Research Insights - Market update October 2022
Investment Market Commentary
Investor confidence during 2022 has continued to evaporate due to major events such as Russia’s invasion of Ukraine and Covid-19 related lockdowns in China. These events have placed further pressure on already stressed global supply chains resulting in rising inflation. Central banks have been forced to raise official cash rates in an effort to control inflation which has negatively impacted returns for assets.
Although prices of some key commodities are declining and other price pressures have begun to dissipate, inflation will likely remain a significant risk factor for investors.
Furthermore, in the US the difference between what the US government pays to borrow money for 2 years is a lot higher than to borrow over 10 years. This “inversion” of the yield curve has historically been a precursor to a recession.
Can we pick recessions, can we avoid losses?
Whilst there are many precursory warnings that a recession may occur the associated investment losses and duration of market movements is varied, see chart 1 below. Usually, markets have moved lower before the recession occurs therefore the majority of losses have already been felt.
Chart 1: US recessions in pale blue with the size of the downturn in the S&P 500 (US Equities) shown in orange, noting the 2022 sell off and no recession bar (yet?).
What if we sold investments?
Panic selling when markets are going down can hurt your portfolio instead of helping it. The dark art of predicting market movements in the short term is a fool’s game, however if you did sell, when would you have confidence to reinvest? Coming out of every market correction is where large gains can be made. Therefore being uninvested in this period can impact long term returns. For instance, it only took 1.2 years post the 2020 COVID sell off for markets to recover. It is important to remember that a bear market is temporary.
Can we avoid permanent loss of capital?
As at today valuations in most asset classes have improved meaningfully providing a solid foundation to build portfolio returns moving forward. Yields on many fixed interest instruments, including cash, have increased substantially and the risk/reward skew for fixed interest investors has improved.
Are there more losses ahead?
As central banks attempt to further address inflation cash rates may move higher but that does not necessarily mean that bond and equity markets will sell off. Companies are still dealing with the impact of inflation and impacts will vary greatly between companies – avoiding overpriced markets will be helpful in this scenario and having diversification across asset classes is beneficial.
US Dollar and commodities
An interesting observation has been the strength of the US Dollar (chart 3), typically in times of market stress investors flock to safety and with the official cash rate in the US above 3% the US Dollar (USD) has been the recipient of flows despite the risks of recession. Investors see the US as one of the safer currency options when compared to European and Asian currencies and less of a risk to further money printing that will weaken currencies.
Conversely commodities, that are priced in USD, have sold off due in part to a higher USD but also due to the risks of China and the global economy slowing. Gold that typically is a safe haven and also an inflation hedge hasn’t received much investor attention as “negative real yields” (inflation minus interest rates) coupled with no income being received sees Gold being sidelined.
Both Iron Ore and Oil have also sharply declined year to date as Chinese economic growth cools and the US Dollar appreciated.
Chart 3. US Dollar versus a basket of trade partners currencies – up 19% in a year.
When does the US Dollar weaken?
A high USD has many ramifications globally and should this trend continue it may result in a coordinated effort by central banks to intervene in currency markets. A similar action occurred in the 1980’s when the Plaza Accord agreement, signed between the five largest nations at the time, was enacted to correct global trade imbalances but caused the “lost decade” in Japan, a period of deflation and low growth. A change in the US central banks narrative could also help to “jawbone” the US dollar lower.
Investment market returns – Returns (%) up to 30 Sept 2022
As the table shows the one year returns from all asset classes other than cash have been negative. It is important to note that the long-term returns from equities have been significantly higher than defensive assets and importantly have generated a return above inflation thereby protecting purchasing power.
Plus 7 Financial Management is here to explain how any market movements may impact your personal situation and your long-term financial goals. You should also contact us if market volatility has caused you to reassess the way you feel about risk.
Important information
This information has been produced by Australian Unity Personal Financial Services Ltd (‘AUPFS’) ABN 26 098 725 145, of 271 Spring Street, Melbourne, VIC 3000, AFSL. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. It does not represent legal, tax, or personal advice and should not be relied on as such. You should obtain financial advice relevant to your circumstances before making investment decisions. AUPFS is a registered tax (financial) adviser and any reference to tax advice contained in this document is incidental to the general financial advice it may contain. You should seek specialist advice from a tax professional to confirm the impact of this advice on your overall tax position. Nothing in this document represents an offer or solicitation in relation to securities or investments in any jurisdiction. Where a particular financial product is mentioned, you should consider the Product Disclosure Statement before making any decisions in relation to the product. A PDS can be obtained from your financial adviser or directly from the product issuer. We make no guarantees regarding future performance or in relation to any particular outcome. Past performance is not indicative of future performance. Whilst every care has been taken in the preparation of this information, it may not remain current after the date of publication and AUPFS and its related bodies corporate make no representation as to its accuracy or completeness. Published: June 2022 © Copyright 2021.
