Markets perform well when the key indicators behind economic growth are strong and there is visibility ahead on how those indicators can be expected to perform. If global or local events create enough chaos, and investors can no longer look ahead and price-in market risk, that’s when things can get a bit scary.
And that’s where we have been multiple times in recent decades.
At the start of 2020 Australia’s economy had been hammered by a series of events, including horrific bushfires, the spread of the COVID-19 virus and a resumption of falling interest rates to try and stimulate a sluggish economy suffering from a lack of consumer spending.
The risk of Australia going into recession became a secondary consideration. The focus was on keeping businesses running or in a state of dormancy where they could return to operational status rapidly once the virus had been contained. A huge spike in the unemployment rate could not be prevented but if businesses could be restarted it was expected drop rapidly. As it turned out employment bounced back quicker than expected and as we entered May employment was stronger than before the pandemic and unemployment was expected to drop to 5 per cent by year end.
Yet even before the virus we had been caught up in a series of global and unpredictable events that had forced central banks to push interest rates low to stimulate activity - and for which we have adopted the term VUCA (volatility, uncertainty, complexity and ambiguity).
A turning point had been on the horizon and in December 2019 markets had been expecting rates to rise. Weeks later the US Federal Reserve cut rates by 0.5 per cent, and its interest rate target dropped to between zero to 0.25 per cent. COVID-19 was another VUCA event, and its impact was dramatic.
Australia followed America into a downward cycle, and our cash rate is now down to just 0.25 per cent and the Reserve Bank of Australia has said it expects it to stay that low until 2024.
What does this mean for my portfolio?
The message may not have sunk in fully yet but it is loud and clear. You cannot predict events like the global financial crisis, COVID-19, Brexit or trade wars. But your portfolio will have to be prepared for such events.
You also cannot predict how long such events will impact markets. Coronavirus will remain an issue for years, not months. It was the same with trade wars, something that initially seemed a matter for diplomacy to resolve in 2019 continued to escalate throughout last year with rising market impacts. It's an issue that still could erupt back into the headlines suddenly.
For now, it’s yesterday’s news as Coronavirus continues to fill the news cycle, but economically we are in recovery mode.
However, we can look back and see VOCA in play when markets had little visibility on the coming impacts from the pandemic. The shockwaves from those fears created another ‘Black Monday’ on March 9 2020 as share market indices across the world had the biggest one day fall since the onset of the global financial crisis in 2008. The Australian market shed over $100 billion in value.
Not surprisingly, the following day there was a market bounce in the US as investors scrambled to take advantage of what were perceived to be low share prices.
The investors selling into the market were panicking, which is never a good time to make investment decisions.
But were the people buying making a better decision?
The answer was maybe, but now in hindsight was can say 'yes, it was a good decision'. Things could easily have turned out differently and even still, for those investors buying it was still a wild ride filled with uncertainty as share prices moved higher but continued to suffer from VOCA.
It also takes nerve to buy when markets are plunging, as the low point cannot be known. In 2020 the ASX200 dropped by 30 per cent from its peak on February 20 to its March 20 low .
Even though it turned out to be the right strategy, we can say buyers at the time were not correctly timing the market, they were responding to one event and frankly, it’s a trade carrying substantial risk.
The lessons are:
- Don’t try and time the market.
- Volatility is the new norm.
When investors consider how they want their portfolio to perform they don’t just think about returns. A major consideration is the ability to be able to withstand unexpected impacts. We have seen ample examples of market moving events over the past decade and each has one thing in common – unpredictability.
Over the long term markets continue to rise – but it’s been a bumpy ride
Source: Citi as of March 20, 2020
What Trends have we seen?
At Citi, we have noticed an increase in clients wanting to lock in returns and reduce risk over the past couple of years.
The latter is in recognition that VUCA is the new norm for investors. Gone are calm and predictable market conditions.
VUCA is driving a renewed focus on income options like corporate bonds and structured investments, and also how foreign exchange can provide a hedge and boost to portfolios.
At Citi we saw a 208 per cent increase in bond transactions year on year in 2020, and for February we had a 121 per cent increase in tailored investments. For the latter we are seeing investors reducing their exposure to direct cash and equities and investing in instruments that allow individual shares to drop between 30-40 per cent without any impact to their capital and return.
What should you do?
- Stress test your portfolio regularly to understand how it performs during market uncertainty.
- Ensure the income from your investments is sufficient for your needs in a low interest environment over the long term.
- Diversify smartly by combining asset allocation with instruments which can earn a positive return, even if the market drops 20 per cent.
- Consider buying another currency for diversification and to offset weakness in the Australian dollar
Any advice is general advice only. It was prepared without taking into account your objectives, financial situation, or needs. You should also obtain and consider the relevant Product Disclosure Statement and terms and conditions before you make a decision about any financial product. Investors are advised to obtain independent legal, financial, and taxation advice prior to investing. Past performance is not an indicator of future performance.