The first month of 2022 has been a volatile one for world markets and this note is to try and explain some of the headwinds your portfolios may be facing.
Markets have been dominated by two fears; what Putin might do in the Ukraine and what higher and more consistent inflation might mean for global interest rates.
Unfortunately, with regards to Russia, we must wait and see what happens with the hope that sense and diplomacy will prevail.
Arguably the largest influence on the markets has been a growing feeling that global inflation may be more sustained than the world has been anticipating. Some of the inflationary pressures are due to supply-side issues caused by the Covid 19 pandemic which in all likelihood will subside if the world moves from pandemic to endemic. However, the demand side pressure is likely to remain with people having stockpiled record levels of cash whilst not being able to spend as they would have previously. If this cash pile is spent, we could find that inflation continues at higher than expected levels. Another issue to consider is that as we move to a greener world there will be significant costs to make this change, which again will be inflationary.
Whilst some inflation is good, too much will see the central banks look at the tools at their disposal to combat it and bring it down to more manageable levels. The key policy available to them is increasing interest rates.
Whilst those with savings love the idea of getting some return on their money, increasing interest rates could affect two areas of your investment portfolio; fixed interest and equities.
Fixed interest has been a fantastic part of portfolios since the financial crisis of 2009 as falling interest rates meant the capital value of fixed interest securities such as corporate bonds increased. This was effectively super-charged by governments buying their own debt and corporate bonds to reduce yields further in a policy coined Quantitative Easing (QE). If Interest rates rise and QE is gradually withdrawn or reversed, it is likely to have the opposite effect on fixed interest with capital values falling.
Some equities will equally suffer under rising interest rates. These are growth companies such as technology stocks whose values have continued to increase in part to the cheap cost of financing. If these costs increase it is harder to justify the premium price these stocks enjoy.
However, not all is gloom as this environment can be very positive for other sectors of the equity market, for example, value stocks such as banks and mining companies who have been very much out of favour.
One market which may benefit is the UK which hasn’t seen much increase in its main index (the FTSE 100) for the past 20 years. The graphs below show that whilst many global markets have fallen in January, especially the tech-heavy Nasdaq in the US, the FTSE 100 has actually risen.
Below is a graph showing the return of the FTSE 100 (UK), MSCI Emerging Markets, S&P 500 (US), MSCI World, Nikkei (Japan) and Nasdaq 100 (US Tech).
Whilst this volatility is uncomfortable and may continue whilst the above factors remain, it could mean your portfolio will drop at times, but it does provide managers with the opportunity to buy stocks at better values and therefore have the opportunity to generate positive returns. Please remember your portfolio is a long-term investment and if you would like to reconsider your risk profile feel free to contact us so that we can review your planning.
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