What a difference a year makes! 12 months ago, with the advent of the vaccines, the story was one of optimism for strong economic recovery after the Covid collapse of 2020. In conjunction with Biden’s election victory and his programme of fiscal stimulus, investors were not only heralding the ‘reopening trade’ but anticipating a new era defined by the opportunities opening up in the transition to carbon net-zero.

 

Global GDP recovery in 2021 exceeded 6% and momentum was expected to continue at a reasonable gallop this year too. But there were clouds evident on the horizon: incipient inflation fears; clogged-up supply chains; Putin mucking about in gas markets, to name but a few. Nevertheless only 6 months ago the IMF was forecasting economic growth, as measured by Gross Domestic Product (GDP), of 4.9% for 2022.

 

But now the wheels are coming off. China’s GDP shrank by 0.5% year-on-year in the first quarter and Q2 is looking no better. This week it was reported that the US economy shrank by 1.4% year-on-year (markets had been anticipating expansion, albeit sluggish, of 1%) in the same period. Those two countries represent 43% of global GDP; between them it means that nearly half the world’s economic activity was subject to contraction in the first three months of 2022, and only half of that period was directly affected by the war in Ukraine. Given we’re already nearly in May, the IMF’s latest 2022 forecast of 3.6% GDP growth is on less than firm foundations.

 

Russia cutting off gas supplies to Poland and Bulgaria is the latest twist in the dislocation of energy markets which has caused international gas prices to surge again. It fuels an already combustible global supply chain problem. Compounding the misery is that in China, General Secretary Xi Jinping’s zero tolerance to Covid has led to Shanghai and Shenzhen, two of the country’s most economically sensitive regions, being placed in strict lock-down. As a result, regional business activity has ground to a halt with global consequences. Windward’s Maritime AI database suggests that with 500 merchant ships currently at anchor outside Chinese ports and unable either to load or discharge cargo, when totted up with the knock-on effects around the maritime networks, fully one in five of the world’s container ships are stuck somewhere, unable to move. It is a global shipping logjam.

 

The immediate effects are already evident in many industries including automotive where there is an over-reliance on imported components. If half a century of globalisation had been a boon for business, war and Covid have highlighted the vulnerability of 21st Century supply chain security when a handful of grit is thrown into the works. Splendid when working smoothly, the precision of such mechanisms is honed so finely that all resilience has been bled out of them.

 

With the threat of ‘stagflation’ (a struggling economy yet with runaway prices) the leading central banks are in a proper pickle. Determined to press on with aggressive monetary tightening to curb rampant inflation (the Federal Reserve chairman, Jay Powell, was suggesting this week that in May his monetary policy committee might have to increase US interest rates by a half-point), they risk killing the economy stone dead in the process.

 

Nobody forecast two unconnected but overlapping global exogenous shocks in two years; but the mess the central banks find themselves in has its roots deep in the last decade and much is of their own making. Complacency verging on indolence maintaining lazily loose monetary policy for far too long after the Global Financial Crisis has left them at the mercy of events rather than in control of them. There is a textbook to be written in due course about it. 

Phase 2 of the Ukrainian war; the heat turns up 

Entering its third month, the war in Ukraine is in a new phase. The geopolitical stakes have been raised several notches. Foreign Secretary Liz Truss said in a speech that the UK’s aim is for Russia to be completely expelled from Ukrainian territory, presumably including the Crimea, annexed by Russia in 2014.

 

What this implies is the total defeat of Russia, an existential threat to Putin’s regime, no hint of offering the ‘off-ramp’ to Putin many suggest as the pragmatic way of bringing hostilities to an end, in the way that President Kennedy gave a face-saving route out to President Khrushchev to de-escalate the Cuban Missile Crisis in 1962. As importantly, the US announced its intention of wanting to “see Russia weakened to the degree it can’t again do the kinds of things that it has done in invading Ukraine”, so said American Defence Secretary Lloyd Austin on a visit to Europe to rally the NATO troops. Whatever that means in practice, it is a distinctly more hawkish tone. 

NATO: open to the jibe of fighting to the last Ukrainian 

But as the new season of planned NATO training exercises begins down its Eastern European flank all the way from the Baltic to the Black Sea, the alliance as yet has no intention of direct intervention deploying its own forces in Ukraine, or imposing a no-fly zone, unless provoked; while the US is supplying by far the majority of kit and cash, Austin’s mission was as much about showing unanimity and solidity of purpose within the alliance as getting NATO allies and other countries to step up to the plate providing military hardware and training to Ukraine’s armed forces. But the current strategy to defeat Putin still relies entirely on the Ukrainians doing all the fighting. 

Mission creep: moving from defence to offence by proxy 

Direct intervention notwithstanding, are the US and UK strategic intentions the same? They are certainly close, as are those of the Baltic States, Poland and the Czech Republic. But what of the rest of NATO? In particular France and Germany, both of whom up until now have been entirely focused on securing a peace settlement, likely to concede Ukraine’s partition and forced neutrality, all of which would fall a long way short of the Anglo-American objective of seeing Russia ejected and defeated.

 

Amid tensions within the NATO camp (and even within the US government) since day one of the conflict about what constituted reasonable help to Kiev without being seen to cross an invisible line provoking Putin in to a wider conflict, this week has witnessed a step change in NATO’s mission creep: it has decisively moved from supplying essentially defensive weapon systems (principally anti-tank, anti-ship, anti-aircraft missiles and drones) to agreeing to supply offensive capability in the form of heavy armour, heavy artillery and, still to be finalised and most sensitive of all, jet aircraft. In February 1941, when Britain and her empire were largely alone confronting Hitler and Mussolini, and Churchill was trying every ruse possible to persuade the Americans into the war (or if not willing actively to participate, to supply the UK with yet more destroyers, aircraft and other weapons under the Lend Lease programme begun in 1940), he told President Roosevelt, “give us the tools and we’ll finish the job”. Today, it’s more a case of the US saying to President Zelensky, “here are some tools, we’re still trying to figure out how many and what sort and where from, but whatever, you go do the job for us. We’re leading the way from right behind you”.

 

The US wants Putin’s conventional military capability thoroughly degraded so he can no longer be a threat to any of his neighbours; the West’s agency for that degradation is the Ukrainian military. It is a tall order. Adding to the aggressive tone, UK Armed Forces Minister, James Heappey, said that it would be perfectly reasonable for UK-supplied munitions to be used by Ukrainian forces against enemy targets inside Russia. However much NATO protests that this is not a proxy war against Russia being hosted by Ukraine, this week’s turn of events says it is exactly that.

 

Sergey Lavrov, the Russian foreign minister, a dissembling character, one whose diplomatic currency is more often than not a web of fiction, fabricated fake news and downright whoppers, all delivered with a sardonic grin and laced with a hint of toxic menace, in this case is quite right in identifying a NATO proxy war as now being under way. With no sense of irony given his invasion of a peaceful neighbour, Putin has said that countries interfering in such a way in his ‘special operation’ in Ukraine should expect a ‘swift and stinging response’ in reprisal. What that constitutes remains to be seen: cyber? Asymmetric? Conventional? Chemical? Tactical nuclear? A combination? We are the closest to finding out since 1962. 

The future: rebuilding Ukraine 

But for all Ukraine is performing magnificent feats in defence of its homeland, the cost in every sense, human, social, financial, is horrendous. It is estimated that it will see its economy shrink by more than a third this year as a result of the war. The damage to real estate and infrastructure is significant and this war is far from finished yet. Russia must be on the hook for substantial reparations when it all ends.

 

However, not only having failed to prevent an invasion (the US and the UK were guarantors of Ukraine’s sovereignty and borders under the 1994 Budapest Memorandum) but now relying on Ukraine to do its heavy lifting against Russia and while still funding Putin’s war machine by close to €1bn per day buying Moscow’s oil and gas, the West is also morally obliged to help rebuild Ukraine when the hostilities are over. The price-tag will be huge. America in particular cannot shy away from the obligation as it did in the aftermath of the Iraqi and Afghan conflicts when it refused to entertain ‘nation building’; it was a significant strategic blunder with enduring consequences. It should take its lead from the Marshall Plan of 1945 and the restitution of Germany and Japan, the more so because Ukraine is an ally, not a foe. 

Putin turns off the gas taps to Poland and Bulgaria 

We have referred often in these musings to the ‘weaponisation’ of Russian gas. We have suggested that one of the few strategic weapons still at Putin’s disposal without resorting to the use of weapons of mass destruction is his ability to withhold gas supplies to western Europe. That is precisely what he has begun doing this week, closing the Yamal pipeline on the Belarus-Polish border and cutting off gas to both Poland and Bulgaria under the pretext that they refused to settle supply contracts in Roubles.

 

Yet there is more to it than that, particularly in the case of Poland. Both countries are NATO members. But Poland’s commitment to the alliance is shining: it is NATO’s poster child. Recognising the threat and with Moscow’s puppet Belarus as its biggest neighbour, last year it announced a doubling of defence spending to 4% of GDP and doubling its army to 240,000 fighting personnel; it is the principal host to the bulk of those limited forces the US currently has stationed in Europe (Poznan, to the west of Warsaw, is the HQ of V Corps, most of which is still ‘States Side’, the principal nominal US military formation in theatre). Further, it is no great secret that Poland has been a willing physical and geographic channel for all those US and British munitions before they are slipped across the border into Ukraine. It was first out of the traps three weeks into the conflict wanting to gift its old MiG29 jets to Kiev, an offer at the time shot down in flames by the Pentagon.

 

Putin is putting down a direct marker that his patience with what he regards as Polish belligerence has reached the limit. Poland has been prepared for this; while the loss of Russian gas is a blow, it is not terminal. With both the Polish and Bulgarian supply agreements with Gazprom (Russia’s commercial energy supplier, Chairman former German Chancellor, Gerhard Schroeder) due to expire at the end of 2022, and up for renegotiation, Poland had already taken mitigating actions to protect itself should new contracts not be agreed. It has taken precautions to keep stocks of liquid natural gas (LNG) at high levels; it has developed the port infrastructure to be able to take deliveries of replacement LNG from the US and the Gulf States (principally Qatar) even if not to the same quantity as will be lost through the Yamal pipeline; and a new pipeline direct from Norway is due to be completed in the autumn. A modest collateral loss is the fee it levies for the Yamal transiting Polish territory though compared with the transit fees paid to Ukraine (around 3% of its GDP) for the pipes which cross its land it is insignificant. Which western European countries are next on Putin’s list for economic throttling by having their gas supplies withheld? Least exposed are the UK and France, but of the rest, he has a long list from which to choose including Germany, Italy and the Netherlands. 

Poland: foes to the front, enemies to the rear 

Perhaps it is no surprise but it still beggars belief that, for the EU, it is business as usual with Poland. Ignoring the fact that Poland is under economic stress with 5 million Ukrainian refugees, it has just lost a chunk of its gas supplies and is on the front line of hostilities, with all the sensitivity of a paving slab Brussels is cheerfully prosecuting its own diplomatic, judicial and economic war against Warsaw. This is the long-running spat about the politicisation of Poland’s judiciary and media, and the failure to uphold EU values. With designated Polish funds being withheld from the €750bn EU Covid recovery package, and since mid-February being fined €1m per day for non-compliance and now on the hook for a €100m failure-to-pay super penalty, Warsaw could be forgiven for wondering who in this conflict the real enemy is: the one in front of it in the Kremlin, or the gremlins in grey suits behind it in Brussels.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

The value of active minds – independent thinking

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Fund specific risks

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