Global market conditions are an important area of discussion at Six Park’s regular Investment Advisory Committee (IAC) meetings. The conflict in Ukraine and its flow-on effects globally were, therefore, a natural focus at last week’s meeting.
At times like this, the IAC plays a vital role in assessing these developments so that Six Park can help clients navigate market volatility and the emotions that come with geopolitical conflicts.
After careful consideration, our IAC did not suggest any changes to Six Park’s investment parameters and suggests that investors avoid making emotionally led investment decisions or “timing the market”, which typically leads to sub-optimal investment outcomes.
The addition of the conflict in Ukraine to the existing concerns of rising inflation and interest rates have exacerbated market volatility. As we’ve pointed out in the past, when fear and uncertainty are the prevailing sentiments among commentators and investors alike, the best course of action for investors is typically to ride out the storm and trust the guidance of professionals who have been through such cycles (especially when the cycles are related to geopolitical conflicts).
Read on for key observations from the IAC as well as an explainer of how geopolitical conflict typically affects markets and investor behaviour.
5 key points from the IAC
- The IAC expects markets to remain volatile until the global outlook becomes more certain or clear. Since 1 February 2022, there have been 28 trading days in the US (as of 14 March). On more than half of those days (15), the S&P 500 has moved either up 1%+ (six days) or down 1%+ (nine times). This is unusually high and will continue to test investors’ resolve to be patient.
- It’s also worth emphasising that altering asset allocations is a relative assessment: if one is to reduce an allocation out of, say, shares, then where to invest that allocation is very important. On this point, the IAC believes that there are currently no compelling alternative asset classes in terms of risk/reward. Low (but likely rising) interest rates and the likelihood of elevated inflation make a re-weighting up in cash or bonds relatively unattractive at this point.
- Our view is that investment diversification (across both growth and defensive asset classes) and periodic portfolio rebalancing is typically the best form of risk management, especially during times of uncertainty. It’s important to appreciate that timing the market is phenomenally difficult, as illuminated by the following quote by one of the most successful investment managers, Peter Lynch (while at Fidelity in the US):
Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.
- Over the past two years, investors have been hit with jarring news related to the global pandemic, and now a war in Ukraine. The reality is that these types of events occur every few years, and they rattle share markets, as well as investors’ emotions. The data is conclusive that share markets provide attractive long-term risk-adjusted returns, but the “price of admission” to achieve these returns is the patience required to ride out the bumps along the way.
- To be clear, if our IAC determines that it is in the best interest of our clients to adjust our asset allocations, we will do so, as we have in the past. We are not at that point yet but will keep you apprised of our assessment as events unfold.
How does geopolitical conflict typically affect markets and investor behaviour?
Geopolitical conflict (whether that’s a war involving ground troops, or other forms of ‘combat’ such as financial/economic sanctions or cyber-attacks) can be unnerving for investors. Share markets generally drop in disruptive and uncertain environments (as evidenced by the 10-15% selldown of major global share indices since the start of 2022).
The conflict in Ukraine comes at a time when investors were already on edge due to accelerating global inflation and the prospect of higher interest rates. So, are we in fact in “uncharted territory”? Are “things different this time”, as some headlines would suggest?
Nobody knows for certain, and things could get worse, but data suggests that when an armed conflict brings about a downturn in the market, the prudent response in the past has typically been to remain invested and ride out the storm.
Of note, the prospect and onset of a geopolitical conflict frequently triggers a market correction, followed by a quick recovery. This dynamic has been closer to the norm (including during the Vietnam War, both Gulf wars, and previous Russian invasions) than the exception. This market cycle mirrors behaviour seen during and after the Global Financial Crisis, the 2018 correction and the onset of the recent pandemic.
History suggests that it is extremely hard to time the market (when to get out, and then back in). The swift fall in markets after the onset of the global pandemic, and its subsequent rapid recovery, is an example when many investors were hurt by selling after the markets had dropped, only to buy back in after they had recovered.
Of course, the past is never a perfect predictor of the future, but it does help to inform our views.
The IAC’s investment outlook
We now expect that higher inflation will last longer due largely to higher oil/energy costs and ongoing supply chain disruptions. This is likely to be accompanied by higher share market volatility. How long inflation remains at an elevated level, and the extent to which slower global growth becomes “stagflation” are important questions that currently have no clear answers.
Our investment outlook will remain driven primarily by global GDP growth, the US Federal Reserve and its policy changes regarding inflation and overall interest rates, and overall corporate profitability and stability which, for now, remain strong.
It is possible that this conflict, and its flow-on effects, may slow the increase of interest rates both in Australia and abroad, which could have a positive impact on share markets. This remains to be seen.
The IAC will continue to closely monitor geopolitical and market developments as they unfold. We will keep you up to date with the IAC’s views.