June 12, 2024

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David Rosenberg: Three investing themes beyond energy in these uncertain geopolitical times

David Rosenberg: Three investing themes beyond energy in these uncertain geopolitical times

Here are some longer-term thematic opportunities that have opened up for investors to explore in their own portfolios

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By David Rosenberg and Marius Jongstra

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The war in Ukraine has further extended this period of heightened geopolitical uncertainty beyond the recent focus on China. Russia has brought war to Europe’s doorstep, ushering in calls of a second Cold War with North Atlantic Treaty Organization (NATO) and Western allies imposing swift sanctions to isolate the country from the rest of the world. Beyond the immediate impacts these events will have on economic growth, we have identified some longer-term thematic opportunities that have opened up for investors to explore in their own portfolios beyond the energy sector.

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Perhaps one of the more obvious impacts as the world enters the Second Cold War is the need for many countries to increase defence spending, improving their readiness in case of further escalation, after years of underinvestment. Just four weeks after the beginning of Russia’s invasion and there have been 11 countries publicly stating plans to increase military budgets, or that intend to do so soon: Romania, Poland, Italy, Norway, Sweden, Latvia, Finland, Netherlands, Japan, Germany and the United States.

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It is no surprise to see a lot of European/NATO countries on that list, with many that have fallen below the suggested budget recommendation (two per cent of gross domestic product) now forced to play catch-up as the threat of war increases on their borders. However, the inclusion of Germany and Japan — two countries without a defence spending mindset — are good indications this trend will have legs behind it for some time.

From an investment perspective, defence stocks are moving back into the spotlight after being pushed aside by some during the rise of environmental, social and corporate governance (ESG) investing. The U.S. and Europe sectors are up five per cent and nine per cent, respectively, over the past three weeks.

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From a valuation’s perspective, these groups appear to carry rich multiples — both roughly 20x forward earnings (about the 90th percentile compared to historical readings) and trade at a premium to their respective benchmarks. However, the improvement in the fundamental outlook more than justifies these valuations. For example, the S&P 500 aerospace and defence subsector has gone from having negative earnings revisions (on a one-month basis) to having some of the largest positive changes in the industries we track.

Overall, earnings for European defence companies are expected to grow at a 20-per-cent pace in 2022 while the U.S. comparable is 26 per cent, both significantly faster than the market and placing the PEG ratio (price-to-earnings relative to growth) at less than 1x. In other words, these stocks represent growth at a reasonable price and are, therefore, worth including in investor portfolios.

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Food, farm products and fertilizers 

Ears of wheat in a field near the village of Hrebeni in Kyiv region, Ukraine.
Ears of wheat in a field near the village of Hrebeni in Kyiv region, Ukraine. Photo by REUTERS/Valentyn Ogirenko/File Photo/File Photo

The impact of this war on the world’s food supply is nontrivial, with Russia and Ukraine representing a significant share of food and agricultural production. Combined, they accounted for one-third of global wheat production (2018 to 2020) and one-quarter of barley production, while Russia is one of the world’s largest fertilizer exporters (by value). Food-security concerns will be acutely felt in the Middle East and Africa — areas that are more reliant on imports from these two countries — but will nonetheless ripple around the globe.

Indeed, we are already seeing price increases for key grains and food products, extending further gains as many markets were still feeling the effects of supply/demand imbalances coming out of the pandemic. As of February, the United Nations’ FAO World Food Price Index was sitting at a record high (data back to 1990).

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Of equal concern is what is happening to global fertilizer markets. Conditions were already tight prior to Russia’s invasion, but have deteriorated further with that country blocking exports to “unfriendly nations” while natural gas prices soar, particularly in Europe, making it harder for producers to fill the gaps (gas is a key input into ammonia-based production).

As planting season approaches in many countries in the Northern Hemisphere, farmers are having to make important decisions: can they afford to use costlier nutrient prices, or will they have to resort to other methods that will result in reduced crop yields? This will ultimately determine how much of the gap from lost output/exports in Ukraine and Russia can be filled.

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There is also the risk that countries will begin to hoard and/or implement their own export bans, which will increase food-security worries, particularly in poorer nations relying heavily on imports. Adding to the uncertainty is that the true effects will not be felt for months to come, when crops have fully grown and are ready to be harvested.

In the meantime, for investors wanting exposure beyond physical commodities, fertilizer companies and farm equipment/technology providers stand to benefit. The VanEck Agribusiness ETF is one such option. It also means that more of the global consumer’s pocketbook will be dedicated towards the food budget, taking away spending from more discretionary items.

Returning manufacturing home 

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Perhaps one of the most long-lasting themes to come from this conflict — in addition to everything that has happened during the pandemic — is the importance of reliable and secure supply chains, especially those that depend on countries with less-than-favourable ideologies when it comes to the West. Russia may be in the spotlight today, but it could easily be China tomorrow.

Regardless, the events that have transpired in the past four weeks resulted in company after company having to abandon relations and business in Russia and Ukraine with no timetable on when they may come back. Those that relied on input materials from these two countries will have to source them elsewhere, while any manufacturing capacity will need to be moved to other jurisdictions. The former is currently taking place in commodity markets around the globe, while the latter is a longer-term theme that investors should pay attention to.

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In the short term, there will be knock-on effects to growth. For example, in Europe, with many auto manufacturers dealing with a lack of parts (as inputs from Russia are restricted), consultants at LMC Automotive cut 2022 sales projections in the region to 3.6 per cent from 8.3 per cent (with risks to the downside the longer this war drags on). Beyond the auto sector, semiconductor manufacturing capacity has been the poster child for this theme as supply concerns early in the pandemic led the push for more domestic capacity. In Washington, D.C., a highly divided Congress could come together and advance the America COMPETES Act — which is aimed at increasing domestic manufacturing competitiveness — which shows this theme to be alive and well. Globalization is not dead; it is merely shifting in a way that incorporates supply chain security and resiliency in ways that were not previously imagined before.

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For investors, companies investing in more reliable manufacturing capacity should see the payoff in higher profits and productivity down the line. It also makes sectors related to the manufacturing theme (such as industrial real estate income trusts, construction and industrial machinery) attractive considerations related to this topic.

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. Marius Jongstra is a senior strategist there. You can sign up for a free, one-month trial on Rosenberg’s website.


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