3 March 2022
Investors that have closely monitored their portfolios over the last few months have seen them yo-yo dramatically and more so since Russia’s invasion of Ukraine at the end of February. Inflation and interest rates are the leading cause of this volatility.
This can be unnerving and lead to emotional decision-making that can negatively affect people’s total wealth. Here’s why you need to stick with the plan, writes Jenaia Clarke from Cambridge Partners.
Volatility is one of the fundamental concepts of investing, and often, even the savviest investors get spooked. In the United States one way of keeping track of volatility is the Chicago Board Options Exchange (CBOE) Volatility Index, also known as ‘the VIX’. This index looks at how likely there is to be volatility in the next 30-days by analysing the prices of option contracts in the S&P500 index (what buyers have agreed in advance to pay) and the strike prices (what these buyers would sell at). It’s most commonly referred to as ‘the Fear Index’ with ranges of 13 to 19 generally indicating a normal market, and above 20 predicting higher levels of future volatility (or fear). Today the VIX is hovering around 30.
But fear can also bring opportunity, as lower share prices mean assets are relatively cheaper to buy than they have been. You may have heard the investing term ‘buy the dip’. This is similar to buying something you love on sale, and when relating this to investing, you’re buying shares in an asset that you believe will grow in price. However, buying the dip has its risks as there’s no guarantee that an asset will rebound.
What is causing the latest volatility?
Many factors cause volatility, uncertainty, a pandemic, and political moves are all common themes that can have an effect on markets. Social media can be another factor, a simple tweet from Elon Musk can surge volatility through crypto markets, and we’ve seen the impact Donald Trump had when he was US President. Current markets are influenced by inflation, rising interest rates, and uncertainty over Russia’s invasion of Ukraine.
Inflation is at the highest levels in New Zealand for 31 years, just below 6%. Inflation is even higher in the US, at over 7%, the highest in 40 years. Central banks are using tools in their arsenal to cool rising prices, and the Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate (OCR) in February to 1%, its third rate hike in four months. The RBNZ is required to keep inflation between one and three percent.
A rise in the OCR means higher interest rates, making borrowing money more expensive. This will have an effect on home and business loans with a general aim to encourage people to save more and spend less. BNZ economist Tony Alexander1 said a higher OCR would mean a higher home loan interest rate, and these, as a rule, would mean more restraint on spending in the housing market. According to Alexander, house prices have fallen 2.5 per cent in the past two months and he expects higher interest rates to continue to have a damping effect on house prices over the next couple of years.
Uncertainty in Russia
Russia’s invasion on the Ukraine impacted markets initially with a fall in the S&P/NZX50 of 3.3 per cent on Thursday. Historically, markets fall in response to threats of war but tend to rebound as they did on Friday, and the S&P/NZX50 ended the week up 1.6 per cent.
Countries around the world are imposing economic sanctions on Russia to punish them for their aggression on Ukraine, and this will likely have immediate and long-term effects on their economy. New Zealand exports in 2020 were approximately US$250 million of, primarily, dairy products, and we have little trade between Ukraine. Therefore the direct effects due to loss of trade on our economy should be limited.
European and US markets may be impacted due to commodities such as oil, aluminium, nickel and natural gas, largely coming out of Russia and grain from Ukraine. Oil prices have already surged, with Brent Crude at over US$100 per barrel and energy prices across Europe growing. These price rises in commodities may end up cooling consumer spending and reducing the need for central banks to raise interest rates.
The humanitarian cost will be high and unnecessary, and we will see continued sanctions imposed on Russia and unanimous global support for Ukraine. As far as markets go, most companies in New Zealand and Australia will have limited direct impact from Russia’s actions, but volatility will continue as inflation and interest rates are the key drivers.
What should you do?
At Cambridge Partners, your Financial Adviser has designed your investment portfolio with a range of diversified assets based on your goals, investment horizon, and risk profile. It is natural to feel anxious when you see your portfolio value drop, but financial plans and investment strategies are designed to achieve your long-term goals, so stick with the plan as volatility is generally short-term.
Investing long-term may provide benefits financially, as you have more time in the market as opposed to timing the market. Withdrawals at this stage in the investment cycle will lock in losses and eliminate the ability to capture any market rebounds.
Having a Financial Adviser provides you with an experienced, impartial, investing mentor that will allow you to sleep easy at night. So, take a breath, keep calm and stick to the plan.
Information as at 3 March 2022. This article is general information and does not consider your financial situation or goals and does not constitute personalised advice. Please contact your financial adviser for advice specific to your situation. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included as part of this article.