Financial markets have been extremely volatile in the past few months, as geo-political tensions tighten in the Ukraine, economies around the world are reeling from mounting energy prices, soaring costs of living and in a desperate attempt to bring down inflation, higher interest rates.
The US economy appears certain to fall into recession, causing investors everywhere to take fright. An economic recession is generally, but not always, defined as two or more consecutive quarters of negative economic growth.
Inflation and interest rates
In addition, the Reserve Bank has made it clear it will continue to lift the domestic cash rate (currently 2.6%) until it has clawed back the rate of inflation from an expected high of 7 per cent, to less than 3 per cent. Australia is more vulnerable to the effects of interest rate hikes as we have high levels of variable rate household debt.
Higher interest rates are already impacting homebuyers. Five rate rises since May, mean a couple earning $92,000 each, can now borrow $264,000 less than they could in April according to analysis by the research house, Canstar.
Economic growth forecasts - reducing
The Organisation of Economic Co-operation and Development is now forecasting economic growth will slow from 2.8 to 2.2 per cent during the next twelve months as the United States, China and Europe all cut back on economic activity.
While Australia is not spared from this global slowdown, with the OECD forecasting domestic growth will reduce from 2.5 to 2 per cent during the coming year, it should survive this turbulent period better than most.
What lies ahead?
Sharemarkets generally fall before economic contractions start and then start rebounding while economies are still contracting. There are signs that headline inflation numbers are coming down. However central banks are likely to continue raising rates which will cause business contractions and higher unemployment.
Volatility is usually short lived; history shows that people who stick with their strategy are generally rewarded
The share price falls we have experienced assume big cuts to profitability and dividends next year and no doubt reflect part of the economic adjustment we will go through.
A wildcard is Putin and the threat of nuclear activity, which adds more uncertainty to the global outlook.
What to do?
When sharemarkets experience volatility it is only natural to feel concerned about how fluctuations may impact your investments. Diversification across different asset classes reduces the effects of volatility and is why most portfolios contain shares, fixed interest, property and cash.
The graph below, produced by Fidelity, shows sharemarket returns and world events over the past 30 years (to December 2021).
Periods of rising interest rates and economic slowdown are part of the economic cycle.
Investing should have a long-term focus and should be measured over years, not months. However, if you are concerned, please contact us.