After a period of unprecedented government and central bank support during the pandemic, the global economy is facing significant headwinds. Supply disruptions post two globally impactful events – the Covid-19 pandemic and Russia’s invasion of Ukraine – have led to inflation soaring, with central banks responding to inflationary pressures by hiking interest rates substantially, marking a wholesale move from quantitative easing to quantitative tightening.
The Bank of England recently warned that the UK faces its longest recession since records began in the 1920s, with a downturn that started this summer expected to last until the middle of 2024. The US economy is already in technical recession, having seen GDP fall for two consecutive quarters (by 1.6% in Q1 2022, and 0.6% in Q2 2022). Financial markets are bracing for a period of extended volatility amid the economic downturn. But how should individual investors respond?
Avoid knee-jerk reactions
It is set to be a difficult time for asset classes as a whole over the coming months, but it’s important to remain disciplined and avoid hasty and panicked reactions when markets experience sharp swings. Price fluctuations are a normal part of investing in shares. Panic selling during a crisis can be hugely detrimental if you crystallise large losses, and you’re not invested when markets recover.
The principle of ‘time in’ markets, rather than ‘timing’ markets, is important. As the table below highlights, the biggest up days often take place during crisis periods. Selling in an attempt to avoid falling share prices can see you miss out on some of the strongest trading days. Long-term investing requires patience and an ability to ride out the ups and downs. Ultimately your investment strategy should be based on your attitude to risk and your financial/life goals, rather than day-to-day market events and sharp swings.
Selling at the wrong time can prove costly
The chart below illustrates average returns in periods around US recessions since 1945. Although returns have been initially lean in the initial months after the US entered recession, over the medium term they have averaged 7% 12 months after the start of recession, and 26% three years after the start. This highlights the benefits of being fully invested during the ‘recovery’ phase in the wake of a recession.
Over long periods, financial markets have generated positive returns in most instances. Sticking to a long-term strategy is crucial (ideally investment horizons should be at least five years), as the ups and downs of financial markets are smoothed out over longer periods of time. Bloomberg data highlights that annual returns for UK equities (FTSE-All-Share total return index) have averaged 8% since 1965.
A diversified portfolio is less vulnerable to sharp swings during bouts of volatility. Diversification is the process of spreading your investments around the main types of assets and geographical markets, so that your exposure to any one of them is limited. Allocating your money across different asset classes – equities, government bonds, corporate bonds, real estate, commodities, and alternative trading strategies – helps reduce exposure to risk and volatility
‘The darkest hour comes before the dawn’
The outlook for the global economy is gloomy at present, but investors who stay disciplined and stick to long-term strategies may be able to realise substantial returns. Even during a recession, investing provides plenty of opportunities for delivering above-inflation returns and growing your real wealth.
Many people opt to delegate investment decisions to a professional who can assess markets with greater objectivity and experience. Do you need support with your investment strategy? Speak to a Lumin expert on 03300 564 446, or get in touch via our contact form.
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