Why is the value of investments falling?
Two global catastrophes started a chain reaction leading to dramatic decline in the value of shares. Ed Tomlinson explains.
KEY POINTS
- The pandemic and war in Ukraine reduced the supply of goods around the world.
- But consumer demand remains high, so prices are rising fast (inflation).
- Central banks are hiking rates to reign in escalating inflation.
- Fearing the impact, investors are selling up, forcing the value of shares down.
Investors, including superannuation members, have a right to be concerned if not anxious about what’s happening with their investments right now.
Seeing your superannuation balance decline is unsettling. For those close to retirement, it can feel alarming.
The US sharemarket has fallen by more than 21% this calendar year – moving into what is known as a ‘bear market’. At the same time the Australian sharemarket suffered a ‘correction’, down nearly 13%, with the sharpest fall occurring the week beginning June 13 when it fell 6.6% alone.
Investments – from the most risky (such as cryptocurrencies) to the most ‘defensive’ (such as bonds) – have fallen significantly in value.
First, I’m going to explain what’s happened, and then how to think about it.
Performance of S&P/ASX 200 in 2022
The story so far: what’s happened in 2022
Bear with me as there is some complexity in explaining what’s happened this year, but it’s worth understanding.
1. Two powerful global disturbances are the root causes of current market troubles.
The first was a resurgence of the pandemic and governmental response to it, particularly in China. Lockdowns etc. continue to disrupt supply chains (the production and distribution of goods) so cars and food etc. aren’t getting to consumers quickly enough.
Secondly, Russia invaded Ukraine. A key economic fallout of the war is its damage to the supply of essential commodities those countries specialised in such as oil, gas and wheat.
2. The result of these forces? Inflation
Supply-chain issues caused a significant increase in prices, as demand is high, but supply is reduced. They've risen sharply and persistently, led by petrol and food. In the past year prices have increased 5% in Australia and up to 8% in other developed countries (in the US they’re rising at their fastest rate in 40 years).
This is a very significant rise. And one key result is that economies are expected to slow, so much so that in the US a potential recession in early 2023 is now forecast.
3. To fight inflation, interest rates are rising
To limit rising prices, public authorities such as the Reserve Bank of Australia are pushing back. The most visible way they're doing this is raising cash rates.
Recently they've been pushing rates up, and fast. That has shocked investors, who’ve been used to cheap money for the past two years. Cash rates are now 1.5% to 1.75% in the US and 0.85% in Australia.
(This has a flow on effect to other types of securities and the most directly impacted is bonds, causing prices to move rapidly.)
4. Rising rates scare investors causing sharemarket downturn
Investors are reacting to rising rates by selling down risky investments such as shares, which pushes down their value.
This downward revaluation is happening because firstly, higher rates may bring on a recession – there are signs this could be true – and secondly, shares are not expected to deliver higher returns making them less attractive.
This risk-aversion is most obvious in cryptocurrencies, a high-risk volatile investment category that has seen spectacular increases in value and is now in significant decline. Spare a thought for those that have sunk significant sums into this category, because while many have sold out, those that haven’t could be caught by major US cryptocurrency networks freezing withdrawals and transfers, citing "extreme" market conditions.
One way to think about all this
Investors and market commentators are having a bit of a meltdown. The first thing to say is that while many of them may be seeing a loss in their investments, you won’t unless you’re cashing out your super in the immediate term –and if you are thinking about withdrawing, please speak with a smartCoach.
We’ve shared our response to members asking ‘If my super has fallen, what should I do?’. I encourage you to read this if you are concerned.
Right now you’re likely seeing a lower balance in your super account. While the drop in market value is scary:
in the long term sharemarkets rise, and go on to new heights
be very careful switching investments in response to a declining market – there is a tendency to want to do so after a sharp decline in value (locking the loss in) and switching back after the market has already regained its value (missing out on the recovery)
historically it’s better to ride out the tough times – superannuation is a long-term investment and market fluctuations are normal for investment markets.
That ‘longer term mindset’ is what I want to emphasise here. Let me show you what I mean. The graph below shows the performance of the S&P/ASX 200 – the flagship indicator of the Australian sharemarket – since 1992. The big dip in the middle (2007) is the global financial crisis, the other sizeable one near the end of the line (2020) was the drop in value once the pandemic hit. And at the very end is where we are now. While the dips are notable, it’s the long-term rise that stands out.
