Investments | 16 February 2022

 

INCURSIONS, INFLATION AND INTEREST RATES – OUR TAKE ON MARKET VOLATILITY

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Remember when Brexit was the biggest news story for UK investors? After what seemed an age of hearing about little else, a deal finally came.

Then a major global pandemic dominated headlines and disrupted our lives. And things appear, whisper it, to be settling on that front as the world learns to live with coronavirus.

And now? Record-breaking inflation, central banks raising interest rates and a potential invasion of Ukraine are disturbing market performance and investors’ sleep.

Here’s our point. Markets have faced challenges before, they will face them again. But history shows they tend to recover. They tend to move on. And over time they tend to move up.

So if you’re investing for the long term – about five years or more – it could be worth standing firm and staying focused on the future.

It’s important to remember that past performance should not be taken as an indicator of future performance. The value of investments and the income you get from them can fall as well as rise and you may not get back what you put in.

MARKET CORRECTIONS - ALL PART OF INVESTING

Coutts Chief Investment Officer Alan Higgins said: “Market corrections, or ‘draw downs’ as we call them, are a normal part of investing. Every once in a while, the markets need to cool off.

“Since 1980, the average correction in the US has been about 14 per cent. There have been big ones, like in March 2020 when coronavirus kicked in and markets fell by over 30 per cent, and small ones of just 5 per cent, which we saw a few times last year.

“But market drops can create good buying opportunities for investors as stock prices fall. And so far, every single time, markets have eventually recovered and continued to rise.”

This point is reinforced by research last month by Goldman Sachs. It showed that the S&P 500 fell by 15% on average during 21 non-recession corrections since 1950, but buying the index at 10% below its high would have generated an average return of 15% over 12 months.

GEO-POLITICAL RISKS RARELY CAUSE LONG-TERM TROUBLE 

There’s no doubt that conflict between Russia and Ukraine would hurt the market mood and, with oil prices rising to eight-year highs, push energy prices up even further. This in turn feeds into further worries about rising inflation.

While a full-scale invasion remains unlikely, any path to de-escalation would not be smooth. But the potential impact of an ‘energy shock’ on the European economy, along with this year’s US mid-term elections and China’s 20th National Party Congress, all favour a diplomatic solution.

Research shows that such geo-political risks don’t damage markets for long. A study by Deutsche Bank in 2017 found that, on average, a market sell-off following a geo-political event lasts 15 days, with markets recovering to former levels 16 days after that.

That’s just a month of difficulties before markets get back on their feet.

INFLATION AND INTEREST RATES - THE REAL ONES TO WATCH

To tackle record-high inflation on both sides of the Atlantic, and stop the economy from over-heating, central banks have already started raising interest rates (the Bank of England) or indicated they’ll do so sooner than initially thought (the US Federal Reserve).

Markets tend not to like higher interest rates – they increase companies’ borrowing costs while discouraging people from buying their products, all of which can dent the share price.

But Alan stresses that, later this year, interest rates should eventually lower again.

“We stand by our view that interest rates won’t stay at high levels and will settle down,” he said. “And we’re talking about them settling at about 1 to 2 per cent rather than the 5 to 6 per cent levels we saw before the 2008 financial crisis.

“The UK and US markets are too sensitive to interest rates for them to get much higher. In the 1970s everything we did was related to oil. Now, with higher debt levels, market performance is much more connected to interest rates.”

He added that the sudden rise of inflation took virtually everyone by surprise.

“The US Federal Reserve and the Bank of England basically underestimated the inflation surge. But consumer prices have risen higher and stayed there longer than most of us expected.”

HOW WE'RE HANDLING MARKET CONDITIONS FOR CLIENTS

We’ve made a number of changes to our clients’ portfolios and funds to help them withstand the current landscape.

We recently reduced our exposure to European equities, a region more likely to be impacted by an invasion of Ukraine, and bought more US stocks, less likely to be hit. More generally, US stocks traditionally tend to do better in a ‘risk-off’ environment too.

It’s also worth noting that we have very limited exposure to Russian equities.

Our allocation to government bonds has also gone some way to mitigating the worst of the recent volatility, because bond prices have risen as risk assets sold off. Investors tend to be drawn to the relative security bonds can provide during such times.