Head of Saxo Strats
Summary: Equity markets were ill-prepared for today's events with equities headed sharply lower and Russian equities dropping 26% on fears over devastating economic sanctions. The energy and mining sector has shown to be the best relative hedge in today's session and will continue to play a crucial role in equity portfolios to withstand inflationary pressures but also adding risk diversification against rising geopolitical risks. We show which stocks have the highest exposure to Eastern Europe/Russia and we point to where the S&P 500 Index could go from current levels. We also highlights our defence theme basket and talk about how retail investors should think asset allocation first and then single stocks.
Commodities are “awkwardly” the safe-haven amid security risks
The invasion of Ukraine has catapulted the global economy and especially Europe from an energy crisis and tight commodity markets to a serious situation about immediate and longer term energy and metals security. As we said on today’s Saxo Market Call podcast the next step in this conflict and financial markets is to what extent the US and especially Europe is willing to inflict self-damage on their economy through tough sanctions against Russia risking retaliation on key ressources such as natural gas and industrial metals. In Europe this fragility is expressed through equity markets in the Netherlands, Germany, and Italy which are all depended on Russian natural ressources. The events in Ukraine will keep inflation rates elevated and given safe-haven flows nominal interest rates will likely come down pushing real interest rates into deep negative territory. Inflationary pressures will continue to negatively impact profit margins and thus equity valuations.
One of the derivatives of today’s actions in Ukraine is that globalization could be rewritten as first the pandemic and now the events in Ukraine have shown how vulnerable developed economies are in terms of their energy and industrial production security. In our view the process of changing global supply chains were already in motion but could get accelerated. Inside this reconfiguration Africa could become a key continent and battleground for resource access and a country like India could benefit enormously from changing global supply chains.
As we wrote yesterday, the energy stocks will and have proven to be a good hedge against geopolitical risks and continued inflationary pressures. The European energy sector is the best performing sector in today’s session with financials and consumer discretionary (carmakers etc.) leading the declines. Inside the materials sector the construction materials, paper and forest products, and chemicals industry groups are down hard while the metals and mining is only slightly down driven by steel makers while mining companies and aluminum smelters are gaining. The best way for retail investors to get exposure to energy and mining are through broad-based ETFs.
Russian equities in particularly have taken a big hit from the invasion with the leading Russian equity index down 26% in local currency. European companies with related Russian assets are also suffering today and the list below shows US and European listed equities with the highest exposure to Eastern Europe/Russia. In USD terms the Russian equity market is down 62% from the peak in September sending Russian equities 25% below the average price since 2013.
The current situation in financial markets is unpredictable and encapsulates the concept of uncertainty (something that cannot be quantified) opposed to risks (which is quantifiable concept). As such nobody knows the outcomes and where equities will find a new equilibrium. One simple heuristics is to look at the spread between the S&P 500 and its 200-day moving average which hit -29% during the Pandemic selloff at the lows. Applying a less impact of around -20% would take the S&P 500 into the territory of around 3,500, which is just above the pre-pandemic levels; some European equity markets are already flirting with levels seen just before the pandemic erasing two years’ of equity returns.
Defence theme basket could become best theme in 2022
Our defence theme basket was as of yesterday unchanged for the year as investors have made bets on increased military spending favouring US and European defence companies. We expect the situation in Ukraine to lead to an increase in military spending over the coming years and potentially the theme basket could be come the best theme basket this year together with our commodity sector basket. The list below shows the constituents in our defence basket and should not be viewed as investment recommendations but an inspiration and a list of companies with the biggest exposure to defence budgets.
| Name | Mkt Cap (USD mn.) | Sales growth (%) | EBITDA growth (%) | Diff to PT (%) | 5yr return |
| Raytheon Technologies Corp | 137,653 | 13.8 | 319.7 | 13.5 | 55.9 |
| Airbus SE | 100,843 | 4.5 | 234.2 | 28.2 | 75.2 |
| Boeing Co/The | 114,513 | 7.1 | 92.8 | 32.9 | 18.4 |
| Lockheed Martin Corp | 105,908 | 2.5 | 5.6 | 5.0 | 66.9 |
| Northrop Grumman Corp | 60,268 | -3.1 | 29.2 | 5.4 | 70.8 |
| General Dynamics Corp | 60,058 | 1.4 | 1.4 | 9.0 | 27.7 |
| L3Harris Technologies Inc | 42,442 | -2.1 | 39.4 | 13.2 | 112.5 |
| TransDigm Group Inc | 34,781 | 2.9 | 17.4 | 17.9 | 203.2 |
| BAE Systems PLC | 25,501 | 1.3 | 29.5 | 5.1 | 20.5 |
| Rolls-Royce Holdings PLC | 13,286 | -3.9 | NA | 10.1 | -53.2 |
| Thales SA | 20,246 | -1.7 | 2.9 | 21.5 | 3.0 |
| Howmet Aerospace Inc | 14,163 | -5.5 | 4.8 | 18.8 | 42.0 |
| Dassault Aviation SA | 10,782 | -14.4 | -28.0 | 12.2 | 13.5 |
| Elbit Systems Ltd | 7,701 | 12.1 | 30.3 | -5.3 | 40.4 |
| Kongsberg Gruppen ASA | 5,685 | 7.2 | 29.9 | 11.5 | 179.8 |
| Leonardo SpA | 4,071 | 1.3 | -7.9 | 35.3 | -45.7 |
| Rheinmetall AG | 4,824 | 2.4 | NA | 16.9 | 56.4 |
| Saab AB | 2,986 | 10.5 | 61.1 | 47.0 | -32.5 |
| Ultra Electronics Holdings PLC | 2,935 | 0.0 | 4.4 | -1.5 | 85.1 |
| QinetiQ Group PLC | 1,989 | 7.2 | -9.1 | 32.0 | 4.1 |
| Babcock International Group PLC | 2,086 | 0.2 | -94.4 | 20.2 | -60.3 |
| Chemring Group PLC | 993 | -2.3 | -2.5 | 33.3 | 45.6 |
| INVISIO AB | 529 | 11.5 | -26.7 | 84.4 | 71.3 |
| Avon Protection PLC | 425 | 0.7 | -98.8 | 66.7 | 10.9 |
| Avio SpA | 303 | -17.7 | -40.4 | 49.4 | 1.3 |
| Aggregate / median values | 774,969 | 1.3 | 4.8 | 17.9 | 40.4 |
Source: Bloomberg and Saxo Group
What can you do in a portfolio?
As we have argued extensively in our previous notes on risk diversification market timing is often not the solution because even if you are lucky and get the exit right when do you enter again. Many retail investors only have equity portfolios and are such quite “naked” in terms of risk diversification even if equity positions are spread across various industries. This is because in crises everything in equities gets highly correlated.
A portfolio that tries to minimize tail risks while aiming to get a good risk-adjusted return should have considerable exposure to short-term government bonds (despite the negative real yield), global equities, inflation-protected government bonds, mortgage bonds, gold, and commodities (Bloomberg’s commodity index consisting of 23 commodities). On top of a well-diversified asset allocation an investor can then add single stocks for specific plays on the themes we mentioned above such as cyber security, commodity sector, logistics and defence. Travel stocks which have done well this year will begin to suffer a lot from the current crisis and while semiconductors have pricing power and a strong outlook the risk premium on semiconductors could go up further.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
