Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
It’s been another rocky period for investors, with both global stock and bond markets down during the first quarter of 2022. Inflation is being stoked ever higher and there could be several interest rate rises in store on top of recent hikes. As the Ukraine crisis rolls into its second month, that only adds to the worry and uncertainty for many.
As we mentioned in a recent article though, this is all part-and-parcel of investing. If you’re thinking about getting out of the markets while things are bumpy, and then jumping back in once things have calmed down, you might find you’ve been left behind by rapid recoveries. They usually come without notice after a period of volatility and mean investors trying to ‘time’ the markets could end up worse off than had they done nothing.
Our advice is, as it always has been, to focus on the long-term and stay invested come rain or shine. Global stock and bond markets will sometimes cause short-term disappointment but on the whole they are resilient and, given enough time, have always recovered.
The global stock market ended the first 3 months of the year down 5.4%. That might actually come as some relief given only a couple of weeks ago it was 16.6% down since the start of the year, but has since recovered strongly.
The best performing equity style factor of recent months (at least in relative terms) was Value, but even it didn’t even escape the drop, falling 1.0%. Value companies are those with attractively-priced shares, but have been out-of-favour for many years as investors preferred companies with high growth expectations. There’s been a reversal of fortunes over the past 12 months though, as investing-for-growth has let off a lot of steam.
The worst performing factor – Quality – slumped 8.4%. Quality companies are those with high profit margins, steady earnings and low levels of debt, so it goes to show even financially-strong companies can still go through rough periods.
Looking at the equity sectors, most ended the quarter underwater, with seven of the major eleven sectors in negative territory. The two biggest fallers were those that have been among the strongest in recent years – Technology and Consumer Discretionary (non-essential consumer goods and services). The former fell 10.3% while the latter dropped 11.3% so both left investors bruised.
By far the biggest gainer over the past three months (as it was in 2021), was the Energy sector with a whopping 21.2% return. Energy is dominated by oil and gas companies. Their fortunes are heavily tied to the price of oil and gas which, as most of us know from our recent bills, have been rising in leaps and bounds.
It was a similar picture for the major stock market regions, with most falling to varying extents, and only a small number bucking the trend. While the USA, Europe and Emerging Markets all fell, the Pacific (excluding Japan) region rose 3.8%. The UK also delivered a small 1.8% gain. Both have significantly lagged the global stock market for many years, but their higher exposure to generally out-of-favour industries such as mining and banking, has worked in their favour recently.
As always, short-term ups and downs in any area are no sound basis for a long-term investment. While we prefer a broad, well-diversified approach to investing, for those investors who would like to focus more on certain equity factors, sectors or regions we would urge you to do your research first and take a long-term view.
The past three months have echoed the performance of bonds and alternatives over the past year – bonds have struggled, while commodities have soared. The global investment-grade bond market delivered a disappointing 6.2% loss since the start of 2022 given the impact of interest rates.
Bonds and interest rates move in the opposite direction to each other, so if interest rates go up it’s generally bad news for bonds. Several central banks have already increased rates recently, including the first hike by the US Federal Reserve since 2018 and three in quick succession by the Bank of England. There are expectations for more later in the year too, in response to rising inflation. Interest rates can be put up to apply the brakes on economic growth, by discouraging consumer and business spending, with the aim of pouring cold water on inflation.
While still the only major bond type to deliver positive numbers over the past 12 months, not even inflation-linked bonds (whose prices rise with inflation) could dodge a drop. Even though they performed better than most other types of bonds during the quarter, they still slumped 4.4%. The biggest faller was corporate bonds, with a 7.4% decline.
As expected during a period of rising interest rates, short-term bonds held up the best among fixed-income bonds. While they still fell 4.4%, this was a better result in relative terms to other conventional bonds. Shorter-term bonds are less sensitive to interest rates than longer-term ones, so they tend to fall less when interest rates rise and vice versa.
Gold had a good quarter, ending with a 6.6% gain. Gold is widely viewed as a ‘safe haven’ asset in times of extreme volatility or during geopolitical crises. Given we’ve had both in recent months with significant stock market falls and Russia’s invasion of Ukraine, investors have been drawn to the yellow metal and that’s pushed up its price.
It was broad commodities, however, that was the star of the show this quarter. With leaping energy prices, as well as big increases in the price of many industrial metals and agricultural produce, commodities delivered a thumping 25.6% gain. Over the past year they’ve risen nearly 50%. High demand from economies opening back up post-lockdown, coupled with ongoing supply disruptions, have led to a perfect storm for commodity prices.
While it’s unlikely the current commodities scenario will persist in the long term, some predict we could be entering the start of a new commodities ‘supercycle’. There’s no guarantee of that though and so we recommend you look before you leap. Commodities can be a highly volatile investment and have had long periods of poor performance.
Returning to bonds, while they’ve delivered disappointment over both the past quarter and year, like any investment they’re not immune to falls. When they do, however, it tends to be fairly mild and they’ve delivered positive returns far more often than not. While the near-term outlook for bonds doesn’t look particularly favourable, we place far more importance on the long-term potential of any investment. We still believe bonds can deliver positive long-term performance while maintaining their mantle as one of the best ways to dampen portfolio volatility.
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