Column: Risks of both rising inflation and economic slowdown, what are the investment tactics in an emergency = Mr. Norihiro Fujito | Reuters

[Tokyo 9th]–The Russian invasion of Ukraine suddenly reversed the hands of the clock 60-70 years ago. The 1956 “Hungarian Revolution” and the 1968 “Prague Spring” in Czechoslovakia are a return to the time when they were overrun by Soviet tanks.

On March 9, the Russian invasion of Ukraine suddenly reversed the hands of the clock 60-70 years ago. The photo was taken on the 7th in front of the stock price board in Tokyo (2022 Reuters / Kim Kyung-Hoon)

Current globalism has been built on the premise that there is no barbarism to invade and control other countries by military force. However, Russia has practiced the logic of “imperialism” in the 19th century in Ukraine. Putin was most afraid that Ukraine would join the North Atlantic Treaty Organization (NATO) and Western-style democracy would spread to Russia. The risk of the collapse of Russia’s centralized dictatorship is assumed to be the biggest factor directly linked to this invasion of Ukraine.

Western countries have implemented economic and financial sanctions on Russia and also provided weapons and fuel to Ukraine. Unfortunately, however, there is an overwhelming military power gap between Russia and Ukraine. The outline of the era is changing rapidly, and the same “new Cold War structure” as after World War II is being constructed.

What should be watched in the market is that commodity prices will continue to rise. If only “geopolitical risk”, the high commodities are transient, as can be seen by looking back at the time of the Gulf War and the Iraq War.

However, this time there is a tight supply and demand at the root. Even before the “Ukrainian risk”, the global economy has turned to recovery and demand is increasing as supply chains continue to be disrupted and supply is declining. The OPEC’s February crude oil production (daily volume, same hereafter) was 28.55 million barrels, but production is still down 16.4% from the peak of 34.14 million barrels in 2016.

The United States has also recovered slowly from the peak of 13.1 million barrels in 2020 to 11.6 million barrels most recently.

However, the biggest impact was reported that Europe and the United States are considering an oil embargo on Russia, whose production had recovered to 11.05 million barrels in February this year. The North Sea Brent crude oil futures price rose to $ 139.1 a barrel at one point, probably due to the observation that Russian crude oil will be locked out of the market.

In addition, the European Union (EU) has relied on Russia for more than 40% of its natural gas imports, so the price of European natural gas futures is currently at a record high of 1 MWh (megawatt hour) = 345.0 euros. was there. It is about 22 times higher than the low of 15.5 euros in March last year.

The natural gas pipeline “Yamar Europe” reaches Germany via Russia and Ukraine, but it has become a battlefield and has been disrupted. “Nord Stream 1” on the Baltic submarine, which directly connects Russia and Germany, also suggested that Russia would stop supplying in retaliation for economic sanctions, and “Nord Stream 2” completed last fall has not been licensed to operate in Germany. The closeness of energy relations between the EU and Russia may backfire, and the soaring price of natural gas may be prolonged due to the sense of urgency.

Non-ferrous metal prices continue to rise. Copper, nickel, aluminum, etc. have typical economic sensitivities and have continued to develop almost in parallel with business sentiment in the United States and China. However, due to the global trend toward electric vehicles (EV), the demand for innovation for non-ferrous metals has increased. According to the International Copper Association, EV uses nearly four times as much copper as ordinary gasoline-powered vehicles, and nickel is also used as the “positive electrode material” for EV in-vehicle batteries. In addition, aluminum is indispensable for reducing the weight of the car body, and the demand for EV is added to the normal demand.

On the other hand, supply has not progressed slowly due to supply chain turmoil, Indonesia, which is the world’s largest producer of nickel ore, has narrowed down exports from its high value-added strategy, and China, which is overwhelming in aluminum production, has slowed down due to power shortages. The situation where supply could not keep up with the increasing demand continued.

With the addition of “Ukraine risk”, Russia has a strong presence in nickel and aluminum production, so it is expected that its impact will be greater.

Wheat futures prices are also rising with a continuous stop high at the moment. Originally, Russia and Ukraine were outstanding in wheat production and export. According to the U.S. Department of Agriculture, Russia’s wheat export volume in 2021-22 was about 35 million tons, the highest in the world, and when combined with Ukraine’s export volume of about 24 million tons, it actually occupies about 30% of the world share. There is.

At present, of course, exports are suspended, and economic sanctions may prolong the soaring price. Agricultural products other than wheat have also continued to soar, and the Food and Agriculture Organization (FAO) food price index hit a record high of 140.7 in February.

Originally, the Federal Reserve Board (FRB) and the European Central Bank (ECB) should swiftly implement strong tightening measures to curb inflation. However, economic and financial sanctions against Russia have shaken the stock prices of European banks, which have high exposure to Russia.

According to the Bank for International Settlements (BIS), the credit balance to Russia is about $ 25 billion each for French and Italian banks and about $ 17 billion for Austria (as of September 2021). France’s Societe Generale’s stock price has plunged 51.3% from a February 10 high of 37.6 euros to a March 7 low of 18.3 euros, with Italy’s Unicredit doing the same.

Although the US bank’s exposure to Russia is relatively low compared to European banks, Citigroup has announced that it is “about $ 9.8 billion.” As for operating companies, British oil giant BP has decided to withdraw from Russia and announced that it will record a write-down of 25 billion dollars.

In addition, the automobile industry, which has finally been on a recovery trend, has once again experienced a sharp drop in stock prices, especially among European manufacturers, due to the turmoil in the supply chain. The Western central banks will have to take this situation into consideration.

FRB Chairman Powell said at the Banking Commission of the US House of Representatives that “a 0.25% rate hike in March is appropriate”, but uncertainty about “Ukraine risk” seems to have led to a cautious gradualism. .. However, as Chair Powell added in parliamentary testimony, the phrase “if inflation remains high, we will raise rates by 0.5% once or multiple times” may emerge.

On the other hand, the ECB is responding to a more difficult situation, and Chief Economist Director Lane said, “We will take any measures to support the economic recovery,” and the policy is suddenly changing to “anything” again. be.

Both central banks must weigh the “risk of rising inflation” and the “risk of slowing / slowing economy”. Although it is necessary to make very difficult decisions, it seems that the focus of emergency crisis response will be to prevent the spread of economic and financial risks and the progress of economic slowdown. However, this emergency response poses a dilemma that further boosts inflation.

Asset management is not normal, and it seems necessary to respond to emergencies. As the Russian army attacked the nuclear power plant, unexpected things could happen in the future. As a countermeasure, the orthodox method is aimed at gradually reducing the inclusion of risk assets such as stocks, increasing the weight of cash and short-term government bonds, and building a portfolio that can respond to changes in the situation.

However, on the investment side, if the cash ratio is accumulated forever, customers may criticize the cautious attitude. Therefore, in equity investment, it is necessary to roughly divide into 1) immediate response and 2) long-term response.

In 1), the first is the shift to “inflation hedge stocks” such as mining, petroleum, non-ferrous metals, steel, shipping, and trading companies. It is necessary for individual companies to examine their exposure to Russia, but considering the soaring commodities, this is a natural measure.

Second, I would like to pay attention to “defense-related stocks,” whose needs are rapidly increasing. The S & P 500 aerospace and defense stock index continues to rise in the form of an inverse correlation with the declining S & P 500 index. In Japan as well, the heavy industry, shipbuilding, and heavy machinery sectors, which have a high contract record with the Ministry of Defense, will be attracting attention. It’s also commendable that these sectors are likely to be in a recovery phase with their earnings momentum out of the worst.

Regarding the long-term response of 2), companies in Japan and the United States that have announced excellent current financial results and good medium-term outlooks continue to be stagnant in terms of stock prices. Currently, it is still an “emergency response” and it is difficult to make a proper evaluation. However, it is assumed that inflation may peak out and the market may return to the “peacetime” market after the second half of the year. In the long run, you should consider picking up good-performing stocks with good business models in a time-dispersed manner.

Edited by: Kazuhiko Tamaki

* This column was published in the Reuters Forex Forum. It is written based on the author’s personal opinion.

* Mr. Norihiro Fujito is a counselor and chief investment strategist of Mitsubishi UFJ Morgan Stanley Securities. Graduated from Waseda University in 1979. Joined Kokusai Securities in 1999. After that, he was in the investment information department at Mitsubishi Securities, Mitsubishi UFJ Securities, and Mitsubishi UFJ Morgan Stanley Securities. He has been in his current position since July 2018. Prior to joining Kokusai Securities, he worked for a life insurance company for about 20 years as a fund manager, pension fund portfolio manager, and planning manager. He has a good reputation for his compelling analysis from a buy-side perspective.

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