investment insights
Energy supply shock and new geopolitical realities
Lombard Odier Private Bank
The conflict in Ukraine has created a negative supply shock. Western sanctions are isolating Russia from a large part of the world, and pressures on commodities will continue to drive energy prices and inflation.
It’s a new state of play for the world economy. Global growth is set to decelerate. Is recession inevitable?
The strength of the post-pandemic rebound offers some economic buffer in most developed economies. The US and eurozone have been expanding faster than average, and job markets, corporate profits and household savings are all solid, supporting production and consumption. Nevertheless, the balance of growth and inflation will worsen, and much depends on how long the war lasts and policy responses.
Central banks continue to fight inflation. The Federal Reserve has started a rapid tightening cycle, and the European Central Bank’s first rate increase is expected towards year-end. But faced with a negative supply shock, the impact of monetary policy is relatively limited. Economies now need more fiscal support, and we expect governments to step in with emergency measures and large-scale, long-term investments.
In this highly uncertain environment, investors have taken a more cautious stance. Our current portfolio positioning reflects a prolonged conflict between Russia and Ukraine, which seems the most likely scenario at this stage. We keep a neutral exposure to equities, with reduced allocations in European equities and small cap stocks, because of their sensitivity to higher energy and labour costs, as well as longer-lasting supply chain disruptions. We remain underweight in fixed income, having tactically increased government bonds, and cut allocations to convertible bonds and emerging market debt.
In alternative asset classes, we have reinforced our allocations to commodities, with a preference for industrial metals, gold and energy, to shield portfolios against any escalation of the conflict in Ukraine that would lead to higher inflation.
Longer-term, new investment opportunities are opening up as spending on cybersecurity, clean energy and defence rises.
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