Markets ended 2021 arguably priced to perfection, with the Morningstar Global Markets index up 16.28% – in fact, it marked the eighth year of double-digit gains in the past decade. Nevertheless, uncertainty around how long inflation would remain at high levels, and the growing possibility of a shift to a less accommodative policy by the various central banks across developed markets, became a source of volatility during the first month of the year – in January, the Morningstar Global Markets index was down 4.65%.
Adding to the worries in February was the growing tension between Russia and Ukraine. As Russia became increasingly aggressive, investors grew nervous. On 22 February, when Russia established a military presence in the region already held by Moscow-backed separatists, the Morningstar Global Markets index was down 0.83%, and the Morningstar Emerging Market index was down 0.99%.
Within a little more than a day, with a full-scale invasion underway, fear and uncertainty roiled global markets and led to a wide array of results. On 24 Feb, the Morningstar Emerging Markets index ended the day down 2.22%, the Morningstar Europe index was down 3.56% and UK Gilts 5-10 year finished up 0.21%. Markets continued to tumble by varying degrees in the weeks that followed, as the scale of human suffering skyrocketed and the response of Western nations isolated Russia from much of its typical economic and financial activity.
Actionable plan
Looking at developments to date, although European markets have recovered slightly from 22 February, advisers and their clients continue to have potentially the hardest job of all in determining what to do with their investments. Our advice – contrary as it may sound – is to stay the course.
This is subtly different to doing nothing – it means you should review goals, affirm risk tolerance and make sure they align with portfolios. This turns a nearly impossible task – when the headlines are screaming, and we are living through history – into an actionable and positive plan. It is also worth remembering that, despite a myriad of horrific wars, inflation and other tragedies, in the long run, markets have managed to climb higher.
If clients are in portfolios that are well-calibrated to their financial goals, then adjusting as markets are selling off is less a form of risk control and more a recipe for loss. That is because not only is it hard to predict whether losses will continue, it is also hard to predict when markets will suddenly recover.
In fact, studies show that market timing is especially difficult because investors need to make not one but two decisions: when to get out and when to get back in. Getting both decisions right has proven elusive to most investors. It is just too complex a world.
Focus must remain on fundamentals and the degree to which price movements become unmoored from those underpinnings. Of course, in a crisis of this magnitude, the chance that not just prices but also fundamentals are in flux is a very real possibility. As a result, our own team is focusing on fundamental shifts that impact earnings, dividends and valuations.
We are unlikely to know the lasting impact immediately so, in the meantime, we are watching the price behaviour of asset classes that are unrelated, or perhaps more indirectly related, to the conflict. Should those areas sell off in sympathy, we are more likely to consider the price gap an opportunity to add at better price points.
Top of mind
Top of mind for us are areas such as Germany and European financials, which have suffered far more than other regions or sectors. In the case of Germany, we are considering the potential for supply-chain disruptions, given the country’s significant international trade. For European financials – and banks in particular – we are considering direct exposure to Russia and the impact potential write-downs could have on our assessment of company value. We are also testing various macroeconomic scenarios, including a recessionary environment, given banks’ economic sensitivity.
Being big believers in behavioural finance, we are aware of our weaknesses. As humans – with all the usual mental shortcomings that brings – we are tempted to develop attractive narratives and overweight those narratives when thinking about the outcome. Trying to think through the political and economic impact is more likely to harm than help returns.
Like everyone else, we are also prone to recency bias, meaning we let our most recent experience dictate our overall perspective. Our most recent experience of market volatility was a sharp bounce – that outcome may or may not be the case this time around.
Rather than equating recent market movement with today’s environment, however, we take a longer look back through history and consider the wider range of outcomes that could occur. Then, we return to the lasting impact on the fundamentals, which in the long run drive asset-class returns, and ultimate drive our laser-focus in managing portfolios that leverage our global team to develop a fundamental view.
Leslie Alba is associate director of research, Morningstar Investment Management Europe
