FFM Fund Newsletter - Feb 2022
Dear Investors, Dear Friends,
After an already eventful month of January, February witnessed a new period of high volatility (the VIX Index climbed 21% during the month, hitting a high of 37.70) and indices in the red (S&P 500 -3.14%, Nasdaq 100 -4.64%, Euro Stoxx 50 -6.00%, CAC 40 -4.86%), essentially due to tensions between Russia and Ukraine that resulted, at the end of the month, in an outright invasion and all-out war between the two countries, the issue of which has yet to be resolved. In such circumstances, discussion of financial markets take a backseat to the human suffering taking place.
Nonetheless, an analysis must be performed.
First, to pick up on something we raised last month, periods of high volatility mean that market participants have widely differing opinions about the course of the economy and its future, which leads to large and extreme movements in stock prices, interest rates and even currencies.
Using this framework, it is interesting to note that markets were most volatile before the invasion began, on February 24. Before that, everything was in flux. Western delegations were flying to Moscow, conferences between Russia and the US announced and then cancelled, but nothing was clear nor certain and therefore markets were experiencing important swings.
Once the invasion began, however, and passed the first moment of stress, financial markets became less strained. Yes, there was still volatility and war in Europe is not to be taken lightly, but at least there was something tangible, one less unknown. This may sound callous, but that is really how financial markets work. And, yes, there are still many uncertainties in the markets, the biggest one being whether central banks will keep their plans to increase short term interest rates this year.
This would seem logical in the face of red-hot commodity markets (oil, in particular, is making new 52-week highs) but illogical in the face of a global slowdown given the war and the crippling sanctions imposed on Russia.
All in all, this newest episode of volatility just goes to show, once again, that the global economy and financial markets are complex dynamic systems, which are, by definition, unpredictable. And, even if one could have predicted exactly when the Russian invasion would happen, inferring the effects of it on the stock market is impossible to do. Indeed, after initially falling on the morning of the invasion, markets mostly rallied. Now, we shall see what happens next. It should be noted that, with all the bad news thrown at the markets since the beginning of the year (multiple potential interest rate hikes in a slowing economy, wild volatility during earnings season and now a war in Europe), for the markets and our investments to be down less than 20% is a sign of strength and a clear positive, in our opinion.
We should also discuss the sanctions put in place against Russia by most Western governments (including Switzerland, which is probably a first), because the breadth and scope is perhaps unprecedented in modern history. Most of the banking sector has been taken off the SWIFT system (although not Gazprombank, making it possible for all to continue buying Russian oil and gas). This had been done to Iran back in 2018 but it is a massive step and, combined to Western central banks essentially blocking the Central Bank of Russia’s currency reserves held by them, is a huge blow to Russia’s economy. Add to that the cancellation of all flights operated by Russian airliners, Boeing and Airbus’s refusal of service, and all planes in Russia that should be grounded in a matter of weeks, even for most internal flights.
For Russia, this is all very bleak and pretty much cancels all the efforts that were made to integrate post-Soviet Russia in the global economy. Given the size of Russia’s economy (about the size of Italy’s in terms of GDP), it seems difficult to believe Russia will be able to fight a war of occupation (of the biggest country in Europe, no less) for more than a few weeks at best. It is all fine and good for the US to stay in Afghanistan for twenty years (with little to show for it) but only a political and economic superpower can withstand the unbelievable costs this entails, and Russia is neither.
All of this is of course watched very closely by China, which harbors similar ambitions with its equivalent of Ukraine, the island of Taiwan.
Without pursuing the geopolitical analysis further, it is fascinating to see, in the modern world, the damage that can be inflicted on a country simply by using financial regulation. It has become difficult to wage a war of aggression while being part of the global economy. For reference, Sberbank, the main Russian bank and second largest bank in Europe by market capitalization at the end of 2021 is now down 99.90%! It also illustrates the fact that investing in emerging markets remains a complicated exercise.
Regarding the performance of our funds in February, the FFM European Selection fund is down -18.38% over the year and the FFM American Growth fund is down -17.98%. It is interesting to note that these figures date from February 23 and 24, calculation days for the month’s last net asset value, just before the start of the Ukrainian crisis. Since then, our portfolios have started to outperform indices, in a reversal of two months of underperformance, which once again gives us comfort in the choice of companies in which we invest. As we have said many times, these periods of underperformance will occur from time to time and there are now so many cross-currents (sharp movements in commodities, rates and currencies) at work that any prediction in the short term seems foolish.
We would like to focus here on one sector in particular, which is obviously at the heart of the current crisis, and leads to the following question: Should we buy oil companies given the current run-up in oil prices? As we have repeatedly stated, we have always felt that most oil companies fail to offer a compelling investment case, given the capital intensive nature of the business and the huge uncertainty linked to the underlying commodity prices. We have also said many times that our favorite in the sector, and probably the best run, would be Total Energies, also because it has a huge refining component.
We (re-)discovered in February that these companies must do business in exotic places with some unsavory partners, like in Russia and that, while oil prices make new highs, oil companies may not. Having said that, we are exposed to the sector via our picks and shovels approach through Spirax-Sarco (oil refining), Alfa Laval (centrifuge systems) and our newest addition, InterPump (hydraulic fluid transmission).
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