Current Markets: The reason behind the dip

Our Chief Investment Officer, David Semmens, details the events that are causing the recent market movements

By David Semmens

Created on: 13/10/2021

Updated: 27/07/2023

Reading time: 15 mins

Please note: this blog was published in October 2021 and its content is based on what was correct at the time of writing. As a result, some of the facts and opinions may no longer be current or relevant.

Over the last few months, our Plans have benefited from really positive performance – and, if you only started investing this year, you may not have experienced a dip as we’ve had in recent weeks. But these things happen – investments go down as well as up. Although we do as much as we can to reduce the risk to your investment accounts, it’s impossible to build a Plan that continuously increases, however much we’d like to.

The reason behind the dip

There are a few reasons why this current dip occurred, but the main reason is a result of the well-publicised supply chain issues. This is happening across the world and is affecting many industries – you may have personally experienced this issue if you’ve struggled to find fuel for your car lately.

As you’ll probably know from the news, this wasn’t caused by a shortage in fuel, but rather HGV drivers. Without these drivers, the goods can’t get to where they need to go – the same problem has been hitting supermarkets across the UK and Europe.

But there are even more knock-on effects of supply chain issues like these. For example, a few months ago we talked about the microchip shortage – this has impacted essentially anything that requires a screen, causing serious delays to a whole host of products, from cars to vacuum cleaners.

The problem is, we’re only just starting to feel the effects of this. There have been temporary Covid-driven shutdowns, which knocked tight supply chains off balance. Now our economic systems – which relies on logistics set up for perfection – are understandably having problems. Any difficulty a sector is facing is being magnified across the economy as efforts to increase production are feeding into a worldwide problem, with some of these issues already reaching consumers.

While this outlook might sound a little gloomy, recent reports from Goldman Sachs show that they are expecting things to get better as investors start to gain confidence that the current pace of inflation is 'transitory' which is central banker speak for temporary.^[1]

Markets have dipped as consumers, businesses, governments, and investors have become increasingly concerned about the economic outlook – which is constantly changing due to the Covid pandemic.

Everyone wants to fix this issue

The good news is that it’s in everyone’s best interest to resolve these problems. Producers and manufacturers are boosting their capacity whenever possible. Long term, price movements are likely to steady when supply and demand balances return to normal. There’s even the potential for some downwards price pressure if producers aren’t nimble enough.

Supply chain issues are a different part of the same problem. To talk about the most obvious problem, petrol panic buying increased demand by as much as 180%^[2]. However, this demand was met and therefore the supply alone wasn’t the issue. The problem, as we mentioned earlier, is logistics. Due to covid, which delayed HGV test takers, and Brexit, there are now 25,000 fewer HGV drivers in the UK^[3]which obviously means fewer lorries being able to transport goods – be that food, petrol, medical equipment, cars, etc. But this isn’t just a British problem, there’s a shortage of HGV drivers in Europe too^[4] and it’s a problem that existed even before the pandemic.

Businesses and governments are already working to try and ease this problem, and there are huge incentives to move quickly and return to normal. Similar to the disruption we’ve seen in the shipping industry, these problems are not something that can be solved by the click of a button. There are physical goods and massive container ships to move and HGV drivers to train.

There’s an economic benefit

The reason companies are focusing their energies on addressing the supply chain issues is the significant first-mover advantage, which will likely reap the greatest benefit. The easiest way to describe this is to imagine that Tesco had an issue with their milk supply chain, but Sainsbury’s didn’t. If you needed milk you’d have to head to Sainsbury’s, and since you’re going there already, you’re likely to do the full food shop too. In this hypothetical scenario, there’s a big financial benefit to Sainsbury’s and potentially significant losses for Tesco.

As you can imagine, companies do not want to find themselves in a position where they’re losing out to their competitors, so they’ll be doing all they can to ensure their supply chain issues are fixed. But in the short term this increases competition for drivers, petrol, and in this example milk. All of which drives up prices.

Similarly, many companies are continuing to find ways to adapt to our ‘new normal’, whether that’s expanding into home office furniture, comfortable homeware, or just making their remote service a permanent fixture. The last two years have given many companies an opportunity to change in ways they may have never done, and many are continuing to find more ways to overcome hardships. As Plato almost said, necessity is the mother of invention.

What about inflation?

A few months ago, we shared an in-depth article on why the markets are worried about inflation. We certainly remain watchful, but our long-term focused reasoning remains valid. Although we will go into more detail regarding recent events.

Central bankers are comfortable that inflationary pressures will fade, but they’re working on a time horizon that’s longer than most peoples’ and know that they can act quickly should they need to. This means that current inflation rates are not key to their thinking. To butcher a Wayne Gretzky quote, ‘Central banks are looking to skate to where the puck is going, not where it is.’

At present, central bankers have generally expressed their comfort with the recent spike in inflation not being durable, especially since the rise has been driven more by pockets of price pressure than broad-based increases. If recent inflationary pressures do not decrease as these supply shocks are eased in the coming quarters, then central bankers will have to reassess their current level of calm. Unfortunately, there is very little that monetary policy can do to fix supply-side problems.

Labour markets provide a similar story

The HGV driver shortage is just one example of the labour shortage. The retail and hospitality sector in particular, has struggled to find the staff they need to operate at full capacity. To try and overcome this shortfall, many jobs have seen increased wages – marking the first time that real wages have risen since the Global Financial Crash in 2008.

However, the post-covid labour market is also still causing uncertainty. That’s because, until recently, both the UK furlough scheme and US emergency unemployment benefits have been supporting those struggling during the pandemic. As these are now coming to an end, it’s likely that we’ll see an influx of people joining the labour market.

The uncertainty comes from how these schemes have been supporting the labour market, as they both display mixed signals. We’ve seen lower overall employment compared to pre-Covid level but also record high levels of vacancies. This has driven an increase in wages, but it’s worth noting that this is compared to last year when there was a weaker environment. During this time, there’s also been a change in the UK’s labour market dynamics following Brexit, with the UK leaving the Single Market and ending the easy movement of EU workers into and from the UK (and vice-versa).

What else is driving the markets?

Talking about everything that’s driving market movements would take all year, however, a notable factor at the moment is the anticipation around Central Banks so-called ‘tapering’ and raising interest rates. After a long period of the Central Banks buying government and corporate bonds, we’re likely to see a slowdown of these purchases over the next six to nine months, effectively ‘tapering’ this monetary support.

What is important is whether or not this changes. Because, if it does, there are greater economic concerns that would be a worry for markets. However, if the economy is looking strong enough to support the current rate of modest interest hikes, then we’d be looking at a more stable recovery.

Policy makers appear to have learned from their past mistakes. In the summer of 2013, when the US Federal Reserve announced it was thinking about tapering to the market it caught investors off guard. This time, it’s well known that this change will happen although when exactly will depend on how the economic data performs. If the outlook weakens, then the market will likely take reassurance that the Federal Reserve will not cut the easing that’s currently supporting the economy and financial markets.

After ending tapering, the next step for central banks to consider is when to raise interest rates. These are two very different decisions.

Think of tapering as rockets that are helping propel the economy forward – if the economy can run fast enough these rockets aren’t needed. Raising interest rates, in this example, would be considered coolers, and they might be needed to stop the economy from overheating as it gets stronger.

The US Central Bank is expected to raise interest rates at the end of 2022 at the earliest, which means there’s still a long road ahead of us. The progress to this point is likely to be very gradual and will depend on whether the economy is in a situation where it is able to bear it. The UK is in a similar position, with the Bank of England already gradually tapering, with an intended end date scheduled for December 2021. Looking ahead, financial markets forecast that the Bank of England will lift interest rates twice by September 2022. But these changes will only occur if the economy can bear them.

Thinking about your investments

We understand that investing when the markets are down can seem counterintuitive, but it could offer some of the best times to enter the market or increase your holdings at better prices. Taking a long-term view and having a diversified portfolio can help ride out the market volatility. Declines do happen and it’s always useful to be prepared for these - especially considering the behavioural biases that tend to creep in when markets fall.

Market volatility is a welcome part of investing, it’s part and parcel of how you can give your money more potential, as without the downs you wouldn’t have the ups. At Wealthify, we’re always keeping a keen eye on the markets, carefully analysing, and monitoring our customers' Plans. We’ll always act in your best interest, removing emotional decisions from a financial equation.

Remember, although it may be scary to see your Plan go down, you aren’t actually losing money. That’s because, until you sell, the loss isn’t real, and the price of the share could go back up at any time – but once you sell it that 50p is gone forever. So, remember, with all investing your capital is at risk and you could get back less than you put in.

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.

You should seek financial advice if you are unsure about investing.