Guess who’s back, back again, volatility is back!
The half time show at this year’s Super Bowl would have brought back memories for anyone trying to improve their dance game in the 1990s. I have certainly enjoyed streaming Dr. Dre’s hits since the show, re-living my university and early career days in London.
Not so enjoyable is the direction financial markets have taken in the last few months. The market has been driven downwards, feasting on fears about inflation and how high and fast interest rates need to rise, war in Ukraine, high valuations, US politics in a stalemate and many other potential culprits.
Cryptocurrencies have not been spared either, which has gone some way to nullify the debate over whether they can be a safe haven in troubled times. It turns out they are just as speculative as the next asset with a fancy story but short on fundamentals. I am not anti-crypto; I own Bitcoin and Ethereum and have invested in two blockchain companies. I am just re-affirming what the market is telling us.
Invest for the long run
So where should investors go from here?
To my mind, one of the most important factors to consider is the outlook for inflation and interest rates. Inflation is bad for financial markets. Central banks have to raise interest rates to try and bring it under control. Rising interest rates has a strong gravity pull on valuations; as rates rise valuations fall. It’s a sad law of market math. Also rising rates tend to remove liquidity from markets, another prop for valuations which is falling away. What does this mean? Assets are going to be worth less. Even good companies will struggle to see their price rise when valuations and liquidity have to compress.
Then there is increased risk premium to holding assets like equities, high yield bonds and cryptocurrencies when you have a geopolitical event like Russia invading Ukraine. This means the market wants a higher level of results to hold the asset, adding more selling pressure when those expectations fall short.
So we currently have two strong forces pulling markets down – the path of rising interest rates and increased risk premia due to geopolitics.
On the plus side, history tells us that the selling always ends. And as markets become ever more efficient, the speed of any re-set now happens in months, not years. Many assets are down over 75 percent since November 2021, a huge correction by any historical standard. So it is conceivable that we are now closer to the end of the correction than the start. Several companies like Alphabet (parent of Google) and Apple have seen their price drop and valuations reach very attractive levels, even as they report record revenue and profits.
Secondly, there are anecdotal signs that economic growth and consequently inflation pressure is easing. If indeed this does start to show through in numbers in the coming months, that will ease pressure on the US Fed to aggressively raise interest rates. This may well help calm down some of the current anxiety in markets. A slower increase in and a lower overall rate of interest rates will help stabilize valuations.
Thirdly, at times like this, it is important to separate trading from investing. Traders can make good profits but it’s extremely difficult, even the best have an high error rate most of the time (the key is in closing your losses early). The more tried and tested path is to invest for the long run, identifying companies or other assets that can grow over time. And as they grow, so should their valuation, leading to rising asset values. If you give your investments enough time, even most amateurs (meant in the best sense of the word) will register winners that deliver outsized returns. So I would encourage readers to invest and not try and trade in times like this.
Timing a market bottom is not possible. But identifying good investments that will grow over time is certainly possible now. And if you don’t have the time or belief to do this yourself, then find a good financial advisor who can help you do this. Patience and discipline are key ingredients to a successful outcome.
Wish everyone good investing.
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