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Navigating equities as Russia’s invasion continues

Equities 12 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  Russian equities are bleeding in London trading and uncertainty has hit maximum with European sanctions over the weekend reaching levels never seen before. We believe investors with pure equity portfolio should use well-diversified asset allocation strategies to increase diversification and inside their equity allocation increase the weight on the commodity sector, cyber security, defence, mega caps and logistics. In today's equity update we discuss the historic shift in Germany in terms of its military and energy security and what it means for defence stocks and energy assets such as green energy, LNG, and air-to-water heat pump manufacturers. We also show European banks and countries with most to lose form the SWIFT ban.


A highly dynamic environment requires the right diversification

The situation in Ukraine is troublesome and highly unpredictable in terms of outcome, and the new sanctions against Russia over the weekend are amplifying the uncertainty. Nobody knows where this ends and we are in a maximum uncertainty environment that requires a rethinking for most investors. The developments over the weekend (discussed further down in today’s note) have forced equity markets lower and catastrophic selloff of Russian assets with Gazprom shares in London down 36% after being down as much as 62%.

Source: Saxo Group

If you are a retail investor with 100% equity portfolio you have two choices besides selling it all, which we believe is a bad strategy because timing is a losing strategy:

  1. Diversify into other assets in a well-structured way. One solution is to a place X amount (depending on your risk profile) into a well-diversified asset allocation portfolio such as those Saxo offers through SaxoSelect. These portfolios, and especially those with lower risk levels, will diversify outside equities and lower risk for the investor with 100% equity portfolio.
  2. If the investor refrains from the above, then the next step is to bolster your 100% equity portfolio in the right way. It is clear from price action and flows, that energy and mining companies (those with little exposure to Russia) are providing good hedges to the current geopolitical risks but also longer term against inflation as it is coming from the supply side of the economy. In addition, themes such as cyber security, logistics, mega caps, and defence are themes that will act well as diversification against growth/technology stocks and overall equity market exposure. Financials would typically be a natural winner during tightening cycles, but the current events make financials high volatility assets with no clear direction as the financial system is being used as key sanctions instrument. We also believe that LNG related assets, air-to-heat pumps and green energy stocks are natural opportunities in the medium-term as the EU will now explore these paths for energy dependence from Russia.

Europe and Germany in historic shift over the weekend

Last week ended with equity markets interpretating the developments as Europe would not inflict too much harm on their economy and there were prospects of peace talks between Ukraine and Russia, but over the weekend things have changed dramatically. Germany has made a historic shift first sending military equipment to a conflict zone for the first time since WWII and on Sunday the Bundestag announced that the country would end its naivete over the past three decades. Germany has announced that it will increase military spending to above 2% of GDP and significantly increase it standing army to the size and importance Germany has in Europe. Other countries might quickly follow the lead of Germany and this will lead to a positive tailwind for Saxo’s defence basket (see basket below) which was also the best performing basket on Friday.

NameMkt Cap (USD mn.)Sales growth (%)EBITDA growth (%)Diff to PT (%)5yr return
Raytheon Technologies Corp146,42813.8319.76.764.9
Airbus SE101,9664.5234.226.171.3
Boeing Co/The117,4637.192.829.517.2
Lockheed Martin Corp111,5152.55.6-0.273.0
Northrop Grumman Corp63,950-3.129.2-0.681.3
General Dynamics Corp63,3101.41.43.432.7
L3Harris Technologies Inc45,083-2.139.44.8129.8
TransDigm Group Inc36,7412.917.411.6216.9
BAE Systems PLC27,4831.317.1-0.526.1
Rolls-Royce Holdings PLC11,873-3.9339.623.5-58.8
Thales SA21,965-1.72.913.18.9
Howmet Aerospace Inc14,976-5.54.811.449.0
Dassault Aviation SA11,631-14.4-28.03.319.7
Elbit Systems Ltd8,20312.130.3NA48.4
Kongsberg Gruppen ASA5,8837.229.97.9185.0
Leonardo SpA4,4961.3-7.921.8-44.9
Rheinmetall AG7,1972.4NA-18.0116.9
Saab AB3,46110.561.128.8-22.7
Ultra Electronics Holdings PLC2,9330.04.4-2.378.6
QinetiQ Group PLC2,0367.2-9.129.85.1
Babcock International Group PLC2,0740.2-94.421.3-62.4
Chemring Group PLC1,034-2.3-2.526.951.5
INVISIO AB57111.5-26.756.585.1
Avon Protection PLC4710.7-98.849.224.9
Avio SpA316-17.7-40.442.25.7
Aggregate / median values813,0591.35.212.448.4
Source: Bloomberg and Saxo Group

In addition, the EU, the US and UK have decided to exclude a number of Russian banks from SWIFT, which is a messaging system for rapid transfers in the international financial system, which will make trade with Russia much more difficult. The energy and resource sectors are still left out of the sanctions which are around 50% of Russia’s national income, but this could come into play in the event Kyiv is taken by Russian forces. The sanctions on banks have hit Russian banks hard today and the ECB said that it expected Sberbank’s subsidies in Europe to fail today or tomorrow. Switzerland has also just announced that it will adopt the EU sanctions on Russia which is increasing the pain for Russian businesspeople as the country was seen as neutral and a key hotspot for Russian offshore wealth. European financials are the biggest loser today down 4% and the list below shows clearly which banks have the highest exposure to Russia and thus which one investors that want to limit Russian exposure should avoid. It also clear from BIS data that Italy, France and Austria are the most vulnerable to Russia sanctions through the banking system.

Source: Bloomberg
Source: Saxo Group

Europe’s energy sector enters new paradigm

Over the weekend, the UK energy company BP announced that it will exit its 20% stake in Rosneft, Russia’s largest oil company, potentially taking a loss of $25bn putting pressure on other European companies to decide what to do with their Russian assets. The Norwegian Wealth Fund also announced over the weekend that it plans to exit all its Russian assets and Equinor followed up on BP saying it will divest all of its JVs in Russia. To defend the RUB and Russian stocks, the Russian central bank hiked interest rates to 20% on Monday and halted trading in Russian equities in Moscow. The decisions by European energy companies are negatively impacting these companies despite higher oil and gas prices, and we should emphasise that these energy assets are still to be regarded as hedging assets as we wrote last week, but the key filter is on the Russian exposure.

Inside the energy developments the invasion of Ukraine has caused Europe’s green energy stocks to surge dramatically higher with Orsted (offshore wind farm developer) and Vestas shares to jump 28% and 35% respectively since the day before the invasion. The green transformation trade was looking very ugly due to inflationary pressures impacting gross margins of green energy assets but also rising interest rates impacting the lofty equity valuation. But Europe’s desire to become independent of Russia will accelerate plans for green energy and we expect strong government funding flowing in this direction over the coming years or decade and we expect the EU to prioritize domestic manufacturers over cheaper Chinese manufacturers.

Source: Bloomberg

Europe’s energy ministers have met today to discuss how Europe can become energy independent from Russia and these discussions will likely continue in the medium-term. In the short-term there are no real quick fixes except from limiting transportation (work-from-home is one mitigation strategy as 50% of oil consumption in the EU is for road transportation). Medium-term strategy is likely including potential gas and oil deals with North African countries, Iran or Venezuela, besides accelerating the green energy share of total energy production on top of more LNG capacity (Germany has decided to build two new LNG terminals as quickly as possible) and air-to-heat pumps replacing gas as the heating source; however, the next dilemma is what energy source we use for electricity production.

The list below shows some companies with exposure to LNG.

  • Sempra Energy
  • Cheniere Energy
  • Flex LNG
  • Golar LNG
  • Awilco
  • NextDecade
  • Teekay

The list below shows companies with exposure to air-to-heat pumps.

  • Mitsubishi Electric
  • Daikin Industries
  • Carrier Global
  • Johnson Controls
  • Nibe Industrier

Companies with Russian exposure

ESG is a popular investment among investors and the invasion of Ukraine means that ESG is likely to expand to include geopolitical risks such as conflict zone assets of the aggressor. In this case Russian assets will get the status of being non-ESG compliant for many portfolios and BP’s decision over the weekend will put enormous morally pressure on other European companies to decide what to do with their Russian assets. The list highlights some key companies with significant business exposure to Russia (others could have exposure through assets besides revenue).

  • Polymetal International
  • Evraz
  • Uniper
  • Forum
  • Raiffesen Bank International
  • Carlsberg
  • Neste
  • Rockwool
  • Renault
  • Danone
  • Sandvik
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