In the first half of 2022, Russia’s invasion of Ukraine pushed already rising inflation to unprecedented levels, sending financial markets into freefall in the process. Colin Vella, Head of Wealth Management at Jesmond Mizzi Financial Advisors, discusses the year to date, the outlook for the future and how investors can make the most of the current volatility.
It has been a tough year for the financial markets so far. How do you assess the current situation?
Runaway inflation and the resulting cost-of-living crisis are at the heart of the problem. Markets were also hit by the uncertainty caused by the Ukraine war.
The markets were in a long period of growth and trading at high levels that might have needed a correction, but they would have been relatively stable without the war.
If you track inflation using the prices of staples like coffee, wheat, oats and similar items, you can see that it has been rising since early 2020, but has spiked since the war began.
The obvious consequence is that people are less able to afford everyday necessities, but it is also affecting monetary policy, as we see with central bank rate hikes.
Another consideration is the fact that people’s desire to get back to normal after all the COVID-19 restrictions in the first half of the year led to artificially high spending and further pushed up inflation, with demand holding up despite the relatively low supply was kept high.
If inflation has been rising for so long, why have markets collapsed now?
The pandemic created less uncertainty than the war. Markets continued to perform well into late 2021 despite rising inflation. They did not reflect the situation on the ground, mainly because the upward pressure on prices was seen as a temporary phenomenon linked to a pandemic disruption that would eventually be resolved.
Unlike war, which could somehow unfold, the global effort to control COVID-19 offered markets an assurance that the return to normal would be sooner rather than later.
Colin Vella
In fact, markets fell in early 2020 as the virus spread around the world, but the drop was short-lived and markets had recovered before lockdowns began.
A large-scale war in Europe is different. Instead of the rapid decline and V-shaped recovery, we have seen the markets slump over a six-month period.
Markets are not reacting well to prolonged uncertainty, and when you add the prospect of unprecedented rate hikes and persistently high inflation, it’s not surprising that markets have reacted this way.
Declines were registered across all asset classes, including those normally considered safe. Why?
Some asset classes are inherently more sensitive to inflation and interest rate levels, so naturally they have been hit harder. For example, longer-dated government bonds with lower yields are more susceptible to a small change in interest rates than higher-yielding assets due to duration risk.
You have the same situation with investment grade bonds, where inflation eats away at all yield and forces a market adjustment.
On the stock side, we’ve seen more modest declines, although typically considered riskier assets.
Growth-based stocks, particularly in the technology and consumer discretionary sectors, took quite a hit as their products tend to be less sought-after during economic downturns and are more vulnerable to rising interest rates and high inflation.
How likely is it that markets will continue to fall in the second half of the year and what avenues do you see for recovery?
Three scenarios could lead to a relatively quick recovery. The first is obviously an end to the war, which would lead to a significant reduction in inflationary pressures and, in all likelihood, a strong recovery.
In the absence of a resolution, things could turn up if inflation is brought under control, either through monetary and possibly fiscal policy changes or by addressing energy shortages and supply chain challenges.
Another possibility is that we are entering a global recession, which could result in markets beginning to recover as they begin to predict a change in monetary policy aimed at accelerating rather than slowing the economy.
We saw some of this in government bonds in June, both in the US and in the EU. After falling through late May, June saw a slight improvement as markets started to discount the fact that US interest rates have already risen 1.75% from an expected maximum of 3.5% are.
Even if the pain is yet to come, it can now be more easily quantified, reducing uncertainty. We could continue to see further declines, but they’re unlikely to be of the magnitude we’ve seen so far this year.
Which assets can we expect to see an initial recovery?
Stocks that have been hit the hardest because they are the most sensitive to inflation are therefore likely to recover the fastest. However, this will not necessarily be the case for growth companies when we enter a recession, as there will be far fewer opportunities for growth in such an economic environment.
We will also see that bonds will recover to some degree, especially when yields stabilize and prices start to become more attractive.
How should investors change their strategy?
A mix of assets remains paramount, but I would also say that the current downturn has created several opportunities for investors to take advantage of.
First, there are many investors whose portfolio does not match their investment objective and for whom a different risk profile and overall strategy would be better suited. It’s always a good time to rebalance your portfolio, but even more so now that there have been so many shifts in the market.
Investors who, on the other hand, have a solid investment strategy would also do well to reassess their portfolios, as while we have seen virtually all asset classes fall, they have not all fallen to the same extent.
Rest assured that the coming months will see opportunities to buy several quality assets with good prospects that some investors, particularly the more conservative ones, would not have considered worth the risk, but which will now be priced much more attractively – yield potential.
The next six months will be uncertain, but there could be a lot of potential in the medium to long term, so now is the time to act.
This interview is not intended to provide investment advice and its content should not be construed as such. The firm is authorized by the MFSA to provide investment services under the Investment Services Act and is a member of the Malta Stock Exchange and a member of the Atlas Group. For further information please contact Jesmond Mizzi Financial Advisors Limited, 67, Level 3, South Street, Valletta on Tel: 2122 4410 or email [email protected]
Independent journalism costs money. Support Times of Malta for the Price for a coffee.
support us
Comments are closed.