[TOP STORY] Market responses to the Russia-Ukraine war

‘I think it’s [a case]…of hold on tight for the next few months, but no major fundamental change to the value of assets’: Peter Little of Anchor Capital.

SIMON BROWN: I’m chatting now with Peter Little, fund manager at Anchor Capital. Peter, I appreciate the early morning time. Last Thursday, as the invasion started in Ukraine, you and your team put out a note, [so] I thought let’s catch up a week later in terms of market responses. The key point perhaps is that these two economies are quite small. Russia is 1.8% of global GDP, Ukraine only 0.2%. But of course this is war in Eastern Europe – there are bigger issues to it. Certainly in terms of the commodity and agricultural space they massively punch above their weight.

PETER LITTLE: Yeah, absolutely. Thanks for having me, Simon. So, spot on. It’s hard to put a humanitarian crisis into dollars and cents, and how that impacts us, but yeah, you’re right. The reality is that in the broader scheme of things, if these two economies were to stop producing, it would be a little wobble for global markets. But obviously, as you say, the commodity part is where the knock-on impact is.

A quarter of Europe’s energy needs are supplied out of Russian coalaa, gas and petrol, and up to 80% of sunflower oil exports, a third of grain exports.

So they’re pretty important in terms of setting the price for those commodities which have a big impact on people’s lives day to day.

SIMON BROWN: If we look at markets, the US was truthfully selling off ahead of the invasion and actually is above the levels which it was [at] – they were closed last Thursday ahead of the invasion. Europe is obviously under pressure; the FTSE 100 and Euro Stoxx 50 have both been falling. Locally we are actually higher because of those commodities.

But that really does make sense. The US is tech-heavy and far from the conflict, Europe is right there and of course we benefit from those commodity prices.

PETER LITTLE: Yeah, absolutely. In the platinum group metals obviously South Africa and Russia produce the bulk of those. It’s just to the extent that their supply can’t get to market and there’s a bit of a squeeze in the prices we are a huge beneficiary of that.

A company like Sasol is obviously a big beneficiary of the oil price, although there are a number of other companies in South Africa that will be sweating on the higher petrol price.

Also the fact that Russia’s essentially like a persona non grata from a EM (emerging market) investment perspective means that there’s a big share of the pipeline to come to South Africa as well. So some benefits for us, certainly.

SIMON BROWN: I take the point. Then the issue is we literally have no idea how this plays out – the duration, none of that. But to my mind the one thing that that’s staring me in the face is the inflation risk. Certainly we are seeing agricultural prices rising across wheat, maze, sunflower and so forth. We’ve got those energy prices rising quite significantly, and we came into the year as a planet with high inflation. Now we’ve potentially got even higher inflation if this continues.

PETER LITTLE: Yeah. In theory the food and energy components of inflation are the sort of headline components that get stripped out when central banks look at inflation. So in theory these components will be transitory and create a bit of noise and a bit of pain for consumers at the pump for a couple of months, but shouldn’t really go beyond that. So central banks should be ignoring this.

The trouble is that for consumers, the kind of psychology of higher food and gas prices is pretty big. And so inflation expectations start to get big on them and then it becomes self-fulfilling.

People expect higher wage hikes, landlords want to put rent up in anticipation of this thing, and those things can become more sticky.

So the [US] Fed’s already got to do a good job of talking people off the ledge and at least be seen to be acting to do something about this. We think that’ll create some monetary tightening over the course of the next few months, but hopefully the back end of the year will see a lot of the stuff sort of drop out of the base and things will get a little easier.

SIMON BROWN: Yeah. As you said, inflation is often about those expectations as much as anything else. You mentioned that the central banks should be ignoring these inflation risks, and I take your point on that a hundred percent. Jerome Powell [chair of the US Fed] was out yesterday saying, nope, we’ve got that meeting in two weeks, and rate increases are still absolutely on the table. That is, certainly for the US, the right response. In Europe, maybe a different game, but even there they need to stick to those guns, do those rate increases and, as you say, kind of carry on as normal.

PETER LITTLE: Yeah. I guess ultimately the bigger question for the economy is how this impacts consumption patterns. Are people sort of squeezed out of normal consumption patterns because they’re spending so much on gas and food, and how does it impact sentiment? Do they become worried about spending in case things get worse? And then that sort of knock-on effect starts to impact majorly on economic output globally. So we really need to worry about what’s happening in sentiment and whether people feel like they’re getting squeezed out of consumption, which is the big driver of economic activity globally – much more meaningful than anything Russia and Ukraine could do.

SIMON BROWN: Locally two stocks have significant exposure. They’ve both issued Sens around it – Barloworld at around 20%*, Mondi** at around 12%. Both have come under significant pressure. Is your sense this has been priced in, or is this a case of rather than taking positions here, watch and see what’s happening in the two companies – both of which are high-quality stocks.

PETER LITTLE: I think people have just globally [adopted] the opinion that it’s ‘sell now and ask questions later’ because it’s really not clear what going to happen. You’ve seen Russian stocks trading in the UK theoretically. Companies like Magnit, which is a supermarket in Russia, should still keep going, but its value has been whacked to zero because you don’t know what’s going to happen. Will your assets be confiscated by the Russian government? Will you ever be able to trade them again? And so I just think of Russia and obviously people’s indignation with Russia’s response, just not wanting to be associated with anything to do with Russia has probably made Russian-affected assets overshoot on the downside. But it’s hard to know when that’ll ever come back.

SIMON BROWN: You ended the note you put out early Thursday last week by saying that you monitor the unfolding situation, for now comfortable that investors are largely insulated, your big investors, against the impact – short-term price fluctuations aside. Is it a fair statement where we now sit, just over a week later, that by and large we are insulated? There are going to be some short-term price fluctuations and there is of course a lot of unknowns, but South African investors and certainly your investors are largely insulated.

PETER LITTLE: Yeah, I would say that still holds true. For us the bigger risk is contagion. Early in the thing we were worried about what China’s response would be. They have similar sort of designs on Taiwan and, to the extent that they took the opportunity to side with Russia and have a go at Taiwan, that’s probably a much bigger issue for us. That doesn’t seem to be the case. China seems to have sort of reduced its vocal support for Russia’s position on Ukraine. So that seems to be mitigating. Obviously to the extent that this spills over into a broader war, it’s kind of all bets are off.

But both of those things are not our base case. So we kind of stick with that narrative that things will be choppy for the next few months as we try to understand the implications of this. You’ve already had, as you’ve said, the inflation worries and central bank tightening going on in the background. That I think continues to be a theme for the next few months.

And so, yeah, I think it’s kind of hold on tight for the next few months, but no major fundamental change to the value of assets.

SIMON BROWN: That, of course, with the caveat that there are a lot of unknowns out there. Things can change in a hurry. Peter Little, fund manager at Anchor Capital, I really appreciate your early morning insights.

*Russia contributes 78% of Barloworld’s Equipment Eurasia’s revenue and 20% of the group’s revenue from continuing operations.
**Mondi has operations in Russia, representing around 12% of the Group’s revenue

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This thing has only just begun, and the financial Armageddon is getting much closer.

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