2022 has gotten off to a bumpy start for investors after a smooth ride upwards since the end of the “COVID Crash” of February-March 2020. Between that time and the start of 2022, equity markets in particular have soared. But these days, markets have been experiencing some critical “tectonic shifts”:
- The end of accommodative monetary policy: To help stimulate economic growth, central banks have kept interest rates low. Expectations of an end to this “accommodative” monetary policy as economies recovered from the downturn grew in the latter half of 2021. And they continued growing at the beginning of 2022 thanks to rising prices. Central banks raised their benchmark interest rates in the first quarter of 2022, and have warned of several more hikes to come, in order to fight increasing inflation.
Impact: Higher rates ripple through money and bond markets, raising the cost of borrowing (e.g., the cost of financing the purchase of a home or expanding a business), as well as negatively impacting equities and bonds by discounting the current value of the expected future cash flows generated from earnings, dividends and interest payments.
- Inflation: Until recently, inflation has been well behaved, hovering around most developed-world central banks’ targets. But now it’s climbing dramatically as global economies rapidly recover from the pandemic. This higher economic growth is spurring greater demand, which increases prices. Disruptions to energy supplies and ongoing supply chain issues are also adding to inflationary pressures.
Impact: Inflation drives up the cost of living, often resulting in reduced spending by consumers and businesses. It also elicits higher interest rates from central banks (see #1 above), which can affect the real (after inflation) returns of investors and savers.
- Fixed income: The bond market has been battered as a result of expectations of and the actual increasing of interest rates, as well as inflation. This has driven yields higher than they have been since before the COVID Crash of 2020.
Impact: Sharply rising yields have resulted in the first negative returns for bond investors in quite some time, as bond yields (which rise and fall inversely to bond prices) have been on a downward trend for almost 40 years. Higher rates reduce the attractiveness of outstanding bonds, while inflation reduces the actual net (i.e., after-inflation) returns for investors.
After markets have delivered outstanding returns over the last two years, it’s not surprising that the latest volatility might be jarring. But it’s important to keep in mind that many of the headwinds facing markets today are likely to normalize over the next 12 months, and do not in and of themselves represent a reason to change your investment plan.
In fact, trying to time the market – attempting to anticipate downturns and then selling and moving to the sidelines to wait for the right time to jump back in – is a losing game. As the following chart shows, guessing wrong and missing the best days in the market can hurt your long-term returns:
Source: RBC GAM, Morningstar. Returns for the S&P 500 TR Index USD as January 31, 2022. An investment cannot be made directly into an index. The above does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results.
Remaining on course to your investment plan takes discipline at times like these. But if history has taught us anything, it is that these moments pass, and in retrospect, are often seen as an opportunity rather than risk for investors. If you have any questions or concerns about today’s markets, please contact us.
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