12/3/2022
The first 2 months of 2022 have not been kind to investors. The MSCI World index, ex Australia is down about 11% and the ASX 300 is down about 4%. News of high inflation rates in the US; and the Federal Reserve scaling back their quantitative easing (QE) program has negatively affected stock markets around the world. Coupled with the terrible situation in Ukraine and the current investing environment doesn’t look overly positive.
Figure 1 shows price growth of the VGS.AX (proxy for the MSCI World ex Australia Index) and VAS.AX (proxy for the ASX300) from 31/12/2021 to 6/3/2022.
Inflation, interest rates and stock markets
Reserve banks use monetary policy (interest rates) to control the rate of inflation in the economy. For example, the US federal reserve has a target inflation rate of 2% per annum, as measured by the price index for personal consumption expenditures (Federal Reserve 2020). Typically, increasing interest rates will reduce inflation by decreasing the amount of money available for consumption and investing activities; whereas decreasing interest rates will have the opposite effect.
It is known that the US Federal reserve will be reducing its bond buying program (QE) through 2022 (Cranson, 2021) and with US inflation rates hitting 7.5% in January 2022 (Trading Economics 2022); it is widely expected that the US Federal reserve will increase interest rates at least once in 2022. This has been reflected in a reduction in stock prices in the US and around the world.
Markets are unpredictable
It’s probably a good time now remember that markets are unpredictable at the best of times. Bad news provides little guarantee of downward price movements. There is so much information that influences asset price movements, and this makes them almost impossible to predict. Currently the war in the Ukraine is dominating headlines, so it would be easy to think that the market won’t recover until the issue is resolved. However, consider what international stock markets have done while Covid-19 has been ravaging the world causing millions of deaths and shutting down entire economies; from November 2019 through to the end of 2021 the MSCI World Index has risen around 30%.
Stay the course
Despite this rough start, it’s important that long term investors do not react emotionally by exiting positions. The future is uncertain, so this period of low or, negative returns might last a few months or a few years, so for long term investors, this should be viewed as buying opportunity. While returns are poor now, history has taught us that markets are very resilient. In 5-, 10- or 20-years’ time, it is very likely that assets will be worth more than they are now. So, if you have managed your risk appropriately and are pursuing a consistent investment strategy, simply continue to do so.
It is important to remember that dollar cost averaging means an investor will automatically purchase more units when prices fall which causes the weighted average cost of capital to fall. This helps to reduce the severity losses in the portfolio.
Keep an eye on your debt levels
My view is the probability of Australian interest rates rising this year is higher than the probability of them remaining where they are or falling. This makes it important to check that you are able to service your debt in the event of one or more interest rate rises. Currently, interest rates are low, so it may be prudent to lock in a fixed interest rate at current levels.
Engineer your freedom
References
Yahoo finance, 2022, Vanguard Australian Shares Index ETF (VAS.AX) 31/12/2021 to 6/3/2022 (Daily), Yahoo finance, available from: <https://au.finance.yahoo.com/quote/VAS.AX/history?period1=1640908800&period2=1646524800&interval=1d&filter=history&frequency=1d&includeAdjustedClose=true>
Yahoo finance, 2022, Vanguard MSCI Index International Shares ETF (VGS.AX) 31/12/2021 to 6/3/2022 (Daily), Yahoo finance, available from: <https://au.finance.yahoo.com/quote/VGS.AX/history?period1=1640908800&period2=1646524800&interval=1d&filter=history&frequency=1d&includeAdjustedClose=true>
Federal Reserve 2020, Why does the Federal Reserve aim for inflation of 2 percent over the longer run?, Board of Governors of the Federal Reserve System, available from: <https://www.federalreserve.gov/faqs/economy_14400.htm>
Cranson, M, 2021, Fed to wind back QE twice as fast as last time, Australian Financial Review, available from: <https://www.afr.com/world/north-america/fed-to-wind-back-qe-twice-as-fast-as-last-time-20211214-p59hbr>
Trading Economics 2022, United States Inflation Rate, Trading Economics, available from: <https://tradingeconomics.com/united-states/inflation-cpi>