Written By Nick Booker
Investors have experienced a difficult start to the year, with both equity and bond markets racking up losses in the first three months. What started as an adverse reaction to the threat of higher interest rates required to tame persistently high inflation, turned into a collapse in response to Russia’s invasion of Ukraine. Events such as wars tend to be outside the usual risk parameters set by markets, extending more into the realm of uncertainty, which, by its nature, is harder to predict.
Even so, there has been a respectable rally for equities since the lows were reached in early March as investors have had more time to assess the situation. There was also some evidence of indiscriminate selling at the bottom, driven by volatility-targeted funds whose gross investment positions are subject to the level of market volatility (i.e. the more volatile things are, the fewer equities these funds can hold). The VIX Index (aka the ‘Fear Index’, which is based around expected volatility of the S&P500 Index) jumped to a peak in the high 30s in early March, a level associated with stressful markets, but a level also only breached in the most extreme of environments.
As is often the case, this environment of ultra-low-priced shares presented the prospect of a rally, which duly arrived, cheered on by hopes of a relatively swift resolution to the war. Equities have also benefitted from a perceived lack of realistic alternatives to invest in.
Based upon current projections, sovereign bonds still carry the guarantee of losses in real terms if held to maturity, because expected inflation is likely to outstrip the value of any coupon paid. Equities, which represent ‘real’ assets, at least come with the possibility of growth.
The first quarter of 2022 has not been a pleasant one for investors, but we must spare our sympathy for those whose lives have been lost or disrupted following the Russian invasion of Ukraine. As investors, we have to accept financial risk in the pursuit of reward, more so than ever today in a world of low interest rates, especially when compared to current levels of inflation.
Although risk assets (shares) have rallied hard from their lows, we still have to negotiate the tightening of monetary policy that will be delivered by central banks over the course of the next year or two, if current inflation projections are correct. We have also yet to find out exactly what shape the world’s corporations are really in, following the sharp increase in materials, distribution and labour costs. Neither do we know how badly consumers will react to soaring energy and food prices.
We were firm in our belief that clients should not panic sell and exit markets when the conflict began. We continue to hold that belief and ascertain markets will remain volatile in the short term and can potentially foresee an economic slowdown if worldwide Government monetary policy becomes predictably tight. Investors should remain cautious and continue to plan for the medium to longer term where periods of volatility are to be expected, however, returns traditionally will stabilise over the medium and longer term investment periods.
If you have any questions arising from the above, please do not hesitate to get in touch with an Integrity365 adviser.
Written By Nick Booker
