latamen
One crisis dealt with, straight onto the next one

One crisis dealt with, straight onto the next one

05-04-2022 | Column

Are we out of the woods? Sitting here in Hong Kong it’s hard to believe that most of the world has almost left the pandemic behind, having found a way to deal with the health risks and move on. Only in China is the fight ongoing, but even here a change in mindset is noticeable. This is a solid positive for the global economy.

  • Arnout  van Rijn
    Arnout
    van Rijn
    CIO Asia Pacific

Speed read

  • The war in Ukraine wipes out the post-Cold War benefits
  • Western investors are feeling the impact through higher commodity prices
  • Bonds’ nominal returns are low, equities are still the place to be

It’s even harder to believe the images of the human tragedies in Ukraine that we are seeing on our screens every day as innocent civilians are killed and refugees flood out of the country. What’s going on in the financial markets pales into insignificance compared with the terror of the invasion. But it’s our job to consider what it all means for investors.

As it stands, the world is faced with a geopolitical crisis that looks set to wipe out some of the benefits that have accrued since the end of the Cold War in 1989 as a result of globalization, cost efficiencies and international trade flows. This is clearly a negative and is resulting in considerable uncertainty for investors.

The Western (NATO) response to the war is very much through economic sanctions, so prices in the financial market give us a good sense of the implications of war in today’s interconnected world, and also what the implications for corporates may be from further deglobalization and higher commodity prices.

Of course it’s not easy to set out a three-month outlook when we don’t even know what next week is going to bring. To suggest that you should prepare yourself for more volatility is not particularly insightful, but it’s probably the best advice anyone can give at present.

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

Lower margins could dent corporate profitability

For now, financial investors are mostly feeling the impact of events in Ukraine through higher input prices in general and commodity prices in particular. The big question is what the combined impact of higher inflation and higher rates will be on economic growth and profitability. At the end of 2021 it looked like earnings could remain strong, but in the first quarter we have already seen some companies signalling that pressure on their margins could dent their profitability. And let’s not forget that corporate profitability is the linchpin that supports the global equity markets.

As well as lower margins, earnings may come under pressure from the slowdown in real economic growth that’s likely to result from the prevailing uncertainty. This is particularly the case in Europe, where markets have suffered the biggest hit.

Asian equities have less to fear from tightening

The low interest rates that have been in place for over a decade have muffled a lot of volatility. But this era is coming to an end. Monetary authorities all over the world are longing for normality, just like ordinary citizens were longing for normality during the dark days of lockdown. The Federal Reserve has already started hiking rates and the ECB feels its hand is also being forced by what is viewed as scarily high inflation in Europe.

The situation in Asia is very different because in its biggest economies – China and Japan – increases in input prices have not yet resulted in much higher consumer price inflation readings. Historically, Asian equities have struggled under a tightening US dollar rate environment but this time may be different. Asian equities lagged during the liquidity-driven rally of the past few years, but will have less to fear from the Fed’s moves because Asia’s central banks don’t need to tighten much in 2022.

Look for pricing power

As ever, our analysts and portfolio managers are carefully collecting data on prices and margins to make a call on where to reduce their exposures and where to remain invested. It looks to me that commodity producers have the most pricing power, but there is also plenty in the technology sector, where shortages are proving persistent.

The healthcare sector may also be able to display its pricing power now that demand for treatment is normalizing and as governments look set to become more willing to provide funding having been confronted with the importance of a well-funded health system during the pandemic. Quality – the ability to generate returns above the cost of capital for a sustained period of time – is likely to remain an important determinant of success, and it will be defined by pricing power.

A supportive environment for Value stocks

Although I have been taught by our quant researchers that timing factors is nigh on impossible, I still like to think that value-oriented strategies will receive further support from higher bond yields in the second quarter. Bond yields are always important for equity investors to consider as they drive the discount rates used in stock valuation models – faraway cashflows are worth less when the discount rate rises.

As yields creep higher in Europe and Japan, it seems a good idea to tilt portfolios towards shorter-duration stocks – in other words, value stocks. Personally, I would add telecoms to the list too as these are firms with strong (albeit regulated) pricing power and are benefitting from very steady demand as they head into a phase in which less capex is required as most of the necessary investments in 5G have already been made.

Time to rethink globalization and energy supplies

What began in 2020 as a scarcity of containers in Asia to ship goods to the West had by March 2022 morphed into a series of supply chain disruptions. Aggravated by the recent run-up in oil and gas prices, these problems have resulted in a rethink about global interdependencies, with politicians clearly moving towards the need for national self-sufficiency. This trend started in the Trump era, when the US wanted to reduce (so far unsuccessfully) its dependence on Asian products – especially those from China.

Governments are now talking about the need to develop their own computer-chip supply chains and of course to become less dependent on imported energy. This has shifted the focus from the long-term green transition to short-term energy security. It now seems likely that natural gas and nuclear energy are going to remain important fuels, at least in the medium term, to help us navigate the green transition to net-zero by 2050.

The vilification of some energy companies looks likely to stop, and we must focus on those that are actually contributing to the transition by making investments in cleaner energy, including gas. Our engagement efforts are clearly paying off in this respect.

The US looks more attractive than Europe

The US scores well from the perspective of energy independence thanks to the shale oil revolution. What’s more, American growth looks less vulnerable than Europe’s at present, so the US seems a good place for equity investors to allocate to.

Within Europe, France has been relatively insulated from the energy shock as most of its energy comes from domestic nuclear plants, and this insulation should help President Macron’s chances of re-election in April. Meanwhile, German Chancellor Olaf Scholz has been making a good impression with his mediation efforts in the Ukraine conflict. Strong and stable political leadership in Europe is welcome during tough times.

A lot rests on China

China is likely to be hitting the headlines in the second quarter. It has tried to stay out of the conflict and focus on its own internal battle against Covid so far, but can President Xi maintain that position? China siding with Russia would be explosively bad news for the markets, whereas any harmonization of China’s relations with the US would leave Russia isolated. This could lead to a quick resolution of the conflict in Ukraine and possibly a breakthrough in the protracted trade war between the US and China at a later stage. That really would be good news for the world.

Equities still more attractive than bonds

With plenty of uncertainty around, investors may be thinking about looking for safety in the fixed income markets, but as bonds’ nominal returns remain very low, they need to remember that allocating to the asset class will not generate enough returns to pay for one’s pension. Equities remains thus the place to be, we believe.

The ‘rally of everything’ that we spoke of last quarter clearly ended very early in 2022. Investors will need to be more selective, but we are not downbeat about equities’ prospects. Stocks retain their appeal as equities are backed by real assets, which tend to move in line with inflation to a certain extent. What’s more, companies generate a margin from these assets and adjust their prices when inflation bites.

Subjects related to this article are:
Logo

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree