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The war in Ukraine has produced many headlines and short-term market moves, but fundamentals rather than headlines are what have driven returns.

William J. Adams

CHIEF INVESTMENT OFFICER - GLOBAL FIXED INCOME MFS

Headlines generate eyeballs, but fundamentals have driven returns. In this way, headlines simply reinforce shorttermism, with little benefit to investment outcomes.

While the war in Ukraine has produced many headlines and short-term market moves, fundamentals rather than headlines are what have driven returns. We advocate an active investment approach that accounts for longer-term themes and investment dynamics.

 These notes often focus on current events and the volume of headlines impacting investors that feature prominently as themes in analysts’ and strategists’ ideas. An important takeaway, in my opinion, is the challenge we face in trying to predict headlines and the near impossibility of successfully trading headlines. Said another way, headlines generate eyeballs, but fundamentals have generally driven returns. In this way, headlines simply reinforce short-termism, with little benefit to investment outcomes.

Observations about recent events in Ukraine are beginning to feel similarly short-term in focus. Market participants debate Russian intentions and actions, the anticipated duration of military activity, and Ukrainian resolve. These analysts seemingly shifting quickly from medical practitioners in the post-Covid world to military strategists. Markets have fallen then rallied, volatility has picked up, commodities have spiked and central bankers have adopted views rooted in unknowns and the increased risk of economic weakness.

Time passes and markets move on. Today’s stories are back to featuring inflation and central bank actions, quarterly earnings and the midterm elections in the United States. The largest military action on the European continent since World War II, initially cast as a seminal event for investors, appears now to be a regional concern and is slowly fading from view.

Even so, humanitarian concerns remain paramount. I have colleagues at MFS who are Ukrainian and Russian, as well as others of Eastern European descent, many of whom have family and friends in the region, so I know the humanitarian crisis is real and the situation continues to pose significant risks in the near term. Also, the human tragedy will not easily fade and should stay a primary concern.

That said, trying to predict short-term outcomes and market directions based on an event like this is, again, extremely difficult. In addition, I believe markets are paying too little attention to potential longer-term fundamental issues that are likely to persist. 

Commodity shocks and supply risks

The initial response to the invasion of Ukraine impacted commodity markets in a swift and predictable manner. Fear of supply disruptions and sanctions caused prices to rise, especially energy and food prices. Most commodities have declined from their peaks but remain higher than before the invasion. Central bankers around the globe now face the task of reining in inflation under the specter of slowing growth and geopolitical tail risk, a significant challenge.

There is a consensus that we are witnessing a challenge to globalization and economic interconnectedness. This is seen as both inflationary, given supply chain issues, and more concerning, as a risk to stability and security in the absence of necessary resources. Many countries now appreciate the risks associated with codependency, especially when you are dependent on an unstable partner or region.

The likely response will be an understandable push for self-sufficiency, building in redundancy and resilience to control your own destiny. Many expect that the investment uptick necessary for such outlays will be a benefit, certainly in shorter-term nominal growth terms, but it may also become the underpinning of structural inflation. At the same, however, the longer-term investment implications appear less strong. One can expect fiscal spending to provide capital for more productive capacity “onshore,” but this will likely challenge already stretched public balance sheets. Also, spending of this nature creates a high likelihood of excess capacity and inventories, along with significant inefficiencies relative to global alternatives. These issues present challenges to real, sustainable economic growth and an improvement in longer-term trend growth rates.

This shift from globalization to regionalization and self-sufficiency may well improve economies’ resilience, but it will come at the cost of efficiency and create an environment conducive to inflationary pressures.

This shift from globalization to regionalization and self-sufficiency may well improve economies’ resilience, but it will come at the cost of efficiency and create an environment conducive to inflationary pressures.

Russia marginalized

Notwithstanding my earlier point regarding investors’ limited insight into how the Ukrainian conflict will end, there is an obvious second long-term consideration. Russian President Vladimir Putin’s intentions appear to be clear: reestablishing geographic security around Russia, with eastern Ukraine serving as a land bridge to Crimea and the Black Sea.

Putin has been widely rebuked by the Western world, resulting in Russia’s isolation from much of the global economy. The conflict has unleashed financial and economic warfare against the Russian economy on a scale not seen in recent memory. Western capital has fled Russia, wealth and the ruble have been decimated and Russian bonds and equities have been shunned by foreign investors.

At this point, the country is now markedly more isolated in the global economy and considerably worse off than prior to the invasion. Many observers speculate that the likely outlook for Russia is little more than a considerably weaker partner of China. Regarding China, the weaponization of financial instruments could help that country’s aspirations to create payment systems akin to those of Western countries, which would help it achieve its ambition of the Renminbi becoming a global reserve currency. All these developments could have implications for the global currency and commodity markets over the long term.

Economic warfare may help defeat Russia, but the cost to the global economic architecture (and to the role of the US, for which there is no global-liquidity alternative) could be enormous and paradigm-shifting.

Headlines are nothing but that: Headlines. Attention-grabbing, often sensationalized attempts to generate readership. In a word, headlines are noise.

ESG

Surprisingly, Russia’s invasion of Ukraine has caused some investors to disparage environmental, social and governance (ESG) investment trends. They point to the underperformance of mandates with material underweights or the outright exclusion of the energy and defense sectors. On the underperformance, while it is stark, in our view it is due to a misplaced belief in box-checking and exclusionary practices on the part of ESG investors and not the result of the consideration of ESG factors per se.

In my view, the integration of ESG and sustainability factors into the research process provides investment benefits, especially over a longer time horizon, when they are considered on an active basis. The exclusion approach to ESG is simplistic, in that complex sustainability topics are viewed through a narrow, good/bad lens. That approach also places securities back on the open market without any engagement opportunity. I believe that the long-term benefits of sustainable investing are best obtained through an engagement-based approach. This allows active investment managers to fully adopt their role and fulfill their responsibilities as active allocators of risk capital, working closely with issuing entities to obtain more positive outcomes.

I will conclude with a point I have made in the past: Headlines are nothing but that: Headlines. Attention-grabbing, often sensationalized attempts to generate readership. In a word, headlines are noise. We must recognize headlines for what they are and, importantly, not lose sight of what is important on a long-term basis. At MFS, we tune out the noise and focus on a long-term investment approach which we believe provides a better way of seeking to create long-term, risk-adjusted performance for clients.

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.