This article is written by
Mike Greely
Mike Greely, Chartered Financial Planner at Amber River’s Colchester office, explores some of the reasons behind the market turbulence, and explains why patience and portfolio positioning can help investors.
It’s been a rollercoaster year for global investment markets. If anyone had expected 2022 to be the year when life returned to ‘normal’, those hopes swiftly evaporated. We’ve seen war break out in Ukraine, global growth has slowed, and much of the developed world is going through a period of high inflation and rising interest rates.
It’s proven to be a difficult environment for investors, many of whom will have seen disappointing returns from their investment portfolios for the year so far. So, what’s been dragging down investment markets, and how long will the negative sentiment continue?
Keeping economies afloat during the pandemic helped to push inflation higher in 2021
The economic backdrop
To give you some background, let’s start with how central banks, such as the US Federal Reserve and the Bank of England, have been attempting to deal with economic damage caused by COVID-19 and subsequent lockdowns.
After the pandemic hit in 2020, central banks responded by boosting the supply of money in the economy, money which governments then made available to support struggling businesses and households.
Keeping economies afloat helped to push inflation higher in 2021, although central banks suggested this was a temporary “transitory” problem, and inflation would return to lower levels this year. However, those reassurances have proved to be wide of the mark.
Instead of seeing inflation fall gradually, several factors have caused inflation to surge even higher in 2022. The war in Ukraine has pushed up food prices (Ukraine is one of the world’s largest wheat exporters), and sanctions imposed on Russia following the invasion have also caused oil and gas prices to reach record levels.
At the same time, the pandemic hasn’t gone away entirely, and is continuing to create supply shortages, especially from China, which is still experiencing harsh COVID lockdowns.
These factors all combined to create an inflation whirlwind in the early months of 2022. Inflation in the UK and the US has now reached 40-year highs of 9.1% and 8.6% respectively, creating a cost-of-living crisis, as the cost of everyday goods and services reaches unaffordable levels for some people.
High inflation is usually one of the first signs that an economy is overheating
Higher inflation, higher interest rates?
Most of the developed world has been living through a period of historically low interest rates since the global financial crisis in 2008. We’ve all grown used to living in a ‘low interest, low inflation’ environment for a very long time.
To give you some context of how long we’ve enjoyed a period of low interest rates, in April 2008, the UK base rate (the benchmark interest rate set by the Bank of England for lending) stood at 5.0%. Over the next 12 months, a series of rate cuts took interest rates to 0.5%, before hitting a low of 0.10% in March 2020.
This year, however, rates have been on the increase. The Bank of England has made four interest rate rises of 0.25% in February, March, May and June of 2022, taking the base rate to 1.25% – a 13-year high. In other words, higher interest rates in the shorter term are here to stay.
The dilemma facing central banks
Central banks now find themselves in a very difficult position. High inflation is usually one of the first signs that an economy is overheating. In such circumstances, interest rates are raised to slow growth and cool down the economy.
Unfortunately, this time, economic growth is already weak after the pandemic. Therefore, although raising interest rates may help to cool down inflation, increasing the cost of borrowing is expected to weaken that frail economic growth even further.
Raising interest rates threatens to choke off the economic recovery that people had hoped for in 2022.
This year there have been very few hiding places for investors
How has this affected investment markets?
Investment values have been falling for most of this year, as investors have become increasingly concerned about higher interest rates and rapidly rising inflation – and how that might reduce people’s spending power. They worry that the outcome could be stagnant economic growth and high inflation – referred to as ‘stagflation’. This is an unpleasant situation, as it means economies could enter into recession (when growth turns negative), at the same time as the cost of everything gets more expensive.
This fear has resulted in quite unusual behaviour in the investment world, particularly in relation to equities (investments in stocks and shares) and bonds (investments in corporate or government debt).
In normal market conditions, it’s a good idea to hold a proportion of equities and bonds in an investment portfolio. Equities and bonds have different characteristics, meaning they usually behave differently, with bond values rising when equity values fall, and vice versa. This ensures that, broadly speaking, when your equity holdings fall in value, your bond holdings increase in value.
However, stagflation fears have turned this on its head. For much of this year, the values of equities and bonds have both fallen at the same time. In other words, this year there have been very few hiding places for investors.
Growth-focused investments have struggled
Another significant factor that has damaged investor returns this year has been the poor performance of some of the most popular and well-known US technology stocks.
Many technology stocks, like Amazon, Google, Facebook, and even Tesla, performed exceptionally well during the pandemic, but have suffered in 2022. These companies, and others like them, are labelled as ‘growth’ stocks because the market expects them to achieve higher profits in the future.
But now that investors have become more pessimistic about the outlook for these companies, they’ve fallen out of favour. Rather than paying a high price in the hope of future growth, investors have instead focused on ‘value’ stocks that have been largely ignored by investors and appear cheap based on current valuations.
How should investors respond to current events?
Right now, it’s fair to say that investment markets are quite negative, and many investors are focused on worst-case scenarios. But it’s important within investing to recognise that when these negative factors are already ‘priced-in’, opportunities may lie ahead.
As a financial planner, part of my role is to understand the global economic forces driving investments. I then aim to reflect these forces in terms of asset allocation (how your investment is divided up across various assets) and portfolio management (how those investments are structured and managed).
Each client portfolio is different; constructed according to their personal life plan and investment trajectory. Throughout the course of this year, we’ve talked to several investors about adjusting their investment portfolios, to help reposition away from areas that are underperforming, and increase exposure to those areas of opportunity.
Investment opportunities will always be there, even if they take some time to reveal themselves. For example, if inflation has already peaked, and there’s a strong argument to suggest it has, sentiment could improve significantly for the rest of the year. Overall, I still think that equities have the best potential to capture good investment returns – although it’s important to remember that like any investment they can go down as well as up.
Sometimes the wisest investment approach is to be patient, stay invested, and ride out the storm
Ignoring the short-term ‘noise’
Of course, it can be difficult for investors to read negative media stories on an almost daily basis without being tempted to sell their investments out of fear they will keep losing money. As investments should always be considered over the longer term, I usually advise clients against this. Not only does this mean you have possibly sold your investments at a loss, but it also means you’ve lost the opportunity of benefitting from a future recovery.
If the past few years have taught investors anything, it’s that global investment markets are increasingly resilient, and that negative headlines and market volatility will not always result in long-term damage to investment portfolios. There’s an old investment saying: “Bull markets make you feel good, bear markets make you rich”. Sometimes the wisest investment approach is to be patient, stay invested, and ride out the storm.
Investing with confidence with Amber River
At the end of the day, all investments carry risk and you should not consider the information provided here as financial advice. Your investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested.
However, a financial planner will help you develop a personalised investment strategy that’s designed to withstand periods of uncertainty and volatility, and which reflects your willingness and capacity for risk. More importantly, they’ll be able to build this into a broader financial plan that takes account of your longer-term life goals – a process we call Life Landscaping® – to help you plan for a life well-lived.
Get in touch
To speak to one of our team, arrange an appointment or find out more, call 0800 915 0000, or alternatively use our contact form here.
Disclaimer:
The information within this article was correct at the time of publishing, but laws and tax rules are subject to change. Your circumstances and where you live in the UK also have an impact on tax treatment.
Related Posts
30 August 2024
5 possible tax and pension changes coming in the Autumn Budget
Read More
14 August 2024
How cuts in the Bank of England base rate could affect you
Read More
19 July 2024
Reducing the financial burden of school fees
Read More