There’s a lot going on out there. Just as the headlines started to ease about Covid-19, we’re witness to the full-scale invasion and scenes of human devastation over in Ukraine. We’re also bombarded with news about the soaring price of energy and a cost-of-living crisis for millions of UK households. And you won’t need reminding that inflation is still on the up. With all that going on, it’s almost possible to forget that Brexit is also playing its part in stoking economic uncertainty.
You might expect all this to adversely affect markets and signal bad news for investors… but it isn’t. As tragic as the situation in the Ukraine is, and as unsettling the energy and supply chain crisis may be, this ‘perfect storm’ hasn’t seemed to have a big effect on global markets.
The state of the markets
Global equity markets generally had a good run up to the end of last year. Although we’ve recently seen some drop off, we can put that down to a price correction on overperformance of US technology stocks, not the Ukraine conflict. Right now, markets are on the rise – and looking healthier than they did five years ago.
A good way to illustrate this is by looking at the performance of the S&P 500 Index, representing the largest companies listed in the US.
Graph 1: S&P 500 performance, 1 January – 31 March 2022
Source: Morningstar data on BBC News
Looking at the last three months, we can see a dip around the end of February, when Russia began its invasion of Ukraine. Although we then see some volatility over the following days, performance has largely been on an upward trajectory since the middle of March.
Now if we pan out to look at the last five years, you can see how high that dip is relative to recent performance. Even at its lowest point, 2022’s figures are higher than a year ago, and significantly more than the four years before that.
Graph 2: S&P 500 performance, 2017 – 2022
Source: Morningstar data on BBC News
For another sense of perspective, note that the lowest point in that five-year period – the Covid-related drop-off in early 2020 – recovered in three months before continuing upwards.
What does this tell us?
Markets go down and markets go up. It’s what they do. But given time, stock markets always recover from the lows. And while there’s no denying the human tragedy of the latest conflict in Ukraine, it hasn’t seemed to have negatively affected equity investors.
A recent US academic study has even found that, rather than being more volatile, the US stock market is actually more stable during times of war. The National Bureau of Economic Research found this to be true of World Wars I and II and the conflicts in Iraq and Afghanistan, identifying a 33% drop in volatility compared to peacetime. Why? There’s never certainty with markets, but the best guess is to do with defence spending boosting company earnings and making it easier to forecast profits. So during wartime, while commodities plummet and inflation soars, equities tend to do more than ok.
Both this research and the S&P 500 data focus on the robustness of US equities during challenging times, so what’s the story for other regions and asset classes?
The bigger picture
We’ve talked in previous WRAPS newsletters about the effect of higher inflation on investments. Cash is obviously the first to suffer, and while lower risk, fixed interest assets like bonds tend to underperform, they will still outperform inflation over time, so earn a rightful place in a well-diversified portfolio.
If we take a look at the returns for different asset classes over the last 20 years, it may come as no surprise that S&P 500 equities take the top spot at 7.5%. Bonds also comfortably beat inflation, reaching 4.8% versus the average CPI of 2.1%.
Graph 3: 20-year annualised returns by asset class, 2001 – 2020
What’s also interesting here is the returns for the average investor – at 2.9%, this barely beats inflation. What’s the equivalent for the average WRAPS investor? We’re pleased to say that it’s more than double – at 6.4%.
So why is the average investor averaging less than half the returns of WRAPS? Quite simply, it’s down to bad investor behaviour.
This video on behavioural biases explores some of this detrimental investor behaviour:
Why you’re better off than the average investor
The key to being a good investor is to think long-term and to not keep adjusting your portfolio, or even checking it! Its value will go up and down – as will inflation – so you should expect this and give it time to perform.
The absolute worst thing you can do when markets are down and your portfolio is lagging is react impulsively. And yet many people who don’t choose to work with a Financial Planner do just this – they lack the confidence and discipline to hold their nerve, instead panicking in response to the headlines. While it’s natural to feel nervous when your money isn’t thriving, if you pull out and sell when markets are low, you’ll miss out on the eventual upside. Likewise, if you buy high, you’ll find it harder to realise returns on your capital when markets start to settle down.
When we say you should have a long-term mindset when investing, the absolute minimum is five years, but the sensible window is 10, or ideally a full economic cycle of 15 years. That said, it’s entirely possible that you could have 50 years of investing ahead of you when you start out. And when you think about cascading your wealth down to the next generations, we could even be talking about triple figures!
Of course, there’s nothing wrong with feeling nervous when times are challenging, and at Wealth Matters, we’re always here to reassure you if you need us. At any time, you can have peace of mind that our WRAPS portfolios are robust and have a proven track record of comfortably outperforming inflation to help you meet your financial goals. As well as fine-tuning your portfolio to keep it in optimal condition, we’ll add extra value through tax planning and estate planning, so you can make the most of what you have, for you and the generations that follow.