Asset allocation changes are also needed to seek diversification against inflation in a changed macroeconomic landscape. Therefore, on Monday, March 7, 2022, our Global Investment Committee (GIC), added a 4% position in natural resources equities divided between the world’s largest commodity producing industries. This includes energy, agriculture and metals, and the narrow industry category of oil field services.
We also reinstated a 2% overweight in gold. Our action reduced equities mostly in Europe and Japan, though natural resources firms in the region are included. That’s because the largest natural resources firms regionally hail from the US, Canada, UK, Australia and Brazil.
The net change reduced our global equities allocation to 2% overweight from 4% previously. Global Fixed Income and cash remain 4% underweight. In fixed income, we hold overweights in US Treasury Inflation Protected Securities, medium duration US Treasuries, IG corporates and variable rate loans. Our thematic equity overweights in pharmaceuticals, cyber-security, payments and fintech, also remain in place.
Russian oil exports are equal to about 9% of global consumption. Russia and Ukraine wheat exports are roughly 18% of the world total. Regionally concentrated, Russia provides the majority of the natural gas imported by Northern European economies. A complete loss of these exports would be the rough equivalent of history’s largest supply shocks. As such, authorities have attempted to shield Russian commodity exports from sanctions.
Changes in trade flows toward Asia could re-direct commodities trade, minimizing shortages and price spikes. Nonetheless, Western sanctions on Russia will very likely disrupt Russian exports in coming months or years. Tragically, Ukraine’s lost output will vault global food commodities prices barring a rapid end to hostilities.
As described in our latest CIO bulletin, the conflict will very likely cause US consumer price inflation to surge to an 8 ½% year/year pace in the next few months with the monthly increases near the pace witnessed during the 1974 OPEC oil embargo. While there are great uncertainties in both directions, near-term crude oil prices could surge to $150 per barrel over the short-term. Severe natural gas shortages and price spikes in Europe this past winter highlighted a need for redundant energy supplies - including both alternatives and conventional sources - prior to the Russia shock. Fortunately, global energy production was already on the rise ahead of the latest turn in the conflict, with US crude oil output 16% above the year-ago pace in the latest week. We would also expect the price shock to spur global renewables investments, but with less immediate variability.
crisis spike price for many commodities is unlikely to be the enduring price, and we would expect lower prices later this year. Nonetheless, longer-term commodity futures prices have shifted higher in level over the coming two years or longer. Replacing lost Russian output will require substantial new investment and production gains in other regions to contain prices. For this reason, oilfield services providers will need to see dramatically enhanced investment activity. Similarly, suppliers of fertilizer and agricultural products will likely see sharply enhanced profitability at the expense of consumers globally.
The Federal Reserve aims to tighten monetary policy into the lingering and building supply shock. This raises downside risk for the US and world economy, particularly as the Fed’s actions build over time. Nonetheless, markets have been reducing the odds of a sharp US monetary tightening as the Fed will be impotent to fight supply disruptions solely with demand management tools. While we maintain a large overweight in medium-duration US Treasury and investment grade bonds, we believe most global yields are still too low to provide a hedge against the inflation spike, even as many equity sectors weaken.
A drop in real interest rates should provide support for the gold price, which remains an effective tail risk hedge in our view. In the near-term, commodity futures indices may benefit from the immediate shock of the Russia conflict. However, peak prices may be reached in a short time span, with losses to follow. The Global Investment Committee will continue to closely monitor unfolding developments and take actions necessary to adjust to emerging risks and potential opportunities with our tactical investment horizon of 12-18 months in mind.