Does the recent share market volatility make you jumpy?

The 2020 COVID-19 share sell off and recent equity market volatility shows just how quickly share prices can move.

Volatility can have different meanings for different investors. For retirees, there is a definite skill in ensuring that their portfolios are adequately diversified and matched to the investment time horizon of each individual. And to do it without becoming so conservative they have to downgrade their lifestyle.

One thing to remember, though, is when volatility rises, value emerges.

What's influencing the outlook?

Ukraine and China
The cruelty of Russia’s ‘special military operation’ has shaken the world but history tells us war does not always derail investment markets. Strikingly, global shares fell over 30% when the world locked down for Covid (February 2020 to March 2020). But even after Russia invaded markets continued to rise slightly over the following few weeks.

There are more specific forces at play that will influence markets. There are widespread attempts to shun Russian energy sources, which constrains supply and means oil and gas prices are rising. Higher energy prices are a major economic blow because they suck cash from consumers’ pockets. Meanwhile, the loss of Ukraine’s harvests will add to food costs.

Somewhat lost in the fog of war is another Chinese Covid crisis – with over 20 million people locked down in Shanghai as Chinese policymakers stick to a zero-Covid policy. That has implications for Chinese industrial production, keeps the pressure on global supply chains and curtails Chinese consumer confidence and spending.

Inflation and interest rates
For investors today, inflation and interest rates are influencing investment assets. Hopes that supply chain pressures would ease as the world recovered from Covid have been dashed by the Ukraine crisis and China’s lockdown. That means inflation is now at rates unthinkable a year ago – 8.6% in the US, 7.8% in the UK and 7.5% in Europe. And around the world interest rates have started to rise in response. There are more rises to come, with the US response stretching to a potential seven rates hikes and six forecast in Australia.

The RBA’s response to rising inflation

The RBA has recently increased its official cash rate by another 0.5% taking it to 0.85% for the second rate hike in this cycle. This was above market expectations.

In justifying the move the RBA noted that: the economy is resilient; the labour market is strong with the unemployment rate falling to just 3.9%; businesses continue to point to higher wages growth; and inflation is expected to increase even more than it expected a month ago, with notably higher prices for electricity, gas and petrol. The RBA’s move is consistent with the stepped up pace of tightening from central banks in New Zealand, Canada and most importantly the US, as they all try to get ahead of the surge in inflation and to contain inflation expectations. This and the low starting point explains why the 0.5% rate hike is the biggest in 22 years.

The RBA’s commentary remained hawkish reiterating that it will “do what is necessary” to return inflation to target and that this will likely require “further steps in the process of normalising monetary conditions” which in short means that more interest rate hikes are likely on the way.

While the rate hikes add to the cost of living the RBA has little choice but to “normalise” interest rates

Even though supply constraints (including those caused by the recent floods) are the main factor behind the rise in inflation, RBA rate hikes won’t boost supply. However, the RBA has little choice but to continue the process of tightening monetary policy due in large part to the following factors:

-  First, strong Australian demand is also a factor with, for example, retail sales still running around 15% above their long-term trend. As is the very tight labour market.

- Second, having a still near zero cash rate when unemployment is 3.9% and inflation is 5% and still rising makes no sense. So the RBA is right to be “normalising monetary conditions”.

- Third, inflation pressures are still building with surging electricity and gas prices, petrol back above $2 a litre, rents starting to rise rapidly and supermarkets warning of more price rises and increasing wage demands. Its looking likely that inflation will now rise to 7% or so in the second half (compared to RBA expectations for a peak around 6%).

- Fourth, the experience from the 1960s and 1970s tells us the longer high inflation persists the more inflation expectations will rise and get built into price and wage setting making it even harder to get inflation back down again without a recession. By raising rates the RBA is signalling its commitment to get inflation back down to the 2-3% target. Not doing so would call that commitment into question which would see inflation expectations rise.

- Finally, the global backdrop now of bigger government, a long period of ultra-easy monetary policy and big budget deficits, the reversal in globalisation and the demographic decline in the proportion of workers relative to consumers, all point to a transition from the falling and low inflation world of the last 30-40 years to structurally higher inflation. This means that central banks like the RBA have to be more hawkish than has been the case for some time.

The RBA Monetary tightening is already appearing to be gaining some traction

The RBA is only seeking to slow things down to take pressure off inflation and give time for supply to catch up. It does not want to crash the economy. It will be watching indicators of spending and things like house prices very closely. It looks like the RBA is already getting traction. Consumer confidence has fallen sharply and is well below where it’s been at the start of past RBA rate hiking cycles.

While the RBA does not target house prices, falling home prices (where economist expect a 10 to 15% top to bottom fall) will weigh on consumer spending (via negative wealth effects as seen in 2017-18). All of which will start to take pressure off inflation and limit the amount by which the RBA ultimately will need to raise the cash rate by.

Ask yourself – has my risk profile changed since I started my investment strategy?

The key to investment selection and portfolio management is optimising ‘risk efficiency’ by choosing the right mix of assets to give you the maximum return for the level of risk you’re able to absorb.

As part of the financial planning process, we gain an understanding of your risk tolerance and match it to the right mix of assets that will have enough risk to grow your portfolio, but not so much that you can’t sleep at night or you are led to sell at the wrong time. Like now. So, if you are feeling overwhelmed by current events and worried if your investments can tolerate the current volatility, please call me.

Ensure your investment portfolio is resilient

Volatility will persist while the world adjusts to a changing economic and geopolitical order. That could mean a wider range of returns – but not necessarily a poorer real-life outcome if you stick to a robust, diversified strategy that’s attuned to your needs.

Remaining diversified across asset classes can help ensure you have the optimal blend of assets in your portfolio to weather a variety of market conditions. When it comes to ensuring you don’t let your emotions influence your investment decisions, I can really help. Call me anytime on 0477 007 838.