Global economics has had a difficult start to 2022. A period of slow growth appears to have taken hold, preliminary data on GDP trends in both the Eurozone and the US have failed to meet expectations, while inflation has soared and energy prices have reached new peaks, particularly in the UK.
The reasons for the turbulence have been well-documented. The ongoing war in Ukraine has put further strain on an international economic system already buckling under the weight of Covid-19 related inflation and supply chain issues. These problems have, inevitably, had a knock-on effect on investment returns.
In terms of inflation, we may have to endure high levels for some time yet, though the ECB does seem to think that it’ll stabilise at its 2% target in the medium term. For the coming months, however, expect to see figures exceed 5% and even reach 10% in the UK. This has been exacerbated by the Ukraine war but was always likely to occur to some extent given the problems caused by Covid-19 over the last two years.
Since the beginning of the year, the performances of all the major indices have been negative or flat. The Global Bond Index, which can be seen in the graph above, hit -8% for the year in May 2022, with performances in negative territory since the turn of the year. The rise in interest rates – primarily a response to inflation – has made the situation in the bond market more difficult.
Inflation, interest rates and yields
The chart below gives an impression of how interest rates on government bonds have shifted in three important markets: UK gilts, US Treasuries and Italian BTPs. In the UK, for instance, the annual yield to maturity grew from just under 1% at the beginning of the year to just under 2% in late May.
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This rise is primarily caused by inflation which, along with higher interest rates, causes yields to rise. And since prices are inversely proportional to yields, this causes the value of government bond holdings to depreciate. The price of an Italian ten-year zero coupon bond, for example, has depreciated by around 13% between the end of last year and the end of April 2022 as a result of rising interest rates.
Ultimately, the upward shifts seen in interest rates can be tied to the general economic transition we are seeing. After 10 years of low inflation allowing for low interest rates and accommodative monetary policy, we have seen prices shoot up, and both politicians and central bankers are being forced to change course.
It’s within the context of these challenging conditions that balanced, diversified investment portfolios are important. There may be dips in their value but, relative to global market indices, these losses are mitigated. A diverse selection of asset classes, geographic areas, currencies and industries means that they are, relatively speaking, less susceptible to shocks.
The active management of our assets allocation team comes into play during periods like these, too. Our experts have evaluated markets daily, making tweaks to our portfolios where necessary to keep them robust in the face of global volatility. We’ll continue to monitor the situation so that we keep our client portfolios fit for purpose in the future.
Taking volatility in its full context
We know that, in times of uncertainty like the one we’re experiencing now, investing can be a stressful endeavour. The crisis in Ukraine has come after two years of abnormally high volatility thanks to the Covid-19 pandemic. It’s been a turbulent time and we are fully aware of how concerning that can be for investors.
Past performance is no guarantee of future returns, but it can help to see the current dip in the context of a volatile couple of years. Covid-19 was disruptive on a scale most of us haven’t experienced in our lifetimes and financial markets were not protected from that. Those who stayed the course largely saw their losses returned within a fairly short timescale; those that disinvested, in many cases, cemented their losses.
Staying focused on your long-term investment objectives and thinking in terms of years rather than months can help put the current volatility into perspective. Also, chatting with your investment consultant and analysing your current position can help, particularly during turbulent periods for markets. Disinvesting during times of unrest has been shown to be a poor decision, serving to crystallise any losses made and risking missing out on the potential recovery.