Please note: this blog was published in January 2023 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.
If the past 12 months taught us anything, it’s that predictions are not only impossible, but somewhat useless too.
If we skim back through last year’s outlooks, for example, did anyone predict Russia invading Ukraine, the Truss-mini-budget-fiasco, and UK mortgage rates doubling?
But although none of us have a crystal ball to predict what will happen this year, one thing we can do is reflect on past periods of market volatility and what this has taught us.
So, in a world of uncertainty, therefore, I want to start this blog with the following timeless – and, in the context of looking forward to 2023 – timely mantra:
If you’re not in the market, you cannot reap the future rewards of human ingenuity.
These words of wisdom were given to me when I experienced my first bear market during 2000’s dot-com crash. Even 23 years later, I still remember that feeling of worry seeing the value of my money go down — a feeling no doubt echoed by many of us in 2022.
The good news for investors, however, is that time is your friend; if you have time on your side, you can afford to take measured risk with your portfolio.
After all, it’s time in the markets, and not the timing of them, that truly counts — and the stats to back this up certainly don’t lie.
Indeed, equities have been shown to deliver positive returns over the long-term: the Barclays Equity Guilt study on long-term market returns – whose data goes back to 1899 and is considered one of the UK’s leading sources of data and analysis – nicely demonstrates just that!
However, patience and perspective will be required; you’ll need to be comfortable with the fact that investing in the market now to achieve your long-term investment goals, means learning to be comfortable with current fluctuations we’re seeing in the value of our investments.
Looking back at 2022
2022 was a tough year for global financial markets, challenging both UK and international investors. Markets reacted badly both to news of Russia’s invasion of Ukraine and Chinese domestic policy, whilst Britain’s brief stint with Trussonomics added fuel to the fire at home. However, the main game in town last year was central banks’ efforts to tame inflation by raising interest rates aggressively and quickly to levels not seen in over 40 years.
The year ended with most international equity markets down circa 20%, including the UK’s FTSE 250. However, one bright spot was the commodity heavy FTSE 100, which ended the year marginally positive, having benefited from the rally in energy and mining stocks. This partially sheltered it in comparison to its global peers.
But the story of 2022 was not the pounding that stocks experienced: rather, the pummelling of bonds due to the sharp rise in interest rates. As things stand, UK government bonds (gilts) returned one of their worst-ever years.
The UK 10-year gilt, for instance, saw a yield jump of over 200% (as rising bond yields mean falling bond prices), starting off the year yielding around 1.25% and finishing at 3.65%.
What happened to the tried and tested 60/40 Portfolio?
As a result of the simultaneous sell-off in both stocks and bonds, the traditional 60/40 portfolio (stocks/bonds) suffered a nasty decline, causing it to break and lose over 15% — its biggest decline since 2008. This was unexpected as the 60/40 portfolio mix has been a mainstay of a successful investment strategy for decades, with equities and bonds acting as diversifiers for each other through the economic cycle.
When I started my career nearly 25 years ago, I was told that the only free lunch in investing was diversification, meaning that it could be beneficial to spread your investments across different asset classes (like stocks, bonds, cash, etc.) and regions to help balance losses in the challenging years.
After all, it’s normal for financial markets and the performance of your investments to go up and down over time. That is why it’s typically recommended to invest for the long-term. The slight draw back to this, however, was not participating fully in the upside of a portfolio invested 100% in stocks during the good years.
Technically, stocks and bonds are negatively correlated, so when stock prices fall, bonds prices rise, thereby smoothing out the returns. Diversifying your investments by asset class and geography is usually an insurance policy which helps take the edge off market declines. If the value of stocks were to fall, then bonds would act as a counterfoil and go up as a result.
Outlook for 2023
Analysing current data points suggests that we have reached or are close to peak inflation, which should allow central banks to take the foot off rate hikes sometime in the first half of 2023.
However, one thing to bear in mind is that we don’t know the exact subsequent economic collateral damage of these higher-interest rate levels. In the nearer term, therefore, expect further volatility. After all, if the past couple of years have taught us anything, it’s that surprises come from unexpected places — and at unexpected times.
There is good news though in that last year’s bear market pushed prices down, and quality stocks and bonds can currently be bought at discounted prices.
Whilst you can’t time the market bottom precisely, it’s certainly valid to say that lower valuations today should translate to higher expected returns in the future. Therefore, last year’s combination of falling bond prices and falling stock prices means that expected returns have increased for diversified investment plans.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
Past performance is not a reliable indicator of future results.
Wealthify does not provide financial advice. Please seek financial advice if you’re unsure about investing.