Russia - Ukraine Conflict and South Africa's (relatively) positive budget speech

It is amazing how the world has changed in such a short period of time. Again! It’s not surprising that this has caused many investors to panic. The article will give you a better understanding and why not to “dash to cash”.

Short-term Impact on the markets

Global equities tumbled on the news of Russia invading Ukraine which rattled markets and pushed nervous investors toward safe-haven assets.

Oil prices have jumped with Brent crude exceeding $100 a barrel for the first time since 2014.

The JSE-listed stocks in our portfolios with material exposure to Russia are:

• Mondi, which has a paper mill in Russia accounting for 18% of earnings before interest and taxes. The share price of Mondi has fallen 30% from its recent high point in February.

• British American Tobacco (BAT) is the number two cigarette player in the Russian market, which accounts for an estimated 2-3% of BAT’s profits.

• The prices of Naspers and Prosus have declined by 35% since the start of February. This group has a small direct exposure to Russia – a classifieds business and a social media business – which accounted for 2-3% of overall value. The large drop in their share prices could be due to fears that the world is becoming increasingly divided which, in turn, has led to renewed concerns about the long-term value of Tencent. Also, the sentiment towards some of the speculative technology sectors in which Naspers has been investing, like food delivery, has turned from extreme optimism to something more realistic.

Potential medium-term impacts on the market

If we attempt to extrapolate from history and use the Russian annexation of Crimea in 2014 and the American invasion of Iraq in 2003 as our benchmark of potential market disruption, the effect of Russia’s invasion of Ukraine on financial markets is likely to be marginal and temporary.

However, it will naturally be associated with higher levels of market volatility if there is uncertainty about how events will ultimately unfold.

Should Russia-Ukraine remain in a regional conflict that does not escalate into a global destabilising event, it should fade as a meaningful driving force for financial markets beyond the short term.

Risky asset classes like equities may experience some short and shallow drawdowns, and safe-haven asset classes like the US dollar and gold (and maybe US bonds) will rally during these periods of conflict escalation.

In our view, geopolitical events like these are likely to only be secondary factors to the more primary fundamental driver of financial markets this year, namely the major global policy transition from the massive monetary and fiscal stimulus of 2020 and 2021 to eventual policy tightening in 2022. How financial markets react to this policy pivot will be much more crucial for the relative performance of the different asset classes than what happens in Russia-Ukraine.

Geopolitical events like these again highlight to investors the advantages of having a diversified investment portfolio. While some asset classes in an investment portfolio could experience short-term drawdowns when risk-off sentiment prevails, other factors like a concomitantly weakening rand would soften the return effect for rand-based investors, for example. Similarly, while there could be near-term pressure on South African (SA) bonds from global risk-off sentiment and a weaker rand, some SA equity sectors will benefit from higher commodity prices and a weaker rand.

In essence, investors should leave it to their financial advisers and investment managers to make sure that their investment portfolios remain positioned appropriately to attain their long-term investment goals. Responding emotionally to any short-term effect that a geopolitical event like the invasion of Ukraine by Russia could have on a portfolio has a high probability of permanently destroying long-term portfolio returns.

South African Budget for 2022/23

Perhaps somewhat overlooked due to recent geopolitical events, Finance Minister Enoch Godongwana’s budget for the 2022/23 fiscal year is a delicate balance between fiscal constraint in areas of previous extravagance and the growing demand for social assistance. In this regard, the budget delivers good news.

With the aim of “keeping money in the pockets of South Africans”, the Finance Minister provided some hope to taxpayers during his maiden Budget speech. The Minister proposed no significant tax increases to the major revenue-generating categories, including personal income tax and VAT for the 2022/2023 tax year. Some tax highlights included:

Tax relief for individual taxpayers - the personal income tax brackets and annual tax rebates will be adjusted by 4.5% in line with expected inflation.

Corporate tax rate set to drop - the corporate income tax rate will reduce from 28% to 27%, effective for years of assessment ending on or after 31 March 2023.

Fuel Levies - there will be no increase in the general fuel or Road Accident Fund levies.

Rise in excise duties - taxes on alcohol and tobacco will increase by between 4.5% and 6.5%.

The Finance Minister discussed certain Financial sector reforms in the Budget:

He noted that Retirement funds play a critical role in channelling savings into productive investments. Regulation 28 of the Pension Funds Act sets out the criteria through which these funds may make investments. Changes have been proposed to these regulations to enable greater investment in infrastructure by these funds. After consultation on these changes, the amendments will be gazetted next month.

Government has also proposed a fundamental restructuring of the retirement system for individuals to allow for greater preservation and partial access to funds through a “two-pot” system. Part of this proposal includes the possibility of short-term access, which would be dependent on the approval by trustees of each fund. Consultations are proceeding following the release of a discussion paper last year and the draft legislation on these amendments will be published for comment in the middle of the year.

In Conclusion:

GIB allocates to underlying asset managers with your best long-term interests at heart. Through national budgets, pandemic, war or peace, we maintain our tried and tested investment process.

We allow our underlying managers to value companies based on their long-term potential through-the-cycle focussing on earning ability of companies and we allow them to invest accordingly. Our allocations to managers are informed by long-term fundamentals, not by sentiment. There is no such thing as a risk-free investment, but we believe that a diversified portfolio will preserve clients’ funds over the long term.

Please do not hesitate to contact us with any questions