The past week has seen significant falls for both equity and bond markets as the US Federal Reserve turned up the heat on the market by embarking on the fastest hikes in interest rates that the world has seen since the 1990s.
It raised US interest rates by 0.75% to 1.75% and here in the UK the Bank of England also raised interest rates 0.25% to 1.25%. Across the world other central banks from the Eurozone to India to Australia and to Switzerland followed suit
Following some weeks in which it begun to look like the central banks’ early efforts were successfully containing the inflationary surge there was a flurry of data which showed they have much more to do if they are going to push the rising cost of living down to more manageable levels.
For the past 40 years a principle has held for investors that central bankers believe that containing inflation is their most crucial task. Without ‘price stability’ they have believed there was no way to achieve sustainable economic growth. However, the consequence of this is that when inflation begins to run out of control central banks must act to push down inflation even if the steps they take risk creating a recession.
As the Federal Reserve announced its decision the chairman Jerome Powell was at pains to suggest he does not yet believe a recession is coming. However, the market disagrees and since his announcement on Wednesday evening sharp falls have been seen as investors computed that higher interest rates would mean lower company earnings.
We have always argued that these falls in shares have two key phases. Firstly, they must fall as they come to terms with rising interest rates. Secondly, they must fall as they tackle the consequences of that for company earnings. In the past week shares have been trying hard to price in both these things. We do not yet know whether they have fully achieved that but we do know that a serious attempt has been made and can therefore hope that a good portion of the fall in equity markets that is necessary to cope with these changing economic times has already occurred.
Times such as this are challenging and unnerving for investors. It is of course understandable that they question whether their investment manager and financial adviser has done all they can to protect their investments. With your portfolio we have taken a number of key steps to protect portfolios.
Our most recent round of changes occurred before this last week’s losses and they included buying longer-term bonds which can protect portfolios in a recession aswell as selling smaller companies which can be disproportionately hit in this environment.
However, there is no magic bullet in these situations. Ultimately we know that staying invested - time ‘in the market’ not ‘timing of the market’ - is what rewards us in the long-term. This involves sticking out the tough times. We can mitigate the impact of falls but not eliminate them. However, the ability to remain invested and allow our fund managers to buy the stocks that emerge as bargains in these situations is exactly how we position portfolios to outperform over the next decade.
Our mettle is tested in these moments but let us not forget that over the past 20 years shares have risen by more than 450%. Over that period the world has seen wars, pandemics, global financial crises, technology crashes and radical re-adjustments to the shape of global political power. All of these events have provided good reasons for investors to run for the hills. But ultimately it would have been a mistake if they had. This crisis is real and will take time to resolve, but like the heatwave that has accompanied it, it will eventually drift away.
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