The Next Rally

VUCA's an acronym we've been seeing around lately, to help sum up some of the craziness we're experiencing in asset prices.

VUCA:

• Volatility - refers to the speed of change in an industry, in markets or the world in general. The more volatile the world is, the more and faster things change.
• Uncertainty - refers to the extent to which we can confidently predict the future. The more uncertain the world is, the harder it is to predict.
• Complexity - refers to the number of factors that we need to consider - their variety and the relationships between them. The more complex the world is, the harder it is to analyse.
• Ambiguity - Ambiguity refers to a lack of clarity about how to interpret something. The more ambiguous the world is, the harder it is to interpret.

It feels as though we’re in the eye of a VUCA storm and for anyone in or nearing retirement, 2022’s tempest will feel more intense. Retirees rely on their investment portfolios to sustain their lifestyle and those new to this will be thinking of another old phrase: “Murphy’s Law” and asking: “What are the chances … just when I need it to be safe?” The good news is - all of this will pass.

Good portfolio construction works to position wisely for the individual, balancing risks. We get protection through owning low-risk assets. The lowest risk asset in NZ is Government Stock. These last twelve months have seen bond funds that are dominated with Government Stock lose between 5% and 9% (on paper). With inflation running at 7%, the real return is more like -15%. But that’s not as bad as the NZ share market, which is lower again and potentially implying a -25% real loss (“real” being the return after the inflation effect). This is big!!

For those nearing or in retirement, good portfolio management liquidates only those parts of a strategy that are needed now. We’d be foolish to sell assets intended for tomorrow, to meet todays’ consumption. While for many, simple term deposits haven't lost ground on paper, in terms of their future value, these deposits are almost guaranteed to lose in the longer-term, as inflation simply destroys their buying power.

There is never “no risk”, as evidenced in recent times by the negative returns recorded by the lowest risk assets (NZ Government Stock). We can’t tell where the world’s share or property markets will be valued in a years’ time, let alone five years. We do know that markets are behaving as they should, it’s just not very pleasant until the current VUCA stops.

In our day to day spending, we all have to pay the higher prices incurred from the effects of inflation; but as investors, we have the option to ride it out - if we don’t have to sell assets at this point, there is every chance the markets will return the value we appear to have lost today (there are decades of evidence that prove capital values will return, providing the investments we held were quality assets) - it’s just, we don’t know precisely when. If we pull-out now, it’s much harder to time a re-entry and harder again to recover realised losses (a better course, is simply to hold).

For forty years we’ve been in an environment of falling interest rates. The crash of 2022 was caused by a sudden reversal of that interest rate trajectory (due to inflation), which saw bond values fall hard. Shares then crashed but somewhat slower, house values will drift lower for longer as bank lending tightens. Ultimately that causes bonds to level out, shares will in turn rally and, a more normal tone will return to the market.

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.