Subscriber OnlyYour Money

Sell in May? How to respond to market volatility

For investors, used to historic low interest rates, it’s a brave new world

It couldn’t go on forever. And now the tide appears to be turning on the era of soaring stock markets, cheap money and low interest rates. After years of bullish growth, volatility has made an unwelcome – for most investors at least – return. Where not so long ago, amid historic low interest rates, equities were one of the few games in town, their shine is beginning to tarnish.

By early May, the S&P 500 was down 18 per cent from its January 3rd peak, while the Nasdaq, home of tech stocks, plummeted by almost 30 per cent from its November high, on the back of a sell-off in the sector.

A combination of factors are at play: the war in Ukraine, global supply chain issues, China's zero-Covid policy, cost-of-living pressures, a slowdown in global economic growth, energy price shocks and expected increases in interest rates on both sides of the Atlantic.

So what’s an investor to do? Sell in May, as the old adage goes, or carry on regardless?

Changing environment

The first thing to do is to understand what's going on. "What is happening is very much this surge in inflation, which is forcing central banks to act quite aggressively now," says Emmanuel Cau, head of European equity strategy at Barclays.

While rising inflation was initially dismissed by many – including European Central Bank (ECB) president Christine Lagarde and its Irish chief economist Philip Lane – as a temporary spike, it is hanging around much longer than initially envisaged, with the initial post-Covid bounce exacerbated by the Russian invasion of Ukraine, especially in relation to energy costs.

In Ireland, inflation hit 7 per cent in April, while EU-wide inflation is expected to average 6.8 per cent by year end.

As Cau notes, the big driver of markets in the last three years has been the significant liquidity available from central banks, which has inflated asset prices and strengthened economies.

“Very easy money has been driving this strong market,” he says. This is now coming to an end, with central banks abandoning their quantitative easing programmes and starting to hike rates amid surging inflation.

The ECB is now expected to hike rates by as much as 0.5 per cent in July, and markets are pricing in a rate of about 0.75 per cent by year end.

Meanwhile, in the US, some say that interest rates may go as high as 3 per cent by year end, after the Fed raised rates by 0.5 per cent earlier this month – its second hike in as many months and its biggest increase since 2000.

For investors, used to historic low interest rates, it’s a brave new world.

"It's more than just a blip . . . there is something fundamental happening," says Vincent Digby, managing director with Impartial Financial Advice. This shift has already seen valuations "adjust".

“Whatever was expensive at the start of year, such as tech, US equities, long duration equities, have been hurt quite a lot,” says Cau. And there might be more pain to come.

“What we’ve not seen yet is growth concerns, earnings concerns,” says Cau, noting that earnings have held up, offering relief to stock markets. However, the impact of rising interest rates and inflation might start to kick in.

“The market is quite nervous that earnings are ready to drop,” he says.

Another key concern is that the Fed, while looking to stem inflation, “might actually do it too much and take the economy into stagflation”.

“That’s what the market is worried about,” says Cau.

This means that while the impact of reducing liquidity still has to be played out entirely, the fear factor among investors is now shifting towards growth, and the earnings side of the equation.

“Earnings have been quite supportive to equity markets. If earnings start to slow, I suspect it will contribute to more pessimism,” says Cau.

Don’t panic

Of course, understanding current volatility might be one thing; knowing what to do about it is quite another. Meera Pandit, a global market strategist with JP Morgan, recently urged investors to "maintain composure and stick to your investment plan", and this steady-as-she-goes approach is one embraced by many.

“In this kind of market, you probably don’t want to overreact to headline news. You want to be quite tactical, as some of the moves we had in the last few weeks can create opportunities,” advises Cau.

Here’s another maxim: time in the market beats timing the market. Selling out can cost you over the long term.

“One thing to avoid in all instances is that you wait for markets to really fall, then move into cash and never get back into the stock market. It’s a cardinal sin to avoid,” says Digby.

As research from JP Morgan shows, if an investor were to miss the 10 best days in the market rather than staying fully invested, they would have cut their return in half from 9.5 per cent to 5.3 per cent annualised over the last 20 years.

And when are the best 10 days typically? Well, according to the research, seven of the 10 best days occurred within two weeks of the 10 worst days, often immediately following the worst days. So, exiting on a bad day means you might potentially miss the rebound.

However, as Cau notes, with the outlook skewed to the downside, investors may want to look to protect their portfolios.

Your own time horizon

This may be particularly true depending on your own time horizon. So if, for example, you’re young, you’re a long way away from retirement, and you’re wondering what to do now, your long time horizon means that you should ignore current volatility and keep up your regular contributions.

“Just keep doing what you’re doing,” says Digby. But your personality will also come into play. If, for example, another hefty fall in equities causes you stress and starts to impact on your lifestyle, then it may be time to look for an “all-weather” approach to investing.

If you’re closer to retirement, and you’ll be relying on your pension fund for income, “maybe a more balanced approach to that is needed,” he adds.

This means you may need to rebalance your portfolio to make it more resilient.

“Don’t panic and say no risk . . . tweak it to make it more resilient,” says Digby. While you can’t cut risk entirely, “a bit of risk management” may be needed now to weather current and future volatility.

Switching

This may mean switching from growth equities to value equities, for example ("You're looking for companies that have long track records of paying dividends, " says Digby) as well as allocating to commodities or defensive assets such as gold.

Cau cites sectors such as energy, banks, utilities and autos as likely to offer opportunities for investors going forward.

“We have a fairly clear preference for sectors which are not expensive . . . we don’t want to overpay for things we buy,” he says, adding that sectors which are not in favour at the moment are those such as industrials and luxury goods, “which have high valuations”.

This rebalancing may also mean a return to bonds.

“Bonds might start to become a reasonable alternative,” says Digby, noting that French government bonds are now yielding about 1.5 per cent, up from “pretty much zero” late last year. Cau agrees, noting that as yields rise, “bonds are becoming more interesting for some investors”.

Cash is back

Rising interest rates may mean turbulence for stock markets, but it also may mean that one of the biggest problems savers and investors have had to face in recent years may soon be a thing of the past.

Holding cash has been a significant cost in recent years, with some institutions charging negative rates on holding cash, while rising inflation has also eroded the real value of this money.

Now, however, Digby says we’re going to start moving away from this to where it won’t cost you to hold cash. Just don’t hold your breath, perhaps, to wait for deposit rates to start to rise.

Want to make better investment decisions? Get the knowledge

If you want to up your knowledge to make better decisions during these volatile times, you could consider investing in an online course. GillenMarkets has just launched such a course, designed to teach people the principles of sound saving and investing.

Led by Rory Gillen, who has over 30 years' experience in investing in stock markets, the aim of the programme is to "help demystify savings and investments and the stock markets so that people can take more control of their financial and pension planning".

The various modules of the course will cover areas such as financial planning; why the stock markets produce better returns than other forms of investment; how to understand and manage risk; how to deal with volatility; and the attractions of regular investing compared to lump-sum investing.

The course runs over nine modules and costs €169 in total. gillenmarkets.com