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Interview of the month - Didier Bouvignies (Rothschild & Co AM Europe): "The markets are already incorporating a conflict that is going to continue"
Calendar17 Mar 2022
Fundhouse: Rothschild & Co
D bouvignie

The current environment is particularly uncertain. Didier Bouvignies (Director of Management at Rothschild & Co Asset Management Europe) believes that it is, however, too soon to talk of stagflation, a climate that would be negative for most major asset classes.

After the coronavirus pandemic, financial market news has been seized for several weeks by the impact of the war between Russia and Ukraine. We asked Didier Bouvignies, Director of Management at Rothschild & Co Asset Management Europe, for his impressions given his long experience in financial markets.

What is your analysis of the current situation?

Didier Bouvignies: “Six months ago, the market demanded that financiers be epidemiologists. Today, it asks us to be experts in military affairs. It is an uncomfortable situation to be in crises that are not fundamentally economic in nature. The cycle previously obeyed certain laws related to human nature. Economic agents tend to get excited when things go well and depressed when the environment deteriorates, with central banks regulating by lowering rates to boost activity or increasing them when there was too much exuberance. We are now in a completely different context with crises of external origin over which we do not have much control.”

What is the impact of the current geopolitical crisis?

D.B.: “The economic situation in Europe is linked to what is happening in Ukraine, but not because of the size of the Russian economy or the risks to the stability of the European financial system. Russia is an economy not much bigger than Spain, and European banks’ exposure to the Russian bond market is low, and is in no way commensurate with the exposure they had in 1998 during the previous Russian debt crisis. On the other hand, Europe will be heavily impacted by the rise in energy prices, as imports from Russia are particularly important for countries such as Germany and Poland”.

What is the main risk for the markets?

D.B.: “The economic impact will be all the greater for the European economies as the belligerents will take time to come to the negotiating table. Another risk could come from a sharp drop in oil and gas imports from Russia, or even a cutting off of pipelines that cross through Ukraine. While the global impact should ultimately remain limited, Europe will be impacted to a greater extent. But at present, economic indicators continue to point to an economic acceleration rather than a slowdown, even though the purchasing power of households is currently suffering from a significant deduction.”

Against this backdrop, the markets have held up relatively well…

D.B.: “There is still no panic caused by this geopolitical crisis, even though there is an intense divergence of performance between Europe and the United States. European equities faced historically large withdrawals focused on financial and cyclical stocks. At the same time, bond markets are also under pressure due to the rise in inflation expectations, with the real rate breaking records into negative territory. In terms of bonds, the rise in interest rate differentials on European high yield is consistent with the idea that the markets are anticipating the arrival of a stagflation environment, a highly unfavourable climate for most major asset classes, characterised by weak growth accompanied by rapid inflation. However, I am convinced that we are not yet in this scenario, but the continuation of the conflict could lead to a more negative environment”.

Is there too much pessimism?

D.B.: “Valuations have fallen back to very low levels. However, stock market corrections caused by geopolitical events tend to have only a temporary impact on price levels, and the sharp fall in European equities already incorporates a conflict that is going to continue and will have a significant impact on growth. Positive news will therefore be welcomed by the stock markets.”

Where are the opportunities in the current market?

D.B.: “The beginning of the year was positive for our portfolios, with a positioning that favoured the normalisation of monetary policies, with short durations at the bond level; and cyclical and financial stocks in equities. It seems to us that it is now too late to play the US equities card more decidedly in our portfolios, and we are now more inclined to increase our exposure to European markets, where the potential for a bounce is much greater. However, we have not yet drawn.”