Investing: Looking Around Corners

What is driving markets at the moment?

Investment markets are concerned about high and rising inflation combined with slowing economic growth. The war in Ukraine is contributing to both a food and an energy crisis, while China’s zero-Covid strategy is leading to further disruption in supply chains. The war and the continuing impact of Covid-19, particularly in China, both add to concerns about inflation and growth short term.

The result? Central banks around the world are facing a difficult scenario. On the one hand they need to show resolve about getting inflation under control, while on the other hand they must be concerned about raising rates too far and too fast and inducing a recession. It is worth remembering that Central Banks set short-term interest rates; however longer-term interest rates (represented by bond yields) have already moved up in a very pronounced way leading to significant losses this year for investors who were holding those bonds.

Meanwhile, governments are facing citizens who want them to help offset the rising cost of living. All of this is adding up to a tricky time in investment markets.

*As at 30.5.2022

Inflation

The latest reading on inflation in the Eurozone is 8.1% for May 2022. This is a record high, well up on the 7.4% reading in April and more than four times as high as the long-term target of 2%.

 

Short-term inflation may well rise further before it begins to recede. These high headline numbers will pile pressure on the ECB to act. As I write, the expectation is that the ECB will stop its bond buying programme in June and then begin rate rises in July, with a 0.25% increase in each of July and September widely expected.

So to summarise, markets are currently expecting:

  • High inflation and potential for it to rise further short-term, before receding;
  • Rising interest rates; and
  • Slowing growth with increasing talk about recession.

Advice for Navigating Markets

Expect choppy seas as markets are likely to remain volatile for some time to come. There is a lot of uncertainty about how things will evolve. Pay particular attention to how the Ukraine war evolves and whether, given recent improvements in case numbers, China begins to ease up on its lockdown policy. The ECB will soon join the US and UK in raising interest rates, but given the difficulty of trying to reduce demand enough to bring inflation under control without precipitating a full blown recession, we need to be highly mindful of the risk of a policy mistake.

For short-term investors, this is not a market to be playing in. For long-term investors, the volatility we have seen in markets (that may well continue to see for the next 18 months) represents an opportunity to build towards your long-term target portfolio, buying on dips and rebalancing as things evolve.

Perhaps the biggest risk at times like this is that people make behavioural mistakes. The way to avoid those is to have a long-term plan that you develop with your advisor. Make sure that plan is based on a core set of investment principles (beliefs) and a long-time horizon. Then, stick to the plan, realising things may well get worse before they improve. Investment is a long-term game and fortune often favours the brave (and the well informed).