Bloomberg — The inflation challenge is at the top of investors’ minds after Russia’s invasion of Ukraine caused oil prices to spike above $100 a barrel, adding to a flurry of red flags that equities were already grappling with.
“An oil rise is a major source of inflationary risk at a time of already-hot global inflation,” said strategists including Chief Investment Officer Vincent Mortier at Amundi, Europe’s largest asset manager. “The risk of stagflation globally is now higher,” they wrote in a note.
While oil has been on a long ascent on the back of a booming economy following the pandemic-induced slump, the invasion of Ukraine prompted a wave of Western sanctions against one of the world’s most important commodity producers, pushing prices even higher. Firms already struggling to maintain margins in the face of surging costs saw everything from natural gas to food and aluminum soaring.
The crisis threw global markets into a tailspin, prompting wild swings, target cuts and allocation changes. Here’s a guide to the emerging landscape, based on conversations and notes circulated to clients by fund managers and equity strategists:
Change of Fortunes
What Bank of America Corp. called a “shock” of rising energy prices led to a chorus of gloomy predictions about the outlook for European markets. Strategists from BofA to Goldman Sachs Group Inc. downgraded their projections for the continent’s benchmarks, citing the impact of the military standoff and rising costs to the European economy.
It’s a remarkable change of fortunes for European equities, which started the year on a high, boosted by optimism that they’d extend their post-pandemic rally and outperform U.S. peers in 2022 amid a global rotation into cheaper, so-called value stocks. Now the risks stemming from the Ukraine war are fueling an exodus of investors, the latest available data on fund flows from EPFR Global indicate.
For investors seeking to retain a foothold in Europe and value shares, the U.K. is being touted as a haven.
“We are exploring opportunities to rotate exposures from continental European stocks into the FTSE 100 and emerging markets,” Paul O’Connor, head of multi-asset at Janus Henderson Investors, said in an email. “We are seeing interesting opportunities appearing in European credit markets, as investor outflows lift yields and spreads.”
Goldman echoed the sentiment, raising its target for the U.K. large-cap benchmark just as it downgraded the euro area on Friday. “The index has almost no tech exposure and a heavy weight in value stocks and financials,” Goldman strategists led by Sharon Bell told clients.
In Asia, strategists at Goldman Sachs are advocating a rotation to commodity-heavy Australia and recommend being overweight on the energy sector. Some money managers like Singapore-based Modular Asset Management expect net exporter Malaysia to become a key hedge amid rising geopolitical tensions.
It may be a counter-intuitive play, but the rise of oil also boosted its biggest competitor in the energy space. Renewable stocks from Europe to China rallied this week, amid expectations that energy supply disruptions from the Ukraine turmoil may cement political will to accelerate the transition to clean power.
The European Renewable Energy Index surged more than 10% this week, in stark contrast with the broader market, which ended another week in the red. Several U.S. green companies also soared, with Sunrun Inc., the country’s biggest residential solar firm, rallying 22% on Thursday, the most since July 2020. and shares of world’s biggest solar module maker Longi Green rose Friday amid expectations of improving outlook for the industry.
“European lawmakers may take steps to reduce the region’s dependence on Russian gas supplies, and we believe renewables could offer the fastest path for curbing gas use from the electricity industry,” Bloomberg Intelligence analyst Rob Barnett wrote in a report on Thursday.
Even if spiking fossil-fuel prices accelerate Europe’s eventual transition to climate neutrality, it’s traditional commodity stocks that will reap the immediate windfall. JPMorgan Chase & Co.’s recommended screen of stocks amid the energy crunch includes Exxon Mobil, while Goldman’s Bell touts an overweight position on European energy, saying the sector is “both inexpensive in its own right and a good hedge against prolonged conflict and further rises in energy prices.”
Oil and gas is the best-performing sector in the S&P 500 index so far this year, with the likes of Marathon Oil Corp. among the biggest gainers. Similarly in Europe, energy and miners are the best performers of 2022 so far, defying a slump of 7% for the Stoxx 600 index.
On the Defense
If there’s one commodity powerhouse that’s at risk of losing out on the rally, it’s Russia, following a wave of sanctions targeting its banks and its economy. The country’s benchmark saw its biggest drop on record on Thursday, after the launch of the attack on Ukraine.
Still, strategists advise investors to hang tight, and avoid making hasty decisions.
“We own shares and bonds in Russia,” says Kevin Thozet, a member of the investment committee at Carmignac. “For now we haven’t sold our positions, we are waiting for this dislocation to normalize a bit, for a stabilization before possibly selling,” he said in a phone interview.
Thozet recommends buying healthcare stocks and consumer staples rather than consumer discretionary shares, while JPMorgan strategists led by Dubravko Lakos-Bujas see defense stocks such as Lockheed Martin Corp. and Northrop Grumman Corp. gaining from the turmoil.
On the other hand, carriers, such as Delta Air Lines Inc. and United Airlines Holdings Inc., will suffer from rising fuel costs, while companies with high Russian revenue, such as PepsiCo Inc., Philip Morris International Inc., Estee Lauder Cos. and McDonald’s Corp. are exposed to the escalation, they wrote in a note.