Chief Investment Officer, Jamie Nicol provides his insights into the effects of the Russian invasion of Ukraine on the current market.
So the war between Russia and Ukraine, has developed significantly over the past couple of weeks, and certainly we’ve seen a much stronger response from Russia, as they’ve tried to take control of the Ukraine. And the consequences of that, has been a much more united response from the West, which has been somewhat of a surprise given historical pattern. And that’s a problem really, because Russia’s responsible for a lot of the world’s grain, a lot of the world’s gas, a lot of the world’s oil, and other commodities. And the fact that there’s significant restrictions on that economy, means we’ve seen commodity prices shoot upwards.
We actually think it’s a massive failure of risk on behalf of Germany and Europe, given that they’ve been very reliant on Russian gas. You would’ve thought they would’ve foreseen some potential problems, given Russia is a bad state actor, but they have been overly reliant and now they’re in a fairly difficult place with commodity prices going up and no real solutions, and no real quick solutions. And I think this is the real problem with commodity prices heading up, normally there’s a quick supply response.
But with ESG concerns, other regulatory concerns overhanging new projects, it’s not like some things can change quickly. So that leaves the world with a lot higher commodity prices, which feeds into this inflation concern that we’ve had for a while, and certainly tightens up capacity as Russia gets taken out of the global economy. Ultimately where this goes, potentially can lead to demand destruction, which potentially means sort of recession. Certainly that risk is elevated in Europe, we believe.
I think from Australia’s perspective though, once again, Australia seems like we’re the lucky country given that our commodities are in high demand, and that will certainly support our terms of trade, LNG, coal, oil, grain. A whole host of commodities that Australia exports are in short supply, and that will support our economy. So I think Australia looks relatively good relative to other parts of the world, albeit we do think the recession risk is elevated.
So we’ve made a number of moves, we’ve reduced our exposure to European recession risk, by selling Virgin money, which is exposed to the UK economy which we’ve more closely tied to the European economy. We’ve increased the resilience of the portfolio by buying into CSL, which has been out of favor and has derated relative to the broader market over the last few years, it’s also a bit of COVID recovery play, so we think we’re buying it cheaper than its been for some time and has very, very resilient earnings at the end of the day.
And finally, adding to some of our commodity exposure, BHP, RIO, South 32, I think some of these stocks will benefit from higher commodity prices. So those are the three key steps that we’ve been undertaking.
I think when you have periods of volatility, there’s always opportunities and you try to find good quality companies that are trading at attractive levels. An example for us, was that CSL example that I gave, which is a great quality company, very resilient earnings, trading cheaper than it has for some time. But then other stock we can think about, is a stock that’s going to do very well in the current environment. Higher commodity prices, boosts its underlying demand for its services, and for us that’s a stock like ALS, Australian Lab Services. It’s a market leader in providing lab services to assess gold, to assess lithium, to assess other commodities, as well as undergoing assessments of water quality, of food quality, of pharmaceutical quality.
And so increasing regulation around the world post COVID, increasing transition of the world to zero carbon, increasing infrastructure work, and increasing demand for commodities, all of those things feeds into demand for its services. So it’s very well-placed for the future, it’s just had a recent upgrade, I think it’s an excellent business with really good margins, very good returns, and that good fundamental backdrop. So you can find these sort of opportunities as the global economy shifts, and as inflation comes through, and as demand changes. There’s going to be opportunities to find good businesses at attractive levels.
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