(Bloomberg) — As the war in Ukraine enters its second month, Wall Street is considering an array of possible outcomes, from de-escalation to protracted conflict. Goldman Sachs Group Inc. is recommending cheap hedges against stagflation in one scenario. BlackRock favors short-dated bonds in another. French titan Amundi SA is warning of tighter liquidity.
Investors who’d taken to the sidelines at the time of the Russian invasion are under increasing pressure to hedge their risks. Many investment specialists say they’re ditching high-conviction strategies that bet on market direction.
“We’re living in a climate of elevated geopolitical uncertainty,” said Mark Dowding, chief investment officer at BlueBay Asset Management in London, which manages $127 billion in assets. “Some of this increase in the risk premia is likely to be permanent because we’ve seen something seismic in the course of this month. Who knows what’s going to happen at a moment’s notice? We could have any headline in the next hour or two.”
A point of consensus is that inflation isn’t subsiding any time soon, and many warn that liquidity and trading conditions may get far tougher.
“Market liquidity conditions appear resilient so far, but this is a point of attention,” said Vincent Mortier, Group Chief Investment Officer of Amundi, Europe’s largest money manager with $2.3 trillion of assets under management. They’ve hedged portfolios with derivatives, such as credit default swaps and put options.
Here are some of the scenarios:
Long War
“A protracted war is the middle of the road scenario that looks likely to many,” said Agnes Belaisch, chief strategist for Europe at Baring Investment Services Ltd. in London. “Investors prefer not to position for any given scenarios about war and peace, given how out of any rationale the path ahead is. Escalation is the worst outcome that many prefer to keep a tail risk.”
The U.S. dollar remains a solid haven asset, in her view. Euro region peripheral short duration bond spreads are attractive as “we believe the ECB will stay relatively loose on monetary policy, protecting the carry,” she said.
Long positions in small- and mid-cap technology stocks could do well in an era of intensifying national security, according to Mark Haefele, CIO at UBS Global Wealth Management. UBS Group AG manages $2.6 trillion in assets, according to its website. He favors investments in the cybersecurity sector and enabling technologies such as 5G+ in wireless telecommunications.
U.S. dividend-paying stocks are a haven given their exposure to the “beneficiaries of rising energy prices as well as businesses that provide stability through heightened volatility,” Michael Fredericks and Justin Christofel at BlackRock Financial Management Inc., wrote in a note to clients Wednesday.
Veteran emerging markets investor Mark Mobius expects the conflict to continue for at least a year. He doesn’t foresee a recession in the U.S. or Asia, but broadly said Europe isn’t in a good position.
“Equities are the way to go because we are seeing inflation coming up, so equities would be the best defense against inflation,” he said.
He prefers companies with pricing power and the ability to pass on costs to consumers in emerging markets such as Taiwan, India, South Korea, Vietnam, Turkey and Brazil among others. He used the recent market dip to top-up some investments in Taiwan, Brazil and India.
De-escalation
Global big tech, with an emphasis on companies with pricing power, is the go-to for Singapore-based DBS Bank Ltd., which sees the world returning to “inflationary growth” — a scenario it sees as positive for stocks broadly. Like many investors, however, DBS is underweight on European equities because the region will take time to resolve its energy reliance on Ukraine and Russia.
“In times when global liquidity is tightening, stay with good quality, highly profitable companies” such as cash-generating tech companies, Hou Wey Fook, CIO at DBS said at a virtual briefing this week. The bank has upgraded Asia ex-Japan equities to overweight from underweight, with a preference for Southeast Asian stocks, as they benefit from rising commodity and energy prices.
Short-dated bonds look more attractive relative to long end, according to BlackRock Investment Institute, as central banks will learn to live with moderate supply-driven inflation, rather than taking policy rates into restrictive territory.
“We expect the sum total of rate hikes to be historically low given the level of inflation,” wrote BII analysts led by head of macro research Elga Bartsch. They also favor U.S. and Japanese equities over credit.
Chinese stocks are also favored positions for both DBS and BII, given the likelihood of easier policy as other central banks tighten, though BII warned “China’s ties to Russia have created a geopolitical stigma risk that could pressure some investors to avoid Chinese assets.”
Sanctions and Commodities
“Even if sanctions were lifted tomorrow, Russia’s traditional clients would be looking to diversify their suppliers,” said Barings’ chief global strategist Christopher Smart. “Prices are set for more gyrations even as they likely drift higher.”
Barings likes commodity-linked currencies, and is avoiding net importers.
Among BlueBay’s favorites are the Australian dollar and South African rand, while the Indian rupee and the Turkish lira are among their picks for currencies to play on the short side.
Stagflation, Recession
Not many discussed this 1970s-style scenario, but Goldman Sachs and T Rowe Price Group Inc. laid out options for this situation. Increasingly cheap hedges against global stagflation include long positions in the U.S. dollar versus the Swiss franc or euro, according to Goldman Sachs’ strategist Ian Tomb.
In the event that stocks and bonds slide in tandem, Tomb favors backing the Japanese yen versus the dollar. It’s a tough call as yield differentials have seen the yen plummet to a six-year low versus the greenback, but Tomb’s analysis suggests it’s still “an excellent hedge when both risk assets and core rates fall.”
Thomas Poullaouec, head of multi-asset solutions for Asia Pacific at T Rowe Price, said he’s been adding to inflationary protection to prepare for the “tail risk of stagflation.” “In that case, we want more duration and more inflationary protection through short-term TIPS,” he said, referring to Treasury Inflation-Protected Securities. He’s also adding to natural resources stocks and energy companies, paring an underweight position earlier in the year.
Israel’s shekel is also likely to weaken versus the dollar in this scenario, in Tomb’s view, given its correlation to technology stocks. So, a short position is a cheap hedge against recession risk or a selloff in core government bonds, he says.
(Updates with views from T Rowe Price and Mark Mobius.)
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