How sanctions are impacting consumers and investors" by Sumit Handa

Sumit Handa, the former chief investment officer (CIO) for the city of Philadelphia and co-head of Pennington Partners' investment committee, explains how sanctions are impacting consumers and investors

Russian forces are not relenting in their push to take over Ukraine. Reports of several strikes against civilian targets like a local shopping mall are piling up as the Associated Press reports that Russia is "

   TOPSHOT - A Ukrainian soldier looks down at an unexploded ordnance at a Second World War (WWII) ... [+] memorial site, in the frontline town of New York, eastern Ukraine on May 16, 2022, on the 82nd day of the Russian invasion of Ukraine. - The Ukranian town of New York, in the eastern Donetsk region, founded by German settlers and members of the Mennonite Church in 1892, was renamed by the Soviet authorities to Novgorodske in 1951. For many years the region campaigned to get its old name 'New York' back, and on July 1, 2021, the Ukrainian parliament supported the change. (Photo by Yasuyoshi CHIBA / AFP) (Photo by YASUYOSHI CHIBA/AFP via Getty Images) 
  AFP via Getty Images
TOPSHOT - A Ukrainian soldier looks down at an unexploded ordnance at a Second World War (WWII) ... memorial site, in the frontline town of New York, eastern Ukraine on May 16, 2022. The Ukranian town of New York, in the eastern Donetsk region, founded by German settlers and members of the Mennonite Church in 1892, was renamed by the Soviet authorities to Novgorodske in 1951. For many years the region campaigned to get its old name 'New York' back and on July 1, 2021; Ukraine's parliament supported that change. (Photo by Yasuyoshi CHIBA / AFP) (Photo by YASUYOSHI CHIBA/AFP via Getty Images)

Sanctions against Russia are being handled

The West's attempts to punish Russia for its invasion of Ukraine have been limited to sanctions. But those international sanctions are starting to affect Russia, which has defaulted on its foreign debt for the first time in over 100 years.

Meanwhile, people in the West who are consumers and investors are feeling the effects of sanctions against Russia. While it cannot be excused that Russian President Vladimir Putin took actions, it's becoming clear that everyone is suffering to some extent as a result of pushing back against Russia—one way or another.

In a recent interview, Sumit Handa, co-head of the investment committee at Pennington Partners and former CIO for the City of Philadelphia shares the war in Ukraine and sanctions against Russia are weighing on consumers. Of course, he doesn't advocate for war and in no way condones what Putin is doing, but there is also a bigger picture at work here.

The sanctions have led to the following problems:

Handa points out that every American company that does business overseas or is involved in or has exposure to Russia, in some way, is feeling the pain of these sanctions. The impacts on shareholders are widespread. For example, some shareholders will have to take a write-down on any property, plant and equipment these companies have in Russia; there are other impacts as well.

"Any company operating in Russia will have to pull out," Handa explained. "It will directly impact the bottom line for those companies. Visa and Mastercard… make money on transactions. Buying vodka in Moscow is not happening anymore, so Visa lost business there."

Visa's shareholders are directly affected by the issue, as it reduces their profits. Despite Visa's high market value and return on invested capital, any loss of revenue affects its shareholders.

The tourism industry is affected

Visa is also losing business on travel. Travelers are generally avoiding Russia right now, and the high inflation and energy prices are convincing many to stay home, costing Visa, Mastercard and other payment firms.

People aren't using Expedia or to arrange trips, which has a trickle-down effect. The reduced travel impacts not only airlines, online travel agencies and hotels but also restaurants and any other industry with any level of exposure to leisure.

In the current market, the following companies are considered to be market leaders:

Visa's financial performance continues to be strong and it is growing at a healthy rate, but the reduced spending has repercussions for everyone. According to Handa, consumers, investors and shareholders are dependent on each other.

The conflict in Ukraine is beneficial to defense companies. The uptick in skirmishes instead of the start of a new cold war means more military spending, which is good for Lockheed Martin and Raytheon. We have seen their stock prices rise and expect them to continue doing well under the current conditions.

The sanctions against Russia have led to higher energy prices and profits for energy companies, which in turn is driven by inflation.

"It doesn't look like these sanctions are going away anytime soon," opined Handa. "I'm not taking Russia's side by any definition, but it is very important to fully understand how these sanctions will impact the lives of average Americans. And since the president has made comments suggesting that they will stay in effect for the foreseeable future, we have to believe this will be the case."

The following are some of the lessons we should take away from the story.

Handa pointed out that there are always lessons to be learned. Of course, the current environment looks very inflationary, but he believes it isn't just from the events taking place in Ukraine. He drew a comparison with the period of stagflation in the 1970s as he looked toward inflation.

"We've already had a quarter of negative GDP," he said. "The country is slowing, and it could be in a recession. With the rising interest rate environment because of what the Fed is doing, things like that aren't new to us."

The current problems are not limited to the issue of sanctions. Handa sees much more in the puzzle than that. He pointed out that we've come out of a "very unique period" in which the Federal Reserve provided so much support in terms of the "benign interest rate environment" and almost $5 trillion in QE over the last two years.

When a business has a large amount of debt, it is at risk of bankruptcy.

According to him, the Federal Reserve has increased its balance sheet by 100% in the last two years. In fact, since the Great Financial Crisis, our national balance sheet has risen from $900 billion to $9 trillion.

"We're in unprecedented times," Handa states. "We're seeing a lot of unwinding of that in the financial markets. Real-time equities are down 60%, 70%, 80% from peak. We're also seeing a widening of bond yields… It will bring back the bond vigilantes."

In an effort to curb inflation, bond investors (bond vigilantes) sold bonds when they considered government policies to be inflationary. In late March, a Forbes contributor claimed that the bond vigilantes had returned.

Ed Yardeni coined the term "bond vigilantes" in the 1980s, making their return today appropriate given that we're back at 1980s-era inflation levels. Handa explains that the bond vigilantes wouldn't buy bonds in the 1980s because interest rates were too low.

The Fed's juggling act

Asset managers have been critical of the Fed's performance over the years, but it faces a delicate balancing act. Raising interest rates can keep inflation in check, but if rates are raised too much and too fast, they could hurt the economy.

"We're already seeing a slowdown because of inflation," Handa says. "Inflation is a tax on the consumer and everyone. Instead of spending $25, it now costs $75 to $100 to fill your gas tank. Natural gas is having an impact on the home. The Fed knows this, but there are many other factors they have to take into account."

As it formulates monetary policy, the Fed is concerned with the high debt level of the federal government, which is over $30 trillion. The annual interest payments on that debt are close to $475 billion.

"Every few years," he explained, "the federal government has to roll over a lot of short-term debt. So when it does, interest payments will increase from $475 billion and could even double."

Doubling interest rates would mean the U.S. would have to pay a lot more in interest, which could affect spending on things like Medicare, Social Security, and defense.

"When the Federal Reserve raises interest rates, it impacts many things," he said. "So, it is a very challenging position to be in, and I do have a great deal of respect for what they do. It's difficult work, everyone criticizes and you can't please everyone."

The unprecedented environment

Asset managers have pointed out that the current situation is unprecedented, since we've never seen the same combination of issues before. History does not repeat itself, but it rhymes.

In 1919, the Spanish flu was widespread around the globe. It was shortly after World War I and led to the formation of the League of Nations as well as the Roaring '20s.

The world is currently experiencing a stagflationary environment and a war, which are two factors that led to the stagflation in the late 1970s and early 1980s.

Guidance on what to consider when making investment decisions

Handa believes that in the current environment, investors should be more careful when investing rather than simply holding traditional investment vehicles that have been successful over the last decade.

In his view, the best way to deal with the current environment is to acquire businesses that can pass their higher expenses on to customers. Although he wasn't advocating for Visa or Mastercard, both companies make money when prices are high.

"So, anyone who is a pricing power beneficiary, any business that is aligned with that should do well," Handa said. "Pricing power is really critical and also those that are monopolistic or oligopolistic… Anything that's growing much more than inflation. We also want to be in businesses generating cash and high cash flow. You need to be in businesses you don't have to worry about inflation eating into them."

Value versus growth What is more important?

The two main investment styles, value and growth, have been widely discussed.

"I'm not suggesting that you go out and buy value stocks or invest in growth in any way," Handa clarifies. "What we've seen is that growth has gotten absolutely crushed because investors have moved from growth to value because we are in this environment."

He noted that it's impossible to know how long the market will remain in this state, but the markets indicate that it could be for a long time.

"That's why we're seeing this leadership change, a changing of the guard at the top level, and so we're seeing investors shift from following growth stocks to looking for value," Handa says.

Michelle Jones was the source of this article.