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Market update June 2022 – Special Edition

Share markets have fallen sharply in recent weeks due to concerns over rising inflation and rising interest rates.

Share markets have fallen sharply in recent weeks due to concerns over rising inflation and rising interest rates. Sharp falls in investment markets are unnerving for clients as no one likes to see their investments fall in value. However, during times like this it is important for clients to not react to emotive headlines and remain focused on their long-term objectives and investment strategy.

Economic and Investment Market Commentary

It has been a tumultuous start to 2022 for investment markets with many markets suffering sharp falls year to date.

These declines have been largely driven by rising inflation, central banks increasing interest rates in an effort to control inflation and investors adjusting their risk appetite and asset valuations to incorporate these changes.

Globally high inflation has become a major worry over the past year. The main contributing factors to rising inflation are:

  • Economies moving out of COVID-19 related lockdowns which has resulted in large shifts in demand combined with bottlenecks in supply chains as businesses ramp up activity.
  • China’s zero-COVID policy has added to global supply chain disruptions this year as lockdowns have been strictly enforced over a number of weeks in major cities. This has severely disrupted the operation of schools, factories and businesses in China and as a result placed further pressure on global supply chains and dramatically changed consumption patterns within China.
  • The invasion of Ukraine by Russia earlier this year has been a major geo-political event. Russia is a significant producer of a number of key commodities. In particular, Russia is one of the three largest oil exporting nations globally and Russia supplies nearly 40% of Europe’s natural gas requirements.

The sustained increase in inflation has been causing central banks to rethink the appropriateness of monetary policy settings. The initial central bank narrative in 2021 and early 2022 was that inflation was transitory and thus not permanent or warranting any changes in central bank policy. However, persistently higher inflation has forced the hand of central banks to adjust policy and focus on reducing inflation.

Central banks around the world have begun to raise official cash rates that in many countries, including Australia, approached zero in 2020 after COVID-19.  The increase in official cash rates such as Australia’s RBA Cash Rate has provided investors with an increasingly attractive, risk-free alternative to other asset classes.

The increase in official cash rates and expectations of future increases can flow through to term deposit rates and government bond yields. As this occurs investors recalibrate valuations of other asset classes such as equities and property to adjust for higher rates of return available in investments that are perceived as risk-free and demand higher rates of return from riskier assets. This can see asset prices (share prices) fall to adjust for the change in required rates of return.

Understanding market volatility

Investment markets can be volatile and don’t always go up. However, over the longer-term investment markets do trend higher.

Table 1 overleaf shows that returns in the short term have been negative and impacted by changing economic circumstances. However, long-term returns have been robust, even taking into account recent market weakness.

Diversification

Diversification can help in cushioning portfolio returns during periods of financial market weakness. A portfolio of assets spread across a variety of asset classes, including shares (domestic and international), fixed income, cash, direct and listed property and alternatives reduces the risk of portfolio returns being reliant on the performance of one particular asset class or a reduced set of factors that drive investment returns.

Table 1 – Returns (%) up to 17 June 2022

Short-term reactions can have long-term consequences

When the value of your investment decreases and media headlines are filled with emotive terms such as “bloodbath” or “billions wiped of markets”, it can be tempting to start selling. However, clients should understand it is natural to be anxious when markets decline, but should also be aware that reacting in an emotional way may compromise their long term objectives.

Periodic share market corrections and occasional bear markets (which are defined as falls greater than 20%) are a normal part of investing in shares. For instance, over the last decade we have seen the share market react to events such as BREXIT in 2016 and COVID-19 in 2020.  If an investor had sold their Australian share market exposure after the Australian share market fell by over 20% in March 2020 and not reinvested back into the market until October 2020 their return from Australian shares (up until the end of May 2022) would be more than 20% lower than an investor who remained invested over this period. In the following chart it can be seen that markets do fluctuate, but over the long term have trended higher.

Chart 1 - Australian equity price history

Important information

This information has been produced by Australian Unity Personal Financial Services Ltd (‘AUPFS’) ABN 26 098 725 145, of 271 Spring Street, Melbourne, VIC 3000, AFSL. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. It does not represent legal, tax, or personal advice and should not be relied on as such. You should obtain financial advice relevant to your circumstances before making investment decisions. AUPFS is a registered tax (financial) adviser and any reference to tax advice contained in this document is incidental to the general financial advice it may contain. You should seek specialist advice from a tax professional to confirm the impact of this advice on your overall tax position. Nothing in this document represents an offer or solicitation in relation to securities or investments in any jurisdiction. Where a particular financial product is mentioned, you should consider the Product Disclosure Statement before making any decisions in relation to the product. A PDS can be obtained from your financial adviser or directly from the product issuer. We make no guarantees regarding future performance or in relation to any particular outcome. Past performance is not indicative of future performance. Whilst every care has been taken in the preparation of this information, it may not remain current after the date of publication and AUPFS and its related bodies corporate make no representation as to its accuracy or completeness. Published: June 2022 © Copyright 2021.

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