MARKET UPDATE - FEB 2022

To appreciate the strength of economic recovery from the sharp 2020 COVID-19 recession, we need to look no further than the labour markets.

Unemployment rates around the world have fallen toward pre-pandemic lows. In most developed markets, pretty much anyone who wants a job can find one.

Fewer workers are participating in the labour force than before the pandemic, and the higher wages they can secure as employers compete for them threaten to take already accelerating inflation to a new level. Although it takes time for wages to climb in tandem with broader prices, when they do, they're fully along for the ride and ready to jump into the driver's seat.

We have seen a number of articles in the AFR in recent weeks echoing this sentiment.

AFR ARTICLE #1

AFR Article #2

Central banks have underestimated this strength in labour markets and the growing wage pressures. With many experts holding the view that, markets are underestimating the degree to which central banks will need to use their powerful tools to pull inflation back to acceptable levels.

Higher rates are in the U.S. economy's best interest. Experts believe that the Federal Reserve may need to raise its target for short-term interest rates to 3% from its current range of 0%–0.25%. That would require steady rate hikes over the next few years, to a degree that markets haven't priced in beyond 2022.

Bond investors should welcome the prospect of higher interest rates. Although rising rates may produce modest negative returns for a time, they're a long-term positive. Many experts believe that there is a silver lining in rising rates—how investors with a longer horizon than their portfolio's duration stand to benefit. Raising short-term rates should also forestall a rise in long-term bond yields because expectations of future inflation should not rise further.

Equity investors may feel less hopeful, and that's understandable. In recent years they've come to enjoy some heady returns, fuelled by negative after-inflation interest rates. The removal of such stimulus as central banks address inflation suggests turbulence ahead.

But negative real interest rates and the higher equity valuations they've promoted have come at a cost of future returns. That's why many experts have a guarded long-term outlook for equities.

Accelerating inflation is a threat to economies that otherwise remain fundamentally sound.

Raising interest rates to subdue it should extend the growth cycle, not shorten it.

In our pervious article we reviewed 2021 and had an overview of 2022.

A month into 2022, we jump in and outline the several issues of concern:

Inflation at 30 year highs, Bond Yields surge, US rate hikes confirmed – is it 4, 5 or 6 to come in 2022.
Across global economies we are seeing too much “debt” & too much “leverage” (again)
How will higher interest rates affect housing demand & business - many experts are concerned.
After 10-11 years, the FED are finally reducing its balance sheet. Many experts are predicting liquidity will soon dry up which may result in volatile markets (potential stock market crash)
Tech stocks have been hammered with many down 50% in the past few months with many experts thinking much more is still to come.
Housing market has “peaked” with many predicting crash or correction coming - but the majority of experts believe a slow to the ‘runaway’ property market is more realistic.
Many see that equity valuations are too high
New COVID variants could emerge & kill growth, will many questioning will vaccines work in the long term?
Supply chain issues & wages growth to cause even more inflationary pressures.
China will continue to slow, with building sector remaining sluggish (due to contagion debt event) – which will cause Iron Ore to drop back, hurt Australia’s terms of trade & the Government’s coffers (that it desperately needs right now).
Many experts believe ALP will win the upcoming election, however many have concerns that ALP will then unveil taxes on business, which will slow growth & hurt corporate profits - to pay for ALP new initiatives.
However, if the Coalition wins the election, will they also raise taxes to try & pay off the $1b of debt that was amassed due to COVID relief?
War still remains a big concern with Russia to invade Ukraine
War with China to invade Taiwan? We know that Xi Jinping wants his “legacy” to be that he “reunited Taiwan with China” – he’s already got “Hong Kong” back.

The Markets right now have so much being thrown at them that it’s easy to be very worried.

Some investors may sell their investments & “play it safe”, waiting until the market has “bottomed” out, and then buy back in.

As my 12 year old nephew explained to me “Uncle Matt - why don’t you just sell high and buy back when it is lower.”

It sounds easy.

However, timing the market is anything but… and knowing when to sell and when to buy back, in our experience more often then not many miss the low & then miss buying back in as they wait for the low again.

Many experts whom were “Bears” and got it right in March 2020 - after markets collapsed -38%, did not buy back in, as they were convinced that the markets were going to fall as much as they did in 2008.

They then held their nerve & did not buy as they waited to be proven correct - but they never got another chance to buy at a lower price as the markets recovered and went on another run.

The graph above illustrates the cost of mistiming the market.

If you were to miss the 20 best days over between October 2003 to December 2017, you would have missed out on 57% worth of returns.

That is enormous to think over a 14 year period if you were only to miss the 20 best days in the market your returns would be 57% worse off.

For $10,000 invested that equates to a $19,600 difference

For $100,000 invested that equates to a $196,000 difference.

For $1,000,000 invested that equates to a $1,960,000 difference.

They are some big numbers for missing a few days over a 14 year period.

Staying invested has been the best proven strategy for generations.

However, in volatile times like now holding extra cash is a prudent way to be ready when an opportunity presents itself.

There are a plethora of reasons as to why you should not have invested in the market over the past 100 years.

In addition, if you continue to believe all the bad news each and every year, then you would never have had the confidence or conviction to invest into the market. Over the past 30 years, you would have missed out on a 1700% return on your capital.

Given the world is in a dire place right now & it feels like it will never get out of this mess – it’s worth doing a quick reminder of the past.

In this age of “instant” information, where events are reacted to instantly, and when you are seeing nothing but news everywhere - it’s worth taking a step back & looking at it from an long time horizon.

The graph above illustrates the returns over the past 30 years. We can see corrections in the market, which at the time felt like the entire world was ending, however time and time again, the market finds a way to stop falling, it needs “time” to then stabilize but once we have done that there will be a recovery.
Therefore, we are in a time when many experts are predicting a "crash" - only time will see if they "finally" correct, after many many years of calling it - can finally get this one right? (a broken clock is right twice a day)

However, for many - they see it as a "correction" in a bull market.

Update on Markets

MARKET UPDATE - FEB 2022