16th June, 2023
Blog, DB News
A Unique 5 Year Period draws to an end….
The word “unprecedented” is banded around way too often in the investment industry. Markets are dynamic and ever-changing, so most market cycles feel different in one way or another.
That said, the most recent 5-year period really has been one of the toughest on record for investment assets. It will be viewed as the end part of a fifteen-year period where interest rates were zero and even negative for most of the developed world. I guess in that sense, ‘unprecedented’ is appropriate.
Despite this, across the last 10 years, our Low to Medium Risk Portfolio has returned 38% gross of advice costs (around 30% net). However, split that into two 5-year chunks, and you’ll find that 27% of that 38% was delivered in the first 5 years, and just 9% in the last 5. This has been disappointing from a numeric perspective, though as always, it’s important to consider the context.
It isn’t unusual to have challenging market periods of course, and in fact we do expect them. In a typical cycle, it would be considered “normal” to experience a 20% stock market fall (“bear market”) once in every 5–10 year period, and the thing about the recent past is that we’ve had two within 5 years – one at the start of Covid, and the second due to the inflation spike from mid-2021 onwards.
Other factors have influenced instability as well, take for example the political backdrop. It isn’t as important a factor as say interest rate levels, or economic growth, but markets and business’ like policy stability. Between 1980 and 2016 we had 5 Prime Ministers, with an average tenure of 7.2 years. Since 2016 we’ve had another 4, with an average tenure of just 1.8 years.
The last 5-year period has encompassed the consequences of Brexit, Covid, the War in Ukraine, an inflation spike, and a corresponding rapid rise in interest rates. Equity markets have fallen more than 25% on 2 occasions, and bond markets in 2022 had their worst period in recent history when UK Government Bonds lost over 45% from their peak in 2020 to where they were last week.
The chart below shows how difficult it has been over the last five years to create positive returns from a diverse portfolio. Diversity is vital in running multi asset portfolios, so the graph below shows the returns from 5 key variables within a multi asset portfolio.
As we referred to earlier, what brought the zero-interest rate cycle to an end was the return of inflation and higher interest rates, the latter of which is used to tame inflation. If interest rates rise too quickly, they are likely to drive a recession, which in turn will likely curb inflation. The takeaway from this being, that a ceiling for inflation and interest rates is likely, and we believe, we are close to or at that ceiling.
Frustratingly, inflation has been stickier than we thought. Why? Well, the consumer has proved very resilient in the Western world, and employment remains at all time highs. This sounds like the perfect scenario, though the latter two factors are inflationary and have essentially served to negatively elongate the end of the cycle. The return of income into our portfolios, that we have so often referred to in recent times, is starting to have a positive effect, though progress has been slow. Capital values have continued to fall over the course of this calendar year, though our portfolios are in the green due to the income that is now coming through as each month goes by. Once capital values level out, and dare I say it inflation takes on a consistent and controlled trajectory, we should see good levels of capital growth to add to our healthy income yield. This will herald the start of the new cycle, and we will all drink to that.