Q1 2022 – Update

3 April 2022

Equity markets had a bad start to the year, worrying about inflation and rising interest rates and then, on February 24th, Russia invaded Ukraine. The markets continued to fall, but only for eight trading days. From their nadir on March 7th, equity markets have rallied back above where they were before the invasion.

Large-cap stocks ended flat over the quarter in the UK, and mid-caps were down 11%. The S&P 500 was down 5% in the US, while NASDAQ ended down 10%. In response to the inflationary threat and an economy that created 1.7m new jobs over the quarter, the Fed raised rates for the first time in three years. Over the same period, the gold price was up 5% and the oil price 30%. In short, there has been a lot happening.


On February 23rd, the worst-case market expectation was for Russia to make a play for the disputed Russian speaking Donbas region in a rerun of the Crimean invasion of 2014. This outcome would have resulted in heightened uncertainty and diplomatic activity, but would have been manageable. Joe Biden seemed resigned to this outcome when referencing the likelihood of a minor incursion in January. But what unfolded was not the border skirmish that everyone, arguably even the Russian army, expected. The full-scale invasion of a sovereign nation with the intent of regime change has lasting implications, regardless of how the war develops. Suddenly investors have stopped being experts on viral infection and have become military strategists.


Over the last few weeks, the West has been busy reassessing previous political certainties as we enter the end of the end of the cold war era. The peace dividend that we have collectively enjoyed since the collapse of the Berlin Wall is cancelled. Germany’s decision to re-arm will make it the third most powerful military power on the planet. China, the second-largest power, is increasingly under scrutiny. Her without limits friendship with Russia begs many unanswered questions.


Russia is not a large economy, but has become vital in supplying Europe with energy. In the near term, Europe cannot function without Russian natural gas. Other supply chains impacted by the conflict include necessities such as fertiliser and wheat. The full implications of these economic realities are yet to be known. Still, it amplifies inflationary concerns as countries, and trading blocs build economic resilience. This action hampers the deflationary impact of globalisation.

Monetary System  

Similarly to COVID, the policy response to the war could become as much of a financial concern as the event itself. The most significant international reaction to Russia’s invasion is the freezing of Russia’s international reserves. Of the c$650bn reserves that Russia had before the invasion, it only has access to c$200bn today. With a sanctioned central bank and its ex-communication from SWIFT, Russia now demands payment for its energy in Roubles. Russia hopes to establish an alternative to the petrodollar standard, and so far, Russia has defied default on its foreign-held debt. However, the strain of these geopolitical tectonic shifts inevitably revives concern over the future of our international monetary order, and the role of the US dollar.


Amidst this macroeconomic maelstrom, the global oil price has become a key barometer. If you look at the daily average oil price chart over the last year, the period since the invasion looks like the end-of-life event in a movie scene of an intensive care ward. While there has been a lot written about the parallels with the oil shocks of the 1970s, the world energy markets are very different today. Fifty years ago, it took the West over a decade of elevated oil prices to bring on stream non-OPEC oil supply from Alaska and the North Sea. Today we have an array of responses, from making friends with Iran and Venezuela to forgiving Saudi Arabia for their human rights violations, building more LNG infrastructure and incentivising North American fracking. More sources of supply and a Chinese economy in the grip of an ineffective COVID response could rapidly conspire to an excess supply of oil. Ever higher inflation is not inevitable.


One casualty of the war is arguably the common acceptance of what constitutes ESG. Can it be justified to explore new sources of natural gas to reduce our funding of a war criminal? Does the aggression against a democratically elected sovereign nation make the manufacture of military weapons morally acceptable? Should nuclear be accepted as an environmentally friendly energy source? And while we ponder these points, should we focus more on the governance issues of transparency around how certain assets have become infiltrated by unexplained wealth under opaque ownership structures? Our accepted ESG frameworks are in need of a refresh.

Looking Ahead

While it is shocking and depressing to have war on our doorstep in Europe, the West’s liberal democracies built on property rights and markets have previously endured similar threats and grown stronger as a result. Spontaneous order is complex, adaptive and antifragile. Autocratic dictatorships are centralised, prone to instability and contain existential flaws. The long arc of our history is not on Putin’s side. It is right to remain positive. However, financial markets have had a turbulent start to the year. Within this backdrop, equities have proven surprisingly resilient since hostilities began. The question now is whether this constitutes the start of a recovery period or is just a bear market rally. The recessionary portent of an inverting yield curve with rising inflation evokes flashbacks to 1970s stagflation. Maybe the closer analogue is the late 1940s, when a period of high inflation and low-interest rates eventually purged the world of its post-war debt burden and created the preconditions for the never had it so good decade from the mid-1950s. As ever, more than one thing can be true simultaneously.

UK Opportunity 

The UK mid-cap and small-cap space had a poor quarter. However, two significant bid approaches evidenced the value offered in this market, as wealth manager Brewin Dolphin and domestic services provider Homeserve both received approaches from Canadian buyers. At the same time, UK focused brokers, Numis and Peel Hunt both bemoaned the slowdown in IPO activity.

We continued to scour the market for opportunities and met 220 management teams during the quarter. We continue to find selective value in the UK mid and small-cap space.

Written by Jeremy McKeown