Financial markets have experienced a violent fall over the first half of the year. Inflation, which has risen to its highest level in 30 years, has been one of the key causes of volatility within the market. Elevated inflation levels have forced central banks to quickly increase interest rates to try to bring inflation back down towards their long-term targets. Raising interest rates increases lending costs and therefore reduces spending. Higher interest costs also slow business investments and governments are often the largest borrowers of all and the higher their interest cost the less they can spend in the economy.
The sharp rise in these interest rates has really spooked some less disciplined investors. Many of whom are already suffering from huge falls in their investment in the hugely speculative cryptocurrencies which have now fallen more than 70%. Fear can take grip at times like this where investors start predicting the worst like uncontrollable inflation and inevitable reduced economic growth. As we have seen many times in the past when fear takes hold, we get sellers outnumbering buyers and markets fall. The last six months has been an extremely unique period because thanks to central bank monetary tightening (rising interest rates) on the back of the worst inflation breakout in decades, not helped by the invasion of Ukraine, bond yields have surged over the last financial year (resulting in an 8-10% loss for bonds) and shares fell between -5% and -10% globally. As a result, balanced growth Investment and KiwiSaver funds have seen on average, a negative return of around -3% to -5% over the last financial year.
Many economists have been quick to point out the need for perspective globally. It is very possible to lose perspective when such sharp changes occur in economic settings. However, if we look longer term, inflation hasn’t been above 2% for that last decade and interest rates are still well below long-term averages. Households have had considerable improvements in net wealth and unemployment is at record lows. So perhaps the economy has had a stumble but let’s remember it is still running!
Remember when looking at your investments in times like this you have not lost money. You have simply got a lower current price on the same assets. Your funds replicate broad groups of companies and while some will do poorly others will do well over time and the net result will always be positive in the long term otherwise the system itself collapses. As of June, the S & P 500 is down 20%. The graph below is perhaps the best indicator of what might happen from here:
Shares could see continued volatility as central banks continue to increase rates higher than is already anticipated to combat high inflation, the war in Ukraine continues and fears of recession remain high. However, we are at a point where a well thought out financial plan comes into effect most, where there is time of discomfort, and you have something to look back at to understand why you invested in the first place. If you are saving for the future, this current pain will eventually convert into a period of considerable gain.
We are starting to see supply issues being resolved and as the world opens, people spending more on services than goods as they were inclined to do while locked down. Interest rate rises are a proven tool for reducing inflation we just need to be patient and wait for the rises to take effect on households and governments. We are also starting to see a number of commodities such as oil, wheat, and coffee decline, and, here in NZ, housing is definitely falling.
Companies still generate cashflows and still generate profits and many have adapted to the “new normal” of Covid. It still pays to invest diversely in business as we are seeing companies with good pricing power recovering already or better holding value.
Low unemployment while tough on employers looking to hire, does mean the economy is in pretty good shape and government coffers should replenish due to a higher tax take.
As bonds in portfolios mature, they will roll over to higher bearing assets, so conservative and balanced funds should generate higher yields in the years following.
There are no winners in war, but wars end.
The world has a history full of problems, but eventually solutions. Don’t bet against human ingenuity.
Some key things for investors to keep bearing in mind are that: share pullbacks are healthy and normal; selling shares after a fall lock in a loss; share pullbacks provide opportunities for investors to buy them more cheaply; and avoid getting thrown off a long-term investment strategy.
Conclusion
It has been an uncomfortable time to be an investor, but that follows a very long period of growth. Some correction is inevitable and the global backdrop, while troubling, is not unique. It will get better. Unless you have to make some changes, or you are getting closer to retirement, the general advice is to stick to the long-term strategy, have patience and bide your time.