Market Commentary, News and Views

Financial markets are normally robust, having learnt the hard way from past lessons of setbacks, such as Black Monday 1987 and the Financial Crisis of 2007-2008. However, very few would have foreseen the full extent of the pandemic and its consequences to the financial system. After the extreme global economic decline witnessed in mid-2020 there had been a meaningful recovery to the end of 2021 with a return of stability, but the adjustment to a post-Covid world was to follow.  

So far, 2022 has been a tough year for investors, an already weakening global economy has been further upset by Putin’s war and supply squeezes creating an unpredictable environment for investors with very few places to hide. The pickup in inflation since the pandemic has forced central banks around the world to end the period of easy money and tighten conditions by raising interest rates to stop inflation from becoming embedded in the system. This action has been met with various degrees of success so far.

This rising rate environment has been painful for both equities (stocks and shares) and bonds (loans)*, as investors reprice the relative attractiveness of these assets against a higher “risk free” rate offered by central banks. Commodities have offered some positive returns. However, investors have needed to be selective here. Energy has been positive a performer but areas such as metals and lumber have seen large falls this year and invariably all commodities have been very volatile. Even cash holders have struggled in real terms with inflation outstripping interest returns for savers; something that we have got used to in recent years and are likely to endure with for some time to come.

Against this backdrop it is understandable to feel nervous, particularly when news flow in the UK centres around unstable government policy, the cost-of-living crisis and unpopular budgets from our numerous Chancellors in recent months. However, it is important to be mindful of the benefits of long-term investing both in managing volatility and in combating inflation.

Timing the market is notoriously hard as investments tend not to move solely in a straight line. Large moves in one direction are often followed by large moves the other way, as evidenced this quarter when markets rallied in July thanks to some weaker economic data (which perversely is a positive for assets at the moment) before changing course, as Central Banks doubled down on their rigid approach towards combating the economic downturn. Thin trading volumes have exacerbated the share price moves this year and it currently doesn’t take a lot to move the dial. This makes market timing even harder and it is easy to get caught out.

Therefore, although it can feel uncomfortable, it is prudent to ride out these bouts of volatility by remaining invested in a diversified portfolio rather than crystallising a loss and looking for another entry point. An example of this is the recent investment performance. Mid-October saw a sizable downturn. Had we disinvested then, for no reason other than fear of worse to follow, we would have missed out on a subsequent rally in recent weeks. Although it is a phrase used all too often, it really is about “time in the market rather than timing the market”.

Inflation is in everyone’s minds at the moment and for investors it is the biggest long-term threat to returns. In the near term, Central Banks face the challenge of bringing it down from its current highs without causing a deep recession, again with varying degrees of success so far. It is likely that headline inflation (a measure of the total inflation within an economy) will come down from the current extreme levels without any further Central Bank intervention as the impact of energy rises over the year will experience reversal. Core inflation (the long run trend in the price levels, excluding food and energy) may prove more lasting and Central Banks will be keen to stop this becoming embedded in spiralling wage costs. Even so, we may be in for a higher period of inflation than we have been used to in the last 20 years. While there are assets that people look at to hedge inflation risk, such as Gold or index linked bonds when conditions are right, one of the most effective ways to combat long term inflation is to remain invested in equities where the companies can pass on their increased costs to consumers. Historically, equities have offered a real return to investors above inflation, though they do so with higher volatility so a long-term investment time horizon is important.

Rising interest rates have been painful for bond investors this year and indeed for traditional 60/40 (equity/bond) portfolios as these two asset classes (that historically have had little correlation with each other) have fallen at the same time. Going forwards this higher rate should also allow bonds to play more of a defensive role in portfolios as if the overall economic environment deteriorates significantly and Central Banks begin to lower rates again. The capital value of the bonds should increase providing support to portfolios when equities will likely be under pressure.

Lastly, it is important to highlight that a lot of the negativity expected in the future has already been priced in to assets and that while things could deteriorate further than the current base case, the downturn could equally be less severe than markets suggest and as July (and the last two weeks) showed, investments can rally quickly from here. Investment experts believe that having a well-diversified portfolio is the best way to navigate these testing times and that over the longer term this should lead to solid returns ahead of inflation.

Important Information

This material has been written with Tatton’s contribution and is for information purposes only and must not be considered as financial advice.

We always recommend that you seek financial advice before making any financial decisions.

The value of your investments can go down as well as up and you may get back less than you originally invested.

* A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest ‘coupon’, which is the annual interest rate paid on a bond expressed as a percentage of the face value. The capital borrowed is repaid in full at the end of the agreed term.