Over recent weeks, I have found myself wondering how many letters there are in the Greek alphabet.
The answer is 24 and it turns out Omicron is the 15th letter. It is of course Greek letters that are assigned to Covid-19 variants as they emerge. It was news of this latest variant, Omicron, that has contributed to recent global sharemarket volatility.
I like to finish my columns for the year with a light-hearted article in December, but it seems the Greeks have disrupted my plans. Investment markets have been climbing a wall of worry as the spectre of a new variant that could require further lockdowns plays on investors’ minds.
To qualify as a correction, a sharemarket must fall by 10% or greater. I have lost count of the number of market corrections that I have observed alongside my clients.
My observation is that, in retrospect, there is a sameness about all of them, but in the heat of the moment they all feel very different. The sameness relates to the fact that sharemarket corrections are generally short and rapid.
This is opposed to the preceding growth which tends to be long and extended. Yes, some of the preceding gains are temporarily absorbed by the current contraction but not in their entirety.
The second element of sameness is the reminder that, as humans, we tend to have a strong negativity bias. Research has quantified this bias and suggests that we fear losses more than twice as much as we enjoy gains.
For this reason, a numerical return of -10% feels like a loss of more than -20%. This rings true when you see the herd mentality that drives markets irrationally lower in the midst of a correction.
But in each correction, there are also differences, sometimes real and sometimes imagined. I wouldn’t mind receiving $10 for every time I have been told “that it is different this time”. In most cases it is not fundamentally different; it is just the normal pattern of company or bond prices getting out of step with economic activity, or interest rates, which then leads to an abrupt realignment.
However, there are periods in history where there has been a sea change in economic forces under way which has then been overlaid by a specific trigger.
Before the emergence of Omicron there was already a paradigm shift under way. Global interest rates have just bottomed out after several decades of consistent falls.
At the same time, inflation pressure in both the local and global economies is now being perceived as persistent rather than transitory. This was already pointing to a potentially challenging environment for shares as rising interest rates tend to create a headwind for share prices.
The uncertainty created by the emergence of Omicron has been the final kicker. The result of the combined effect is that the volatility we have seen in some sectors has been the highest seen since the selloff that occurred in the initial Covid-19 response in March of 2020.
One of the questions you need to ask yourself is: does your investment strategy have a game plan to deal with the current volatility and the evolving investment environment? From a planning perspective I recommend a checklist approach:
1. Quantify your current position and the volatility you are experiencing in the context of your long-term investment goals. Yes, you might have given up some recent gains but what is your average rate of return since inception and are you still on track to meet your investment objectives?
2. Review your investment timeframe and the asset allocation that is being applied. Does it fit with your risk profile, or does it need adjusting?
3. Understand the causes of the current market conditions and ask yourself if the assets that you hold are well placed to cope with a changing environment. Are you still holding too much in fixed interest which is vulnerable to inflation and rising interest rates?
4. Ask how the situation can be turned to your advantage. The 2020 investment year highlighted that with risk also comes great opportunity. The coming year is likely to be a year which will also present both.
Wishing you a safe and relaxing festive season and all the very best for 2022.
- Peter Ashworth is a principal of New Zealand Funds Management Limited, and is a Dunedin-based financial adviser. The opinions expressed in this column are his own and not necessarily that of his employer. His disclosure statements are available on request and free of charge.
