War and Peace (of mind)

The Hitchhiker’s Guide to the Galaxy may just be the best investment book ever written. It’s not because of the interesting galactic tale of Zaphod Beeblebrox and Arthur Dent but because of the two large words inscribed on the cover of the guide, “Don’t Panic”. Every now and again it’s instructive to take the book off the shelf, dust it off and simply re-read the cover. With markets facing a significant amount of uncertainty at present, it may just be one of those times right now.

Markets ebb and flow but history has shown us that a long-term investment in the equity market not only pays dividends (pun intended) but helps to grow that capital investment. Achieving that growth is a function of staying the course and not trying to second guess and trade every turn of the market. It’s not always easy to maintain a strong constitution, however, and as bombs explode around Ukraine, investors are worried. Despite all of the concern, there is no-one who knows how the Russo-Ukraine war will play out and there is no-one who knows exactly how the markets will respond. Markets are sometimes cautious beasts and factor in the worst but at other times they simply march on and ignore any bad news. The Russian incursion into Ukraine, however, seems to be just a brick in the current market wall of worry.

Much of that wall is constructed on concerns around the withdrawal of extremely easy fiscal and monetary policy around the world. Leading the charge and grabbing most of the headlines is the tightening of monetary policy in the United States. In early 2020 as countries went into lockdown to buy time ahead of the impending virus storm, economic activity collapsed. Central banks responded by dramatically easing monetary policy and governments began doling out cash to try and maintain businesses and households and stimulate demand and growth. Many developed economy central banks slashed interest rates to zero and then adopted asset-buying programmes to inject more liquidity into the financial system. The easy money was a powerful drug for markets and the S&P 500 and the FTSE/JSE All Share index were among many global market indices that recorded numerous record highs in 2021.

In the real economy, the lockdowns halted many manufacturing and production processes and that created supply chain shortages that are still being worked through today. Coupled with that, energy prices began rising as demand recovered in a supply-constrained environment. Higher energy prices, supply shortages and growing demand all worked in concert to drive inflation higher, the bugbear of any central banker. With US consumer price inflation reaching multi-decade highs, the Federal Reserve slowly came round to the realisation that they would have to increase their pace of policy normalisation. Normalising policy was all about reducing asset purchases to zero and beginning the interest rate hiking cycle. Six months ago, the expectation was that the Fed would slowly wind down their asset-buying programme (“quantitative easing” or “QE”) and begin hiking rates gradually from early 2023. The rampant inflation, however, has forced the Fed’s hand to the point of fast-tracking the reduction in asset-buying and more aggressively raising interest rates. The expectation now is that QE will end in early March with the Federal Reserve raising rates by as much as 50 basis points at the March meeting. The war in Ukraine, rampant inflation and the threat of tightening policy (including a withdrawal of government handouts) all create uncertainty for the markets. With valuations stretched in many parts, markets have taken the route of least resistance and we have witnessed the S&P 500 index falling by around 11% in the first 55 days of 2022. The JSE has fared a lot better but has given up its gains to be flat for the year.

Going forward, markets will have to survive on less accommodative policy and will need to work through those valuations as corporate earnings grow albeit at a slower pace than during the economic recovery of 2021. The rising market tide of 2021 carried all ships but this year earnings, valuations and corporate quality will be paramount and investors will need to keep a steady hand on the tiller. Amidst the market storms, investors should stay the course and heed the guidance of a galaxy best-seller. Don’t panic!