A bumpy start to the year

With financial markets' recent decline, we understand that many people are worried. Here are the actions we’ve taken and what we will be paying attention to as the situation develops.

By David Semmens

Posted 1 year ago

Reading time: 8 mins

With financial markets falling and the value of investments dropping in the first few weeks of the year, we understand that many people are worried about their Investment Plans and are wondering what they can do to minimise their losses. But should you be concerned? With investing, it is normal for stock markets to go up and down, after all.

Here are the actions we’ve taken and what we will be paying particular attention to as the situation continues to develop.

Despite continued uncertainty due to Covid-19, 2021 still followed 2020 as a strong year for financial markets as we witnessed lower market drawdowns (the decline from highs to lows) and volatility (a measure that captures the size of fluctuations seen in market prices) than many of the previous years. However, fast-forward a few weeks into the start of 2022 and there have been notable drawdowns across most major markets.

The speed and magnitude of the market moves may come as a surprise to many, but especially those who are relatively new to investing and haven’t experienced such market dips (which are a normal part of investing and something that can be expected) previously. While markets have weathered downturns of this magnitude in the past, we understand that this doesn’t make it any easier to stomach, especially since we must remember that past performance is not a guarantee of future performance.

Figure 1: FTSE-100 Total Return since inception through various crises

Figure 1: FTSE-100 Total Return since inception through various crises

Source: Bloomberg, FTSE-100 index

Looking ahead

As we’ve explained before, market volatility is an ever-present part of investing and something that is to be expected. It is actually volatility, and the associated potential risks, which drive the higher potential returns seen in equity and bond markets in comparison to the guaranteed but low savings rates earned by keeping your cash in a bank or building society account.

We’ve previously outlined many of the reasons why 2022 was expected to be an interesting year in another blog, with Covid-19, higher inflation, and politics being some of the key players. So, let's revisit those in light of recent news.

Interest rates

Expectations are that the Federal Reserve and the Bank of England will raise interest rates 3-4 times in 2022, with a further 3 and 1-2 respectively in 2023. But this will only take us back to a similar level to that of pre-Covid times.

Based on historic data, this is still a supportive environment for the stock market and both consumer and corporate balances remain robust due to Covid savings (generated by consumers) and Covid earnings (generated by corporates). The markets’ experience of the Covid-19 recession was also very different from that of the prior recessions due to the “unprecedented” (probably the most overused word of 2020-2022) support from governments for both businesses and households.

The current market expectation for interest rates remains data-dependent, with the path forward for real interest rates determined by both policy rates and the change in inflation rate.

It is important to note that the outlook here is incredibly fluid, and that expected policy changes ahead are not set in stone – so things could change quickly. There is an element of financial market apprehension that policy makers, either central bankers (monetary) or those in government (fiscal), will make a mistake by raising interest rates too much or too quickly. Equally, if inflation slows faster than expected then the observed increase in interest rates will likely be much lower.

Figure 2: Expected central bank interest rates vs. historic averages

Source: Bloomberg, policy rates deflated by PCE (US) or CPI (UK), forecast uses economist consensus

Inflation

Actual inflation rates have risen over the last year to levels not seen since the early 1990s, so this has understandably led to inflationary concerns being elevated right now.

Much of what drove inflation higher in 2021 was continued lockdown restrictions, and we saw a significant spike in the amount of physical goods being purchased online as consumers shifted their spending away from things like restaurants and holidays. Unfortunately, this also happened at a time when supply-chain difficulties hindered corporates from being able to meet that demand. But there is some good news as these difficulties are expected to ease as we move through 2022 and into 2023.

Another thing we could expect to see is that this excess demand for purchasing goods will decline as people’s spending reverts toward services (like restaurant meals and holidays abroad) - a process which is already being seen in the UK as Covid-19 restrictions are continuing to be eased this year.

At the same time, corporates have an incentive to meet that demand generated by consumers. So perhaps unsurprisingly, the shipping sector has seen a spark in activity. This has meant that in some cases, they’ve had to increase working hours in a bid to clear the backlog caused by this change in spending habits.

For instance, the Port of Los Angeles and Port of Savannah in the USA (which are key West and East Coast ports in America) saw record-breaking years for container volumes in 2021. However, this doesn’t eliminate all the frictions we’ve highlighted, although it does signal a significant step forward towards their alleviation. For instance, the numbers of ships waiting in Savannah is currently down to one or two at any one time compared to 13 ships just a month ago, and 25 ships back in October.

Similarly, the situation regarding the lack of lorry drivers in the UK is improving, but obviously, you can’t train to be a lorry driver overnight – as a matter of fact, the process takes a reported 8-10 weeks without Covid or Brexit labour shortages to contend with. For this reason, this could continue to have an impact for some time, but there has been partial progress, so this can still be expected to contribute to lower inflation going forward.

Another area where further progress could certainly be possible is UK-EU trade relations as the queues of lorries on both sides of the border get used to those trade barriers that were erected since the UK left the European Union.

Politics

Since the release of our 2022 Investment Outlook, tensions have increased between Ukraine and Russia, while relations between China and the US have also deteriorated further. The potential impact of economic sanctions on Russia would compound an already difficult energy market in Europe, which could cause concerns, although diplomatic steps are being taken to mitigate this where possible.

Despite more aggressive rhetoric on both sides, there is also little incentive for the US or China to allow their political difficulties to hinder economic co-operation. Similarly, as the two largest economies in the world, they have already demonstrated their willingness to agree quickly on the need to ensure de-escalation of Ukraine-Russia tensions.

What action have we taken?

In an email to customers earlier this month we explained that we had made some changes to our customers’ Plans.

In Cautious, Tentative, Confident, and Ambitious Plans we have increased the amount of short-term bonds and the amount of shares customers with these Plans hold. Additionally, in our Adventurous Plans, we have reduced the amount of bonds while increasing the level of shares.

And finally, in our Original Plans only, we’ve reduced the level of Emerging Market Local Currency Bonds and increased investments in Global Property. The global property market has only recently returned to above pre-Covid levels, and an inflationary environment is typically well-positioned to pass on price increases through rentals while also providing a healthy income to support returns. This doesn’t apply to our Ethical Plans, as they do not hold property or Emerging Market Bonds.

In this email, we also reiterated our positive outlook for equities which have seen their implied valuations (current stock prices divided by estimated future corporate earnings in the year ahead) decline due to the reasons discussed above. This means that on a historic basis, they are cheaper than they were just a few weeks ago.

This is underpinned by the current outlook for GDP (economic growth). With the UK easing lockdown restrictions, the post-Covid recovery plan is on track to deliver above trend GDP for the second year in a row. Not only that, but it’s also being forecast to do so globally for a third straight year in 2023 as well.

There is also economic volatility associated with the continued loosening and tightening of Covid-19 restrictions, which makes the economic data being released subject to greater revisions – and making things more difficult to assess. However, overall, continued business innovation in the face of adversity has supported earnings growth, with both household and business balance sheets remaining strong.

While we’ve seen alarming declines for some individual companies, such as Peloton (who are down 33% year to date as of 27/01/2022) and Moderna (who are down 41%), this highlights the importance of diversification both from a geographic and sector perspective. But unfortunately, not all sectors can do well in every period, and we have seen our Ethical Plans underperform our Original Plans so far in January. The reason for this is simple; our Ethical Plans have greater exposure to those sectors that have had a more difficult start to the year (for example, Technology and Healthcare) and lower exposure to those that have had a less tricky first month – such as the Financial and Energy sectors. Since Ethical Investment Plans by design (due to their explicit exclusions of Weapons, Tobacco, Gambling and Adult Entertainment companies) will have different sector exposures to Original Plans, there will understandably be deviations in performance, although historic longer-term performance indicates that these differences have typically evened out.

Our view is that the sharp decline in the market has triggered an overreaction, resulting in many sectors (perhaps unfairly) bearing the brunt of this downturn. This is not a new phenomenon, and we remain watchful of market conditions while being cautious of chasing a trend that would see us move away from our investment approach, which is focussed on the long term.

We have stayed invested because sharp sell offs often see sharp turnarounds and missing out on those positive days could be more costly to our customers. This is because we anticipate that markets will recover once uncertainty around interest rates lessens, and the outlook for growth should become more stable and reassuring.

As ever, we’re keeping a close eye on this situation and will look to make changes to your Plan as and when potential opportunities may arise to do so. If you’d like more detail about your specific Plan’s performance, our Customer Care team are always on hand to help. You can get in touch with us Monday to Friday 8am - 6:30pm and Saturday between 9am – 12:30pm, either online or by calling us on 0800 802 1800.

With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.

Wealthify does not offer financial advice. Please seek financial advice if you're unsure about investing.

Please remember that past performance is not a reliable indicator of your future results.

References