In our opinion, it is likely that the current devaluation / decline in bonds has run its course (or is close to it), and we thus expect that bond returns will revert to positive figures in the near- to medium term.

THE OUTLOOK GOING FORWARD

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In light of the above, it is important to view the year-to-date performance of your portfolio in context – it has been a very challenging period indeed, and generating positive returns under these conditions would have been very difficult, if not impossible, for most investors.

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Market sentiment remains broadly negative in the short term, and this is likely to remain the case until the outlook for inflation improves – once that happens, we will have a better idea of how interest rates may move going forward. There are indeed market commentators who believe that the rampant inflation we’re seeing at the moment is transitory, i.e. that it is predominantly due to supply-side disruptions that occurred during the height of the pandemic, and that it will normalise fairly soon, as the world recovers from these structural disruptions.

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Nonetheless, with the current level of uncertainty persisting, it is entirely possible that share prices could come under further pressure, and, for the same reason, bonds may continue to produce poor returns as well.

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This could change quickly though, and one should keep in mind that markets are forward-looking; in other words, we should be mindful of the fact that investors are already “pricing in” negative future circumstances, and that this is reflected in current asset prices (e.g. share prices). If investors get an indication that the inflation / interest rate outcomes are likely to be less severe than they feared, share prices as well as bond prices could correct upwards rapidly. Of course, the opposite could also occur, but there is no doubt that the cycle will reverse at some point, and when it happens, the recovery could be fast – that is why it is generally not a good idea to attempt to “time the market” by moving in and out of the market based on one’s perception of “tops” and “bottoms”, especially if one has a well-diversified portfolio.

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As you may be aware, there are also fears that the global economy could tip into recession, in other words, an extended period of declining economic activity / output and depressed asset values. While this remains a strong possibility, it is worth pointing out that spiralling inflation is not a feature of a recession – in other words, a recession situation should spell the end of the current fears about rapidly-increasing interest rates.

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This also means that, while share prices may struggle during a recession, bonds are likely to rise in value, thus providing the kind of “ballast” that we generally expect them to provide within a diversified portfolio. As implied above, the current situation where shares and bonds are producing negative returns simultaneously is somewhat anomalous, and likely just part and parcel of a “normalisation process” after a highly unusual period, i.e. the pandemic and the measures applied by governments and central banks to support their economies.

DON’T SUCCUMB TO SHORT-TERM-ITIS: THE IMPORTANCE OF STAYING THE COURSE

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While you would likely have seen a decline in both the “growth” as well as the “defensive” components of your portfolio over the last six months, this is the result of very unusual circumstances, and you should thus not lose faith in the fundamental longer-term diversification benefits built into your portfolio. Six months is a very short period in investment terms, and one should guard against reading too much into short-term performance figures, regardless of whether they are positive or negative.

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When all is said and done, the underlying assets that you are invested in are the companies that produce the goods and services that power our economies – longer term, these economies have produced increasing value and have rewarded its investors handsomely. This is unlikely to change anytime soon (and a good business does not become a bad business simply because its share price has fallen) but the price that we have to pay for this growth potential is that we occasionally have to endure periods of significant uncertainty and discomfort.

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Periods like the one we are experiencing at the moment is a real test of investors’ mettle – when one is bombarded with bad news on a daily basis, the temptation to capitulate (to “cash out” and thus to realise losses) can be very strong. But history shows that markets are very resilient in the long run – they always bounce back eventually. And the recovery can be much faster than most investors expect: for example, the S&P500 index (US stock market) has declined by 10% to 20% more than twenty-five times during the last seventy-five years, and on average it took only around four months to recover the losses suffered during these downturns.

For most investors in well-diversified long-term portfolios, the greatest risk factor is probably not market volatility by itself, but rather their emotional response to it – either because they get ahead of themselves (“greedy”) when things go well, or because they become excessively fearful when things take a turn for the worse.

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Managing these emotions is easier said than done, so, as always, we would encourage you to engage with us if you should have any questions or concerns about your portfolio – now, more than ever, it is important to be mindful of your emotions and to continue taking a disciplined and reasoned approach to your investment decisions. This approach has served countless investors well and, no doubt, it will do the same for you.

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Daniel Rossouw
Joel Evans