After a long period of financial markets being treated largely as background noise by the media, news of their daily swings have been promoted back to the front pages of newspapers and the top of TV news bulletins. Naturally, investors are suddenly sitting up and taking notice. What’s causing all the volatility? More importantly, what if anything can you do about it?
As in 2008/09 and the first quarter of 2020, the ups and downs — mostly the downs in this case — of financial markets are newsworthy again. Global share markets are more than 20% below their recent peaks, which as the media constantly reminds us, meets the textbook definition of a “bear market”.
The image of a grizzly bear rampaging through markets and terrorising everyday investors is a potent one for the media, particularly given the demonstrated power of fear in generating and monetising the attention of mass audiences.
The obvious questions that come to mind for all of us at these times include:
How worried should we be about the future?
What is causing all the volatility?
How safe are our investments?
Is there anything we can do about it?
The answer to the first question is that, obviously, this is a worrying time. There is no downplaying the emotional impact of seeing one’s portfolio balance significantly lower than it was a few months ago. You naturally feel poorer and more anxious because you feel you have no control over the outcomes. So the initial response is to acknowledge how you feel.
The answer to the second question — what’s causing all the volatility — is pretty evident. Everything is suddenly getting more expensive and central banks are jamming on the monetary brakes after years of having the pedal to the metal.
The upsurge in inflation is due to a combination of factors. Global supply chains were disrupted by the pandemic at the same time as central banks and governments were pumping up demand through monetary and fiscal stimulus. Disruption to supply alongside the supercharging of demand was a sure-fire recipe for inflation.
But on top of inflationary consequences of the pandemic and the policy response was Russia’s invasion of Ukraine, which like the oil shock of the early 1970s, has put a rocket under the markets for commodities —particularly oil, gas and food.
Central banks, who a year ago were downplaying the inflationary shock as transitory, are now expressing concerns this could become baked into the system and are reversing course on interest rates and bond buying programs at speed.
All this is happening as the world starts the highly difficult and decades-long process of seeking to transition away from fossil fuels in a bid to rein in the worsening effects of human-made climate change.
The result of this confluence of factors is a major adjustment in both stock and bond markets. Bond yields, which just a couple of years ago, were in negative territory even out to longer-dated maturities, have been ratcheting higher. Concerned that central banks will overdo the reversal of stimulus and push the major economies into a deep recession, share markets have been adjusting lower.
Expect more volatility
With all that in mind, we come to the really difficult question. What does this mean for your investment portfolio? Certainly, the historical evidence shows that the sort of upheaval we have been seeing can be a precursor of future volatility.
The danger for individual investors, however, is in trying to time the market, getting out in the hope of missing the storm and then getting back in when the coast is clear. Evidence and experience suggests this behaviour only risks making a bad situation worse. Inevitably all you achieve by selling into a down market is turning a paper loss into a real one and putting at risk the opportunity to enjoy the bounce when it comes.
The most recent example of the virtue of discipline was in early 2020 when major benchmarks fell by between 30 and 40% in the space of a few weeks, only to bounce back and reach record highs within a few months.
Ten points to keep in mind
Now, this bear market is unlikely to be as benign or as short-lived as the one we saw two years ago. But it’s worth asking yourself, even at moments of extreme uncertainty as we are seeing at the moment, what — if anything — has fundamentally changed about investment principles.
- Stocks remain the best long-term investment. They have generated annual returns of 10% or more over the past century, a period that has included a Great Depression, two world wars, commodity shocks, pandemics and other crises. But we also know stocks don’t go up in a straight line and there will be negative periods. That volatility is the price we pay for the long-term returns available from owning stocks.
- We also know the virtue of holding tight in difficult times. In periods ranging from the 1987 crash to the US savings and loans crisis of the late ‘80s, to Asian currency crisis of the late ‘90s to the dot-com crash and the GFC, a diversified portfolio of stocks and bonds has returned to positive territory three to five years afterwards, at the most.
- Markets are forward looking. A lot of bad news is in the price. If news on inflation, interest rates, the Ukraine and whatever else the future has in store is unexpectedly worse than what is already reflected in prices, then, yes, markets could head further south. But, equally, if the news is not as bad as expected, risky assets could reverse course.
- Risk does not go only in one direction. What moves markets is the unexpected. Imagine what would happen to stock markets if Russia and Ukraine came to a negotiated settlement or supply chains out of China came unstuck. That’s not a prediction, by the way, but neither is it out of the bounds of possibility.
- Even when stocks are falling, somebody is buying. By definition, there cannot be more sellers than buyers if trades are being done. Markets work by bringing buyers together at prices satisfactory to both. Those buying at these lower prices are receiving a higher expected return than they were a few months ago.
- or the past few years, income investors have complained about rock bottom yields in bond markets. That is now no longer the case. The correction in global bond markets means you have the opportunity of earning a significantly higher return than you did a year ago.
- There are things you can control. These include how you allocate your portfolio between stocks, bonds, commodities, property, cash and other assets. Difficult markets like this can be an opportunity to rebalance towards lower priced assets. You can diversify your holdings across sectors and countries and currencies. If you really cannot bear the volatility, you can change your allocation but in a disciplined and structured way that allows you to sleep at night. Talk to your adviser and see what is possible.
- Keep in mind that nothing lasts forever. Good markets don’t stay that way. But neither do bad ones. And the turning point will often come before the economic news turns for the better. What matters is your investment horizon, not the media’s daily news cycle. Your emotional barometer is attuned to the short term. Your financial wellbeing barometer should be attuned to the long term.
- Understand that even during a period of great uncertainty and volatility, companies are still innovating and creating wealth. The energy transition, for instance, is not just a challenge but an opportunity. As a long-term investor you have a chance to share in that wealth created.
- Lastly, stick to your plan. A good financial plan is one that is built according to your needs and risk appetite. It makes allowances for times like these when all the news seems bad. It provides a cushion of cash and uses disciplined rebalancing to keep your on target for your goals. That is the value of having an adviser who knows you and what your circumstances are.
Bearing up to a bear market isn’t easy, it’s true. But the challenge is ultimately doable with a structured plan, a long-term focus, and an understanding that nothing lasts forever.