The question on everyone’s mind in investment circles at present, is whether Russia decides to invade Ukraine. Why this is important to investment markets is less to do with the potential for conflict in the region, which has been present for some years now, and more to do with the fact that Russia supplies between 30-50% of Europe’s gas needs which would not go down well with the European constituents if the US or NATO imposed strict sanctions on Russia and Russia retaliated by turning off their gas.
One view is that Russia is flexing its muscle at a time when the US President and Democrat party is struggling in the polls. This may be an opportune time to demonstrate some strength when the US and NATO are also preoccupied with the tensions between China and Taiwan.
So how is this likely to impact on investment markets in the short to medium term?
The answer to that would depend on the seriousness and duration of any conflict. History would suggest that this would most likely be a short-lived correction of say 5-10% lasting maybe three to six months. However, regardless of whether a conflict occurs, investment markets are likely to be volatile in the short term and not necessarily anything to do with the current Russian crisis. Rather, we believe the biggest risk to markets right now is inflation and the central bank reaction to that inflation, followed by weaker than expected Chinese growth and health restrictions imposed by the pandemic.
There is no doubt that inflation is on the rise around the globe, and this has been exacerbated by supply chain delays caused by the pandemic. Inflation has resulted in wages growth now around 4-5% in the US and likely to rise here to around 3% by mid-year. Interest rates are likely to start increasing in Australia by mid-year which may see the cash rate rising from 0.25% to around 2% over the next two years. This would mean an increase in mortgage rates to similar levels that we witnessed in 2018 of around 4.5 -5 %. Certainly higher than current rates but significantly less than the rates many experienced in the 80’s when average rates peaked around 18%. This increase is likely to place some downward pressure on house prices over this timeframe which should be a welcome relief for some looking to enter the housing market for the first time.
Is coronavirus still an economic threat?
Whilst the risk of any new variant still exists, the combination of vaccines along with new treatments has lessened the risks and allowed reopening to continue. Key drivers of growth this year is likely to be ongoing reopening, pent up demand, excess savings, strong business investment and low inventory levels.