What is going on with markets in 2022? After such a good year in 2021, we look at what has caused some rocky returns in January.
2021 was a good year for investing in the stock market, with global equities gaining over 20% (1) as company profits staged a strong recovery from the pandemic lows. However, the New Year has brought renewed volatility as markets weigh up the potential impact of higher inflation and interest rates which they might not have expected.
You may have noticed your own portfolio might have given up some of the last years’ gains. Markets, by their very nature, go up and down but when these moves are sharper and more frequent than normal it means volatility has increased.
Markets dislike uncertainty and opinions are currently divided on whether, and by how much, inflation will continue to rise around the world. Consumer Price Inflation (CPI) rose 5.4% in the 12 months to December (2) in the UK whilst in the US it increased 7% (3) with energy and wage cost pressures looking set to persist. Another issue has been supply-chain bottlenecks, which have pushed up import prices — but there are signs that these backlogs may now be easing.
When reality differs from expectations, the result is often greater volatility.
Central Banks, such as the Bank of England, will be monitoring trends to decide how far interest rates need to rise. They have to tread a careful path between not doing enough to tackle the threat of persistent inflation and taking too aggressive an approach which could damage business and consumer confidence.
Consumer spending is an important part of overall economic growth and if our living costs are going up sharply, we may be tempted to cut back on non-essential items. There is also some uncertainty about whether the Omicron variant will delay the recovery so company results and outlook statements will be closely watched.
Volatility over a short time periods (as we have witnessed in January) has been experienced many times before in financial markets, so it is a good time to remind yourself that investing is for the long term.
For sure, higher inflation reduces the real return (meaning your money will buy you less) on fixed income products such as bonds and cash deposits. Equities (or shares), however, are considered to potentially offer more protection against inflation as companies may be able to pass on price rises to customers and possibly increase dividends.
Whilst higher interest rates do push up borrowing costs, they are likely to remain low by historic standards. Furthermore, many consumers who built up savings during lockdown are sitting on more cash than usual. With vaccinations enabling the world to live with Covid, there should be plenty of pent-up demand to support the economic recovery as things return to normal.
That said, always consider how much risk you are willing to take. Equities are at the higher end of the risk spectrum (so they tend to be more volatile than bonds). To lower your portfolio volatility away from equities, you could keep some bonds and cash which are at the lower end of the risk spectrum from equities. Another way that you can try and reduce volatility can be to diversify across different geographical regions as not all areas will perform well at the same time.
In fact, with volatility can come opportunity. Either by putting any spare cash to work when the market dips or setting up a regular savings plan to help average out the price you pay (known as pound-cost averaging) volatility could even work in your favour.
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