Perspective

Ukraine crisis: what does it mean for asset allocation?


Russia’s invasion of Ukraine, which is having devastating human consequences, has increased the risk of a stagflation environment – one of slowing economic growth but high inflation. 

How should investors prepare for this possible scenario? Our analysis reveals which asset classes are likely to outperform if it comes to pass.

  • Our live blog on the Ukraine crisis will be updated regularly throughout the week, it can be found here.  

In general, there are four different phases of the business cycle based on the evolution of output: recovery, expansion, slowdown and recession.

The table below shows the average real (inflation-adjusted) total return of major asset classes for each business cycle phase during high inflation environments.

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Historically, the slowdown phase has favoured investing in traditional inflation-hedges such as gold (+19.3%) and commodities (+16.7%).

This makes economic sense. Gold is often seen as a safe-haven asset and so tends to appreciate in times of economic uncertainty.

Commodities, such as raw materials and oil, are a source of input costs for companies as well as a key component of inflation indices. So, they will typically perform well when inflation rises too (often because they are the cause of the rise in inflation).

In comparison, the slowdown phase has proved very challenging for equities (-0.6%), as companies combat falling revenues and rising costs.

Keeping your savings in cash (-0.2%), proxied via T-Bills, hasn’t been a better strategy.

Although US Treasury bonds have performed well in the past (+6.4%), they should be treated with caution today.

In theory, they should benefit from falling real rates, driven by declining growth.

However, rising inflation eats into their income, putting upward pressure on yields and downward pressure on prices.

In practice, the extent to which this harms bond returns will depend on their duration and starting yield (higher yields provide a larger cushion to absorb rate rises).

What are the key takeaways for asset allocation?

Last year, the reflation environment favoured investing in risk assets such as equities and commodities, while gold has suffered.

This is consistent with what we would expect using our previous analysis. However, if we are on the cusp of a period of stagflation, then a shift in performance leadership may be on the way.

In this scenario, equity returns may become more muted while gold and commodities may outperform. This is exactly what has manifested so far in 2022.

Meanwhile, central banks are stuck between a rock and a hard place. Hiking interest rates too quickly could send the global economy into recession. But keeping rates low for too long could send inflation spiralling out of control.

Taken together, the outcome for bonds is uncertain and will depend on the tug-of-war between inflation and growth sentiment.

 

The views and opinions contained herein are those of the Authors, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

 

This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

 

Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested.

 

Schroders has expressed its own views in this document and these may change (to be used if the 1st statement above is not being used).

 

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The forecasts stated in the document are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today’s date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change.