“There will be volatility” but long-term investors urged to buy the dip
Long-term investors are being reminded that short-term volatility is unlikely to have a lasting impact on their portfolios.
It has been a tumultuous time for investors.
January ended on a positive note in the US, but only after the NASDAQ-100 had its best 2-day rally since 2020, posting nearly a 6.6% gain in just 2 trading sessions.
This follows days where the tech-favoured index has fallen almost 5% in a single day.
The news, while less extreme, is similar in Australia, which is down 6.5% in the last month of trading, but has fared better in recent days.
Despite the resounding swings in values, industry experts urge investors to think long-term.
Why is the market so volatile at the moment?
One of the key drivers in recent years for share prices has been ultra-low interest rates.
This is because low rates mean it is easy to serve debt for businesses and the opportunity costs of putting money into longer-term growth assets is reduced with lower rates.
However, as banks around the world begin to fight rising inflation, it is likely that these ultra-low interest rates will become a thing of the past.
As Morningstar's head of institutional portfolio management and solutions Jody Fitzgerald recently points out, this can become a problem for markets.
"A little bit of inflation is actually good for markets as it reflects stronger economic activity, but there's a tipping point where central banks will need to respond through tightening monetary policy, which ultimately will slow the economy down."
"We seem to be at that tipping point," Fitzgerald said.
What does this mean for portfolios
Unfortunately for investors, rising interest rates will mean increasing volatility.
"There will be volatility in rates markets and we've seen that in last month or so," Fitzgerald said.
"That volatility will then lead into equity markets and also FX markets."
"Simplistically, when bond yields rise, equities declined and that is because the equities are being discounted at a higher rate," she explains.
However, the investor notes that it's not that simple with underlying dynamics potentially creating opportunities for investors.
"During this environment, growth stocks will reprice and we are seeing that at the moment through tech," she said.
"But there are some equities that will actually perform well during an inflationary period. As it happens the assets that will do well from an inflationary period are attractively priced."
Problematic for short-term investors
Morningstar is quick to point out that investors need to achieve inflation returns, otherwise they are eroding the value of their capital.
As such, in a higher inflation world, those who need their capital over the short-term or retirees are negatively impacted by higher inflation.
"These groups tend to be more conservatively invested and the reality is in a high inflation environment they will struggle to keep pace with inflation without taking more risk," Fitzgerald continues.
The other types of businesses that tend to do well according to Fitzgerald are businesses with a "high degree of pricing power" as they can effectively pass on higher costs to consumers.
This becomes less of a problem long-term
While short-term investors might have issues over the short-term, this issue will not impact long-term investors.
That is because they can ride out rising interest rates and short-term weaker growth in share prices.
"If you're someone in your 20s and you might not need this money for 30 years then you probably don't have to focus too much on what's going to happen over the next few years," Dan Kemp, Morningstar's chief investment officer said.
Remember winners keep winning
During a separate Munro Partners media briefing, the message for investors remained the same.
Even in volatile markets Munro Partners' chief investment officer Nick Griffin opines that share price will ultimately reflect earnings growth.
He suggests that structural winners that are taking market share from the incumbents will continue to grow even as shareholders run for the exits.
"Ecommerce is still taking share from regular commerce, cloud-computing is still taking share from workplaces, the Internet is still taking its share of advertising spend and digital payments are taking share from cash," he explains.
As such, he points out that companies such as Google, Visa and Microsoft will continue to have strong structural earnings growth over the medium term, even if they are trading on a higher multiple than the market average.