Ukraine war exacerbates rough start to 2022

Commentary on the March 2022 quarter by Russell Investments, UniSaver’s investment manager and consultant

Global markets

Global share markets fell in the March quarter, with the MSCI ACWI Index returning -6.8% in New Zealand dollar (NZD) terms.[1] Much of the decline was driven by a combination of heightened geopolitical risks and global rate hike expectations. Geopolitical risks rose sharply in the wake of Russia’s invasion of Ukraine, with the West imposing a raft of economic sanctions designed to isolate the country from the rest of the global economy. Sanctions, however, may yet prove to be a double-edged sword given that the subsequent disruption to global energy and commodity markets is likely to drive up prices and add to already-high inflationary pressures.

Meanwhile, the US Federal Reserve raised interest rates for the first time since 2018 amid persistently high inflation and warned that rates may need to rise faster than previously thought, and the Bank of England raised interest rates for a third consecutive month in March. Stocks were also impacted by a fresh wave of COVID-19 infections in China and renewed concerns over Beijing’s regulatory pressures after officials imposed additional restrictions on the country’s big technology names. Limiting the decline was a series of robust US and European earnings updates and some encouraging economic data, including further improvements in US and European manufacturing activity.

At the country level, all three major US indices – the S&P 500 Index (-4.9%), the Dow Jones Industrial Average (-4.6%) and the tech-heavy NASDAQ (-9.1%) – fell from their recent highs over the period. Stocks were also lower in China (-14.5% ), Europe (-9.2% ) and Japan (-2.3%), while the UK’s commodity-heavy FTSE 100 Index (1.8%) recorded positive performance.

The global listed infrastructure market performed very well over the period, returning 7.5% in hedged NZD terms. Infrastructure stocks gained as surging energy prices following Russia’s invasion of Ukraine contributed to strong performances across the market’s energy-related names. North America recorded the largest returns for the quarter, followed by the UK and Japan. In terms of sectors, energy and airports were standouts, with the latter in particular benefiting from easing travel restrictions across Europe and recovering passenger numbers.

Global bonds fell, returning -4.8% in hedged NZD terms. Longer-term government bond yields rose (prices fell) over the period, driven largely by tighter monetary policy globally. Partly offsetting this were the asset class’ traditionally defensive characteristics in the wake of Russia’s invasion of Ukraine. In credit markets, spreads on US and European investment-grade and high-yield debt widened as investors turned more cautious amid increasingly hawkish central bank comments and the war in Ukraine.

New Zealand shares

The New Zealand share market fell over the period, returning -6.9% . Contributing to the decline was the Reserve Bank of New Zealand’s (RBNZ) decision to raise the official cash rate a further 0.25% (to 1.00%) in response to surging inflation, which hit a 31-year high in the final quarter of last year.

Stocks were also impacted by rising bond yields, the ongoing spread of Omicron and the war in Ukraine. Limiting the decline was the unemployment rate, which fell to just 3.2% in the December quarter – the measure’s lowest level since modern records began in 1986 – and a series of encouraging earnings updates. At the sector level, information technology was the worst performer, followed by healthcare and consumer discretionary. In contrast, energy, communication services and utilities all posted good gains.

New Zealand fixed income

The New Zealand bond market also fell over the period, returning -3.6% . Domestic long-term government bond yields rose (prices fell) after the RBNZ raised interest rates again in February and as investors bet on more aggressive tightening to come. Bonds were also impacted by a series of encouraging earnings results and a further drop in the unemployment rate. The yield on New Zealand 10-year government bonds closed the quarter 83 basis points higher at 3.2%. Meanwhile, credit markets weakened, with spreads widening over the period.

How did markets affect UniSaver’s investment options?

The sharp sell-off in both shares and bonds meant that all of the UniSaver investment options, except for Cash, delivered negative returns over the March quarter. However, longer term returns remain positive, with Conservative, Balanced and Growth returning -0.6%, 1.6% and 3.7% over the last year, and 2.8%, 5.9% and 7.6% p.a. over the last three years[2].

As ever, we remind members that investing for retirement is a long-term journey. We encourage you to resist the urge to react to short-term market movements and focus instead on long-term goals and objectives.

Looking ahead

The conflict in Ukraine has created significant uncertainty which will mean more market volatility ahead.  The consequences of the invasion are likely to be lower global growth, with Europe taking the largest hit, and higher inflation. Even so, global growth this year should still be above trend, provided hostilities ease and global energy prices stabilise. Above-trend growth should support equities over bonds and cash.

Russia/Ukraine has added to the challenges facing emerging markets (EM). China’s economy was already under pressure from the real estate downturn and weak credit growth. This has been made worse by the shutdown of major cities due to the zero-tolerance COVID-19 policy, and has been further exacerbated by surging energy and commodity prices. The MSCI China index has taken a beating on worries that the regulatory crackdown on technology firms may not have ended. Broader EM faces the difficulties of Fed tightening, a stronger U.S. dollar (USD), rising food prices and more expensive energy. EM could stage a turnaround if, as seems likely, China undertakes significant stimulus and commodity prices pull back on easing hostilities in Ukraine.

Global Listed Infrastructure has been one of the better-performing asset classes so far this year, benefiting from energy exposure, while real-estate investment trusts have posted negative returns. Both should benefit if Russia/Ukraine hostilities subside, the pandemic recovery resumes and inflation concerns continue.

Government bond valuations are mixed after the recent selloff, with U.S. now fairly valued and Japanese, German and UK bonds still expensive. Yields will face upward pressure from continuing inflation increases, but a positive for government bonds is that markets have fully priced potential tightening by most central banks, and this should limit the extent of any further selloff.

The U.S. dollar has made gains this year on the expectation of interest rate rises from the Federal Reserve and safe-haven appeal during the Russia/Ukraine conflict. It should weaken if hostilities subside and lower inflation outcomes later in the year lead to less Fed tightening than markets currently expect. The main beneficiaries are likely to be the euro, which has become more undervalued, and the Japanese yen, which has weakened on commodity price inflation and China growth concerns. We also believe British sterling and the economically sensitive commodity currencies - the Australian dollar, New Zealand dollar and Canadian dollar - can make further gains.

The information contained in this publication was prepared by Russell Investment Group Limited (RIG). RIG is the investment manager for UniSaver.  This publication has been compiled from sources considered to be reliable, but is not guaranteed. This publication provides general information only and should not be relied upon in making an investment decision. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. All investments are subject to risks. Past performance is not a reliable indicator of future performance.

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[1] An index is a basket of securities that measures the performance of a particular market.

[2] Return net of fees and tax at 28%