As the Russia-Ukraine crisis unfolds, analysts from Singapore banks see a cautious US Federal Reserve as prices of commodities rise and supply chain issues worsen.
According to Hou Wey Fook, chief investment officer at the DBS chief investment office, the risk of economic contagion from the Russia-Ukraine crisis is low.
“Russia accounts for only 1.8% of global GDP (vs 24.7% for US and 17.4% for China). Similarly, in terms of global trade flows, Russia accounts for only 1.7% of global exports (vs 12.1% for China and 9.5% for US), and 1.4% of global imports (vs 12.8% for US and 10.8% for China),” writes Hou in a Feb 28 note.
A bigger threat arising from the crisis will come from the commodities channel, says Hou. “Global supply chain disruption has already triggered a sharp spike in global inflation and surging energy prices will only exacerbate the situation.”
Hou even warns of stagflation, the combination of high inflation and slower growth, saying it “should not be ruled out”. “Given Europe’s high dependency on Russia for its energy needs, a prolonged crisis could result in production shutdown and supply shortages.”
With the recent turn of events, the US Federal Reserve could be more cautious in the hiking cycle and pare back expectations for aggressive hikes, says Hou. “Although inflation may remain elevated due to higher oil prices, it is worth noting that rate hikes are generally ineffective in curtailing supply-side driven energy price rises, and the Fed would remain concerned about not stifling growth with higher rates.”
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Equity rally?
A common assumption among investors is that military conflicts are devastating for financial markets. Hou thinks otherwise. “Drawing from the experience of major military conflicts since 1990, global equities have, on average, rallied 38% during military conflicts. The largest rally took place during the Afghanistan and Iraq war. Rising uncertainties, meanwhile, triggered average gains of 138% for gold and 89% for crude oil.”
Hou thinks a more relevant example is the 2014 Crimean crisis, which saw Russia invading and annexing the peninsula from Ukraine. In the entire span of the crisis, global equity markets were flat while gold and oil registered only slight dips.
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How should clients hedge their portfolios? Hou points to even higher gold prices. “As a hard asset, gold has preserved and risen in value during environments of hyperinflation, stagflation, and negative interest rates. Its attribute of being uncorrelated to risk assets make it an effective hedge during periods of high volatility.”
Europe is most exposed to the conflict due to its proximity as well as dependency on Russia’s energy resources, says Hou. “Domestic sentiments will likely be weak in the near term, and recovery delayed. Investors should stay with resilient sectors such as oil majors, luxury brands and commodity producers while scanning the banks for exposure to Russia and companies involved in the Nord Stream 2 project, which has been halted.”
In equities, the outperformers include oil majors, commodities producers, net oil exporters, and commodity exporters due to rising commodity prices, writes Hou. In fixed income, Developed Markets Investment Grade (IG) credit is anticipated to outperform from a combination of a paring back of rate hike expectations of both the Fed and the ECB, and flight to safety flows towards fixed income assets, he adds.
“For more risk-seeking flows, Emerging Markets credit of high carry, commodity-exporting regions such as the Gulf Cooperation Council (GCC) and LatAm could also see tailwinds from higher oil prices,” says Hou.
SGX names
DBS Group Research analysts Yeo Kee Yan, Janice Chua and Woon Bing Yong note that market rate hike expectations remain off its February high, with banks United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC) most affected by fluctuations.
In addition, transport-related companies such as Singapore Airlines (SIA), SBS Transit, ComfortDelGro and Hutchison Port Holdings Trust (HPHT) face cost pressure if Brent crude stays elevated around US$100/barrel over the next few months, but Keppel Corp can benefit if sustained high oil price stimulates capex that leads to higher orders for rigs, say the DBS analysts.
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In a Feb 28 note, the DBS analysts think the Straits Times Index (STI) could see further short-term decline to the level of 3,150-3,200 points (12.7x P/E), making it a good tactical buy opportunity.
The Ukraine sell-off is an opportunity to relook at the reopening theme, say the DBS analysts. “With the Singapore government seeking to further reopen borders once the Omicron wave passes, logic tells us that stock prices are likely to hold at or above their respective Omicron low back in earlyDecember 2021.”
They add: “Looking at the timeline of the global Omicron wave, we think Covid-19 measures here could ease by end-March to mid-April. Our picks are hospitality/tourism (Ascott Residence Trust, CDL Hospitality Trusts, Genting Singapore), retail (Frasers Centrepoint Trust, CapitaLand Integrated Commercial Trust), transport (ComfortDelGro) and aviation (SATS).”
International equities
UOB Global Economics & Markets Research remains that the Fed will stick to its anticipated hiking trajectory. “In fact, the uncomfortable spike in commodities prices and rising inflation expectations have added to concerns that the Fed may well front load its rate hikes further to better control rising inflation risks.”
They add in a Feb 28 note: “As such, we maintain our view that the Fed will hike by 50 bps in March, followed by four more 25 bps hikes across the remainder of this year, with a total cumulative rise in Fed Fund Rates of 150 bps this year.”
US stocks ended mixed on Feb 28 after enduring another volatile trading session with the indices erasing much of the earlier losses, notes UOB on March 1.
The S&P 500 index ended lower by 0.24% to close at 4,373.94, while the Dow Jones Industrial Average (DJIA) lost a bit more than 166 points, down 0.49%, to close at 33,892.60.
The NASDAQ was the best among the three major indices as it rose by 0.41% to end at 13,751.40.
Asian equities fared “relatively well” yesterday despite the uncertainties on global markets arising from the escalating tensions in Russia, says UOB. “Most major benchmarks managed to end the day with modest gains. In North Asia, China’s Shanghai Composite Index (SHCOMP) and Shenzhen Composite Index (SZCOMP) both added about 0.3% to 3,462 and 2,318. Similarly, the Taiwan Stock Exchange (TWSE) also added 0.3% to 17,652.”
“South Korea’s Korea Stock Exchange (KOSPI) fared better with a 0.8% gain to 2,699. However, Hong Kong’s Hang Seng Index (HSI) eased by 0.2% instead to 22,713,” notes UOB.
In Southeast Asia, Malaysia’s Kuala Lumpur Composite Index (KLCI) led with a 1% gain to 1,608, followed by a 0.3% rise in Thailand’s Stock Exchange of Thailand (SET) to 1,685. However, Singapore’s STI retreated by 1.5% instead to 3,242, as a result of pullback in banking stocks after the government announced plans to sanction Russia and block various banking activities and financial transactions connected to Russia.
Awaiting the West’s response
Asian markets tumbled by between 1.5% to 4% in reaction to the Russian attack, writes Carmen Lee, head of OCBC Investment Research. “In this environment, we continue to maintain our view of holding a diversified portfolio of value stocks in Asia as growth stocks are likely to be more vulnerable to further selling pressure.”
Oil’s price surge past US$100 a barrel marks a first since 2014. “This has led to heightened market fears that oil could head higher, adding to global inflationary concern and weighing heavily on financial markets. Risk premium will go higher in the near term and while markets await western nations’ response, this will create further price volatility,” she adds.
Commodity prices also spiked, and if sustained, could mean higher global food costs for consumers, says Lee. “It will also mean higher transportation and electricity costs. These are factors that could dent global growth prospects.”
She adds: “With surging oil prices, oil-exporting countries will fare better and the oil-importing countries will suffer. For companies involved in producing goods, higher raw material costs will exert pressure on their production and cost structures.”
This could result in a margin squeeze, says Lee. “New investments could also be put on hold as corporates assess demand outlook and the potential impact on their businesses and profits.”
Photo: Bloomberg
