We are at the point in the downturn where nothing catastrophic has happened yet but there is mounting evidence of dislocations and bubbles forming everywhere. From bond markets to currencies there are crises unfolding around the world and it won’t take much for something, somewhere to break. Right now, global financial markets have a 2007 early phase of the GFC feel, where everything is heading the wrong way, and no one can really stop it. It just needs to run the course.
I wrote earlier this year (15th June 2022) when the US share market (S&P500) was down 21% from its peak, that I expect that figure to end up being in the range of 25-40% down from its peak. In the meantime, we’ve seen markets go up and come back down. But nothing has changed, and I still believe that will be the case. The S&P500 is now down about 23% from its highs but there is a long way to go. The impact of all the negative influences have not yet come home to roost, that’s still ahead.
Interest rates across the world will go higher still. Corporate earnings are going to fall in the quarters ahead. A European economy in chaos will take its toll on the global economy. Large multinationals with earnings from Europe and China are especially susceptible. Further still, with so much uncertainty in the world, we are seeing the flight of capital to the ultimate safe haven in the US dollar and that is wreaking havoc across the world as it impacts currencies and interest rates for all nations.
Perhaps the most stunning moves this year has been the dramatic rise in global bond yields and the subsequent collapse in bond values. This has already been a once in a lifetime event, but the consequences are yet to truly filter through and be felt. With countries worldwide needing to fund budget deficits, at higher interest rates, the competition for capital is going to become a problem. It means countries with weaker economies and currencies will need to pay more. Some won’t get funding…then what happens to their budget? That has flow on effects for all markets too.
Yet we haven’t seen investors panic and markets capitulate. Until we get that I don’t think we are near the bottom. That’s the part for markets where there is no floor, no stable ground and everyone starts to panic. I expect that is ahead of us in the coming months where any of the following are possibilities:
The spiralling of the energy crisis leading to a severe recession in Europe
The fragmentation of the EU under the strain of geopolitical and economic turmoil
Russia escalating the war with Ukraine
China and Taiwan tensions leading to conflict with the US
Currency crisis unfolding – from the pound to the euro and the yen
Bond yields and interest rates soaring
Social unrest globally as countries struggle to survive
Where to invest in times like this? It’s the same answer I’ve given since the start of the year and late last year. Be overweight in cash. I know it is unpopular especially with inflation high too but as interest rates started rising in the first 6 months of the year and every other asset value fell, cash was the best way to protect your capital. I think rates keep going higher in the short-term creating a similar environment to the Jan-Jun period of this year for share markets where they fell substantially.
What am I avoiding? High growth stocks that don’t make a profit, as well as most property, and fixed rate bonds. Though as interest rates start to peak, the bond area is going to become a lot more attractive. I am also avoiding unlisted private equity and venture capital investments that many investors have fallen in love with. While unlisted investments may not appear volatile because they are not listed on the stock exchange this doesn’t mean the underlying assets won’t fall in value.
Frankly, I am surprised it has taken so long to get to this point. It is the reason I have been talking about being overweight cash since late last year. But the reality is these things simply take a lot longer to flow through the system than you’d think. When I look ahead and think about how things will play out it feels like it should take 6 months but inevitably it takes 18 months. That puts us at the halfway mark.
In my opinion, at this point, you should have the maximum amount of cash you would ever have in your portfolio. I am not necessarily saying increase cash now, I am saying you should have been prepared already. Cash is still king as it has been for all of 2022. Outside of that the most important investment strategy for the next few months is going to be patience, keeping it simple and a focus on high quality investments that you are confident holding for the long term regardless of volatility.
General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.