Investment markets have definitely struggled in 2022, following strong returns in previous years.
It is strange to think that markets recovered so strongly after the initial shock of the horror of Covid.
In reality though, it makes perfect sense. We were all stuck at home doing online shopping and watching Netflix, while ordering Uber Eats or ordering new computers for home offices, so we could attend the Zoom meetings.
At the same time the world governments showered money to keep things moving and kept interest rates at historically low levels. A little like how we spend crazily before Christmas, all the while mentally shutting out the reckoning on the credit card in the new year!
So a few years later, we find all that massive spending has helped create inflation. Initially this inflation occurred in shares and property prices. Now though it is with everyday goods and services, including basic necessities of life. This makes it imperative for governments and central banks to jump on inflation and the most obvious instrument is to increase interest rates.
As many of us already know all too well, higher rates on big loans mean less money for spending. It also means that there may be less potential buyers for your inflated asset. Less buyers, or even buyers limited by stricter bank lending criteria, can mean potentially lower selling prices. The reduction in demand will be painful for many and it will be a very difficult time for the Reserve Bank to negotiate between reduction in demand to sustainable levels or actually crashing our economy.
The task is made all the move difficult due to the high volume of fixed-rate loans originated by banks during the pandemic and funded by the Reserve Bank’s term funding facility. Whilst variable rates are rising at present in step with the Reserve Bank’s cash rate increases, there is an expectation that the impact will be felt more severely over the following 18 months as fixed-rate loans with interest rates around 2% expire and the borrowers will experience a potential doubling or tripling in their interest rate.
This may sound like a doomsday prediction, but in fact is simply what has always gone on in our economy and lives in the past and will in the future. Markets react, but somehow the world ends up years later in a better position than ever. Negative or lower returns every few years is a necessary evil when pursuing long term returns above inflation.