On June 16, markets tumbled. The S&P 500 closed more than 3 per cent down, part of a global retreat that saw stocks around the world decline. This was in response to spiking inflation and the reaction of central banks – to hike interest rates - which in turn sparked fears of a recession.
Despite the UAE’s inflation in Q1-2022 being relatively low at 3.35 per cent, the Central Bank raised its base rate by three-quarters of a percentage point in step with the US Federal Reserve. Dubai's main share index (DFMGI) retreated 1.7 per cent; in Abu Dhabi, the index dropped 0.8 per cent. Saudi Arabia's benchmark index (TASI) also fell 1.3 per cent.
Globally, markets have seen remarkable volatility in the past year. In the first half of this year, the S&P 500 fell 20.6 per cent - the largest first-half fall since 1970. Most recently, the IMF raised its projection for global inflation with a forecast of 8.3 per cent for this year.
As central banks seek to curb inflation, increase interest rates and reduce monetary stimulus, equity and bond performance have been impacted and many investors may have seen the value of their portfolios fall.
Navigating volatile markets
Investing in assets, industries and geographies that have negative correlations (i.e. they react differently to the same event) helps to reduce risk and smooth returns. Different asset classes perform better in different market conditions. According to Historical Returns by Asset Class (1985 – Oct. 2020), over the past 20 years, no one asset class has been top-performing every year.
Annual best-performing asset classes have ranged from US large cap equities, US small cap equities, emerging market equities, gold, Real Estate Investment Trusts (REITs) and international bonds.
Exciting diversification options also exist outside traditional financial instruments, from structured products that provide unique risk/reward profiles to alternative investments in private equity, infrastructure and even assets such as fine art.
Diversification across sectors is important. Big Tech stocks benefited from the change in consumer behaviour as people stayed at home during the pandemic and turned to technology for interactions, retail and entertainment. As the pandemic receded, technology has seen reduced demand and this has depressed share prices.
The hospitality industry had a difficult pandemic, but recovered as the pandemic has eased. Those solely invested in hospitality in 2020 or technology in 2022 would have suffered greater losses than those with a well-balanced, diversified portfolio.
Geographical diversification is particularly important as investors tend to have ‘home bias’–they are more likely to invest disproportionately into their own country. However, evidence shows that global diversification is important to deliver long-term, risk-adjusted returns.
Though it is important to diversify, there are secular trends which are likely to persist regardless of market cycles. One example is climate change. Government policies and consumer action to tackle climate change are driving the introduction of new green technologies and an increased focus on ESG investment criteria.
Other mega trends include automation/robotics, changing demographics, urbanisation and shifts in global economic power – all of which may provide attractive investment opportunities.
A disciplined approach
Stock market volatility can be worrying for investors who witness their paper wealth fall. However, it is essential to maintain investment discipline and a long-term perspective.
Recent Bank of America research showed that from 1930 to 2020, if investors missed the 10 best stock market days of each decade, they would have received a total return of 28 per cent. By contrast, those who remained invested throughout would have achieved a total return of 17,715 per cent.
Most people’s wealth and investment goals are long-term, and it is important to match this with a long-term investment approach and discipline.
Investors should seek to optimise portfolio costs. It is important to structure investments in a way that is tax efficient. It is also worthwhile optimising custodian, investment management and operating costs. Here an expert wealth manager can source preferential deals and benefit from economies of scale in negotiating fees and access assets normally only available to institutions.
Wealth management specialists can use the latest technology to manage costs and improve investment decisions.
Although market volatility may seem pervading, it is important to remember that markets recover. In the 12 times that the S&P 500 has fallen from all-time peaks, it has taken less than a year to recover to original peaks on eight occasions.
The key is to remain diversified, remain disciplined and stay the course. As Warren Buffett, the world’s most famous investor said, “The most important quality for an investor is temperament.”