A recent scroll through my Twitter feed uncovered one of two responses to the recent market volatility. Firstly, that the world is ending, we’re all doomed and accordingly that someone’s portfolio has been smashed to smithereens. Alternatively, that this is all temporary, that anyone urging caution is an idiot, and that investors really ought to be buckling up because this will all be over in no time at all.
Personally, I’ve never had much problem sitting tight during market volatility. I’m prepared for it to happen; it’s not pleasant when it does, but I know that buying high and selling low is nothing more than a great way to lose money. Having said that, I’ve found myself struggling to feel particularly hopeful about my returns in 2022 – to be honest, I’m pretty resigned to not beating inflation this year if even if I manage to eke out a positive return, which is currently looking less and less likely at the months roll by. I’m currently say on a 7% loss year to date – not the end of the world after last year’s 23% return but all the more painful when you add in our sky-rocketing inflation rate of 9%.
Weathering market volatility is a natural part of investing. Millions of investors around the world make decisions on companies every day; some want to open new positions, expand existing ones, others are looking to close positions or sell entire portfolios. The conflict behind these different decisions is what creates volatility – sometimes more people want to buy than sell, sometimes the reverse. Accepting that, as I do, I therefore find it little more than an academic exercise to discount volatility and concentrate on building a robust portfolio full of interesting companies which I think will do well in the future.
Having said that, I can’t recall a time I’ve felt as genuinely gloomy about our economic future as this year. The spectre of inflation, which I’ve had concerns about for years, has finally reared it’s head. At first, I was called a fool for worrying about it – apparently, we’d entered some wonderful golden age where we could endlessly expand our money supply and reduce interest rates and it would never cause inflation because this time was different.
Then, as inflation began to pick up last year, I was told that it was only transitory. I was making a fuss over nothing; things would soon settle down and it was all just a delayed result to the COVID lockdowns.
Inflation continued to rise. Investors told me that this might be a bit more severe than they thought, but still, I shouldn’t worry, the Central Bank would sort it all out.
Now, inflation is at 9% – the Bank of England believes possibly even higher for the lowest income households – and there are talks of a recession as the combination of supply chain shortages, skyrocketing inflation and rising interest rates threaten our economic prosperity.
Honestly, I’m struggling to see a sensible way forward from this mess. Central Banks have collectively pumped so much cash into the global economy than high inflation seems all but certainly here to stay for the next few years. Interest rates rises will pull down house prices, dampen demand for credit and increase the likelihood of rising default rates around the world. Supply chain issues are causing shortages in most major economies. Labour shortages are curtailing economic productivity. There are talks of food shortages, fuel shortages, and rising inequality. It’s one of the most challenging outlooks I can remember.
The thing is that panicking and worrying definitely aren’t going to improve things. Selling my entire portfolio and sitting in cash guarantees losing money to inflation. How much remains to be seen. Precious metals may or not keep up with inflation but at any rate are non-productive. Ultimately, I like the idea of owning productive, high-quality companies. The problem is that quite a lot of them have taken a hammering and I honestly think markets have got more downside risk to come.
Don’t Feed the Trolls
Two weeks ago, I sent out a tweet musing about interest rate rises. Rates hit 1% and the markets tanked. What did people think if they reach 2, 3 or 4%.
An account responded telling me that ‘markets are forward looking’ and that all I was doing with my tweet was demonstrating my total lack of awareness about how markets actually work. Rate rises were already priced in and yet again, I was a total idiot for worrying about future rises. Since then markets have been pretty solidly red every day.
A friend recently asked me about what I was doing with my portfolio – am I buying, selling, holding? The answer is that I’m holding, but extremely pessimistic about my returns this year. I don’t feel like I have much clarity over future markets but the impression I have is that worse is yet to come; and things are already looking pretty ropey.
My gut reaction to the inflation problem is simply that if pumping cash into the economy got us into this mess, then taking it back out (i.e Quantitative Tightening), should reverse the problem. The only problem with that is the Quantitative Tightening is likely to put quite a lot of presume on economic growth; with less money circulating around the economy, households and businesses would have less to spend, economic actors would need to cut prices to encourage spending but the pound value of the economy would contract.
Savers would benefit – the pounds in our pocket would be worth more but those in debt would suffer – fixed credit payments would become harder and harder to pay, potentially pushing up default rates. If Quantitative Tightening was maintained for an extended period of time, spending could be significantly curtailed as consumers would come to always expect prices to be cheaper in the future.
Asset prices would deflate; pensions would shrink in value and house prices would decline. Hardly the stuff of economic dreams and as such central banks are almost certainly never going to take this approach.
But how am I really responding to this. In truth, I’m still trying to figure out my strategy as market volatility continues to spike – I like the companies I hold and I don’t feel like I want to divest of my entire portfolio. I’m prepared to take some serious economic pain to hold them; markets could carry on the way they’re going for three or four years and I’d still want to own the businesses I do. Cash is totally unattractive to me with inflation at 10%; I want enough to be able to live my life but beyond that it’s just a wasting asset.
My mindset is therefore very much on clarifying my definition of value and trying to hold onto that regardless of how volatile the markets get.
How do I measure Value?
The successful businesses I invest in generate growing revenues and free cash flow, some of which are returned to shareholders in the form of dividends. Those dividends enable me to spend time with friends and family, to pursue my charitable goals, and provide a cushion of safety should I lose employment or suffer ill-health.
In addition, I enjoy the process of investing – I am able to apply the principles of my education to analysing and understanding leading businesses. It provides me with a source of interest and learning; positive mental engagement which enriches my life.
Regardless of whether individual prices go up or down, those outcomes are valuable to me. I believe they will continue to be of value to me in the future and so I hope to persevere with my investing journey even if the economic storm we currently face continues for many years to come.
A larger source of unease for me comes not from the fears for my portfolio but for the economic damage we’re facing in sky-high inflation, broken supply chains and whatever else is to come. Economic pain is no good thing; various studies have shown it has a real-world impact in causing rising hardship, depression and in extreme cases, even mortality.
It’s not all about The Money…
My thoughts, therefore, are not so much on the individual movement of markets and companies, which I can do little about, but on the individuals around me that will struggle if economic conditions continue to deteriorate. Although I started this week’s blog with the intention of writing about markets, the more I’ve written, the more I’ve ended up thinking about the human cost of the economic challenges we face.
I was utterly infuriated by the Governor of the Bank of England, Andrew Bailey, who has now twice called for workers to hold back on asking for pay rises to try and hold back inflation. Although I understand the academic reasoning behind this, the optics of a man earning £500k a year telling the rest of us that we must ‘shoulder the burden together’ is so utterly farcical it is beyond belief.
The cost to Mr. Bailey of inflation causing his salary of £500k to be worth £450k in a year’s time is statistically equivalent to salary of £50k being reduced to £45k but the real-world impact is in no way comparable. I dread to think how much worse it would be for someone on the minimum wage of just £13k but to suggest that we can all shoulder such a burden with equal ease is so ludicrous as to be insulting.
So what was the point of writing this week’s blog? What penetrating insights have I got to share about markets and market volatility? Not so much, it might seem at first, but I will leave you with this thought. If you can, consider what you can do to help those around you weather the growing economic turbulence. I fear this will get harder before it gets better but together, we can make it through.