We help you consider all areas and put together a financial plan that helps you to achieve your financial goals
Looking for Financial Advice?
Book a no obligation call with one of our experts
Sticking to the knitting
Financial markets, particularly US equities, have been on a wild ride so far this year. Volatility, how much prices move up and down, has increased markedly this year as markets aggressively try to price in expected interest rate rises from the US Federal Reserve (Fed).
But readers should not be perturbed. Market volatility is normal and declines in value, whilst deeply uncomfortable, are to be expected from time to time. History suggests that the best thing to do through periods such as these is not panic and stick to the long-term plan.
How should we view the current conditions?
As humans, we are prone to a phenomenon known as recency bias. That is our subconscious preference to rely on information that is most recent and, therefore, easy to recall. Financial markets have, since the onset of the global pandemic almost two years ago, enjoyed very strong returns with only the slightest whiff of a correction along the way (a correction generally is accepted to be a decline in value of 10% or more from the recent highest point). Prior to the pandemic induced sell-off in February and March 2020, financial markets had enjoyed about 10 years of good returns, and relatively little volatility, arguably supported along the way by central banks, particularly the Fed. So, it is possible that investors have been somewhat lulled into a false sense of security over recent times, making the market movements of the past four weeks deeply uncomfortable.
However, to reiterate, bouts of volatility and, therefore, declines in value are normal and to be expected. A commonly used measure of the volatility of the US stock market is the VIX index. As we can see below, volatility has increased substantially this year, further evidenced by some US indexes falling more then 4% on Monday 24th January, only to finish the day slightly up:
This chart, which is over the past 20 years, also demonstrates that short spikes in volatility (i.e. bigger swings in prices) are reasonably frequent.
Potential regime change
The root cause of this appears to be the fear/expectation that the Fed will be more aggressive in raising interest rates than originally thought and that the ample spare cash (liquidity) in the financial system will start to be removed soon.
Rock bottom interest rates, low inflation and plenty of liquidity has been highly supportive of higher growth companies, and particularly technology companies over the past 10 years. These companies are, by and large, found in the US and over 25% of the S&P 500 is made up of six technology-based companies. The expectation of regime change to one of higher inflation, higher interest rates and less support from central banks has, therefore, had a disproportionate effect on the US stock market. On the flip side, so called “old economy” markets (ones with higher weightings in financial, oil & gas, industrials etc) such as the UK have held up distinctly better:
Correction or bear market?
So, is this a run of the mill correction or something more sinister? A bear market is often described as a fall of 20% or more but there is no universally accepted definition. Whether we are on the verge of a bear market, we don’t know. However, there are several reasons to be optimistic.
The first is that history suggests that a market wobble before, or around, the first Fed rate rise of a new tightening cycle is a common occurrence. This is particularly the case for technology and growth stocks as shown in the chart below from our friends at BCA Research:
This behaviour is true for the US market as a whole. The following chart shows that the S&P 500 has, over the past four tightening cycles, suffered fairly major wobbles around the first rate rise but then goes on to deliver positive returns over the subsequent 12 months:
So, this indicates that current market behaviour is not only normal but may also be fairly short lived.
The second reason to believe that we are not on the cusp of a bear market is that the global economy is in pretty good shape. Whilst GDP growth is slowing, it is forecast to remain above the pre-pandemic trend in developed markets:
Covid cases appear to be peaking (for now) in the US and UK and US consumers are still sitting on an estimated $2 trillion of excess savings. This should buoy activity and, provided we don’t see a policy error from central back (i.e. raising interest rates too quickly), an imminent recession isn’t likely. This all adds up to a supportive backdrop for equities for the time being.
Regular readers will know that we are believers that diversification across asset classes, regions and industries works over the long term. In today’s world of instant news flow, it is all too easy to get caught up in the day-to-day noise and lose focus on the long-term plan.
It is human nature to want to take action to avoid pain. However, successful long term investors are disciplined, and history shows that the best thing to do in turbulent times is, more often than not, nothing. Trust in the diversification of your portfolio and stick with the plan.
I’ll leave you with this final thought. Research from JP Morgan shows that, since 1986, the average intra-year drop in the FTSE All Share has been 15.5%. Sounds painful. But, if you rode out those falls, you would have enjoyed a positive return in 25 of the past 36 years, or 69.4% of the time. Those are not bad odds.
Until next time, stay well.
Our Financial Advisers are available on the phone so please contact us if you have any questions.
Past performance is not a guide to future performance and may not be repeated. Investment involves risk.
The value of investments and the income from them may go down as well as up and investors may not get back any of the amount originally invested. Because of this, an investor is not certain to make a profit on an investment and may lose money. Exchange rate changes may cause the value of overseas investments to rise or fall.
This communication/presentation is for information purposes only. Nothing in this communication constitutes financial, professional or investment advice or a personal recommendation. This communication should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the document. Any opinions expressed in this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or companies within the same group as Ascot Lloyd as a result of using different assumptions and criteria.
This communication is issued by Capital Professional Limited, trading as Ascot Lloyd. Ground Floor Reading Bridge House, George Street, Reading, England, RG1 8LS. Capital Professional Limited is registered in England and Wales (number 07584487) and is authorised and regulated by the Financial Conduct Authority (FRN: 578614).