 million refugees (10% of the Ukrainian population). This number has the potential to grow as news of massacres, the purported use of chemical weapons and other appalling atrocities surface.
The West has responded by hitting Russia with economic sanctions. We expect Russia’s continued aggression will be met with escalating sanctions aimed at further isolating and hampering its economy. Further, the pursuit of potential war crimes against Russia’s leadership will continue to define Russia as a pariah state. These actions, while necessary, will create additional inflationary pressures in commodity costs and food prices. To stave off these inflationary pressures (and potentially stagflation), central banks are now more motivated to tighten the money supply. This will accelerate the increase in interest rates.
This war is further stressing the global supply chain. For a country its size, Russia features an underdeveloped economy that relies primarily on the export of commodities. Its most important industry is oil and gas production, the vast majority of which is exported. Russia is currently the world’s second largest oil producer, representing 11% of global production. Furthermore, it is the largest supplier of natural gas to the European Union, supplying 41% of its needs. Russia is the world’s largest exporter of wheat and, when combined with Ukraine, supplies 29% of international wheat sales and 80% of sunflower oil. Finally, Russia is an important exporter of fertilizer and such metals as nickel, platinum, and palladium. The restriction of these supplies has already resulted in escalating prices.
As a result, financial markets are now faced with geopolitical risk, inflation, and a rising interest rate scenario, none of which are friendly to equity or bond markets. On the other hand, the global economy continues to grow, and some important economies are benefitting from a world that is exiting the crisis of the COVID-19 pandemic. Both the United States and Canada are experiencing strong demand, high levels of employment, growing industrial production, and surging retail sales. These factors are leading to strong quarterly results being reported by the companies we invest in.
Strong local economies and company fundamentals notwithstanding, geopolitical and macro-economic risks remain a concern. As a result, we have prudently elevated the cash level in your portfolio. This provides a measure of downside protection should economic growth stall or recede and facilitates buying opportunities when we believe the time is right. If our concerns are too pessimistic, a significant majority of your portfolio remains invested and will benefit from further performance.
Our mandate is to protect your capital during periods of volatility and grow its value in rising markets. We believe our current strategy of elevated cash levels provides an opportunity to do both.