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Ukraine/Russia Macro update

2022 was supposed to play out quite differently: COVID-19 was moving from pandemic to endemic status, allowing countries and citizens around the world to travel and socialize more freely. Some of the cyclical inflation effects were set to wane as supply chains normalized.

Companies should have been able to plan ahead, possibly igniting a merger wave. This combination of factors was going to bring a potential cycle-ending final boom of growth and optimism. It should have been a good time for risk assets, with credit spreads staying tight and equities continuing to move upwards.

Unfortunately, none of this materialized. Repeated COVID-19 outbreaks in China kept supply chains in a mess; Russia instigated an armed conflict in Ukraine which exposed the fragility of a global trade system we have generally taken for granted. These factors cemented the inflationary dynamics that were already at play.

Optimism has been replaced with pessimism, and emerging clarity fudged by new-found uncertainty. The confidence that central bankers felt with respect to the transience of inflation has given way to a sense that they are behind the curve in taming the inflationary dragon.

How durable will these inflationary pressures be and will central bankers accidentally tip the global economy into recession?

Markets and investors have scrambled to reprice risk, particularly in the growthier areas of technology disruption. The S&P 500 formally entered a bear market, and bonds and stocks started to positively correlate for the first time in over 20 years. The primary questions investors are trying to answer now concern the durability of the inflationary pressures and whether central bankers in their zeal accidentally tip the global economy into recession.

The focus of our mid-year Panorama is squarely on what happens if inflation becomes a persistent problem. We open with a discussion I recently had with Manoj Pradhan, Chief Economist at Talking Heads Macro. Manoj has written an excellent book arguing for the return of structural inflation.

The theme is further explored in the context of asset allocation – what does structural inflation mean for equity and bond investors? And what does it mean for sustainable investing adoption given the new focus on returns from ‘brown’ industries that have been excluded from many environmental, social and governance (ESG) mandates.

Alternatives clearly have a role to play as a portfolio diversifier, given both equity and bond beta is in retreat – our Hedge Funds Solutions team and our Real Estate and Private Markets team explore the potential opportunities and benefits of these allocations if inflation endures.

Please enjoy this mid-year edition of Panorama and as always, please reach out to your trusted ÃÛ¶¹ÊÓƵ Asset Management partner for any further advice.

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