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Back and forth – what’s behind the market volatility?

In the past few weeks market volatility has shown no signs of settling down, with large swings in asset prices. But it’s not just the war between Russia and Ukraine creating global instability. Julian Broom, our Chief Investment Officer, reviews what’s been happening across world markets.

With the war between Russia and Ukraine sadly showing no clear signs of ending, it’s natural to assume that the recent volatility in world markets can be easily explained. As things stand tensions remain high, with the possibility that the conflict could even spill over into other parts of Europe.

Markets initially reflected the geo-political situation, with a flurry of activity, and then a more settled period took hold as diplomatic negotiations began, with only tentative signs of resolution. Some shifts continue to play out, with swings in US indices of 0 to 1.5 per cent coming as reports of either a long-term conflict or a peaceful outcome are assessed by market participants.  It’s clear that either scenario will have a meaningful impact on markets – be that a continuing rise in commodity process and/or a period of stagflation – where we see high inflation levels coupled with slow economic growth.

Is market volatility just because of war?

Despite this deeply worrying time for Europe, and the world, there are other factors in play influencing markets, largely unrelated to the war.

The first of these is the action of central banks, which have delivered extraordinary liquidity into markets in the past two years. This cushion has protected global markets from volatility whilst driving the value of assets up. As this support is withdrawn and with inflation rising, markets are now confronted with a ‘new normal’. Equities haven’t yet recovered enough to bolster markets, but there are some glimmers of hope, notably solid corporate earnings and those still willing to ‘buy the dip’. Even so, these factors don’t make up for the sizeable shift in central bank policy.

Over the next 12 months, a number of scenarios are likely to be on the cards, but the least likely appears to be a ‘soft landing’ for the economy. Much more probable is that economic growth is impacted by high inflation, and the worrying possibility of stagflation. Alternatively, a surge in productivity and the gradual recovery of the global supply chain could help to cover rising wage costs and gradually reduce some of the inflationary pressures which remain persistent. However, this is unlikely to be resolved soon and, if anything, the war between Russia and Ukraine arguably points to an era of deglobalisation.

Where does this leave investors?

Ultimately, it’s important to maintain a sensible long-term outlook and to avoid knee jerk reactions; the risk of short termism can lead to investment mistakes. We know that – analytically – remaining invested and not being out of the market (in cash) over these periods has delivered much stronger returns than trying to time buying back into the market and potentially missing some of the best trading days over a period of time.

Recent market volatility has also demonstrated some of the problems with this – we need only look as far as Chinese markets in recent weeks, which have experienced lows in line with those seen in 2008, followed by 15% rebounds. Against this, our portfolios are strategic in approach and not designed to try and time markets. At The Fry Group our longer-term view around more sustained inflation levels remains and we have further reduced interest rate sensitivity across our portfolios.

More recently geo-political tensions between the US and China – and the latter’s potential support of Russia – have served as a reminder of the potential for negative outcomes from the world’s two biggest trading partners, and a longer-term trend around deglobalisation.

With all this in mind, it’s likely that volatility will be at play certainly over the short to medium term, although portfolios are positioned for this outcome and we remain confident that asset allocation and individual fund selection can still generate positive returns. To discuss any aspect of your investment portfolio please contact your nearest office.