Stick to your investment plan

Lots going on to spook markets: geopolitics, inflation concerns, Covid, tightening monetary policy. Some commentators have been calling this the perfect storm.

It’s easy to see why. The chart below shows the downward trajectory of stocks since end of last year. Interestingly, we are only seeing a drawdown of about 10%. With everything going on, it feels the drawdown should be more than 10%. So it feels promising markets aren’t as bad as they feel they should be.

Now it depends on what you specifically hold. Commodities (e.g. oil, wheat) have done well due to the supply side shock we’ve seeen recently. If you hold lots of tech (which many do), then you feel the pain alot more.

Take a look at the chart below which shows out or underperformance of different sectors against global stocks. I like to categorise them into 3 buckets:

1)?????Inflation busting sectors like Energy, Material and Financials (Green, Blue and Red) – Energy and Materials companies benefit from higher prices, while Financials benefits from higher interest rates that come with higher inflation. Unsurprisingly, these sectors have done the best, delivering modest to strong returns.

2)?????Defensive sectors like healthcare and consumer staples (Light Blue and Purple) have also done relatively well, albeit slightly negative in absolute terms . These have proven to be good safe havens within the equities world, especially when you take into account stable dividend payouts.

3)?????Growth sectors like tech (Yellow) have really suffered. I’ve written a lot about this already (higher interest rates, elevated valuatons, etc) so I won’t go into detail again.

What else do we know? Let’s look into history. In previous geopolitical events (18 of them over 80 years that included conflicts and terrorist attacks), US stocks returned to pre-selloff levels after 35 days. A comforting sign if we believe history repeats itself.

Back to the market environment today. Yes, there are several risks to be concerned about. But actually, markets are not panicking too much. The stock market is not down as much as people think but expectations on volatility haven’t risen as much either.

Look at the chart below. Yes, volatility (orange line) as measured by the VIX index (a measure of fear in the market) has picked up. Investors interpret levels above 20 as a sign of market stress. We are currently at about 30, a lot lower than the 70-ish levels when Covid hit in 2020 or the Global Financial Crisis. In fact, the VIX has struggled to rise higher than 35.

I’d argue market forces are still primarily fundamentally driven (focus on earnings, growth, inflation, monetary policy) but investors are just trying to make sense of the fundamental factors of businesses, economy and people’s spending power. Watch out for the upcoming central bank language from the US and UK.

I’ll end on a positive note. Financial markets are forward looking. They appear short-term orientated now because investors have little predictive power around geopolitics. There will come a time (hopefully soon if history is a guide) where you’ll want to pick up investments at more attractive valuations.

But most importantly, remember that you lock in losses if you panic sell. Instead, a combination of the 3 different types of stock investments (inflation busting, defensive and growth) may be a prudent approach until a more dominant trend emerges from the uncertainty.