The renewed market volatility and economic uncertainty of the past few weeks will have been unnerving for many investors.

Just how long these volatile conditions endure remains to be seen. But it’s precisely the sort of trading environment that Vanguard’s four investment principles are designed to help you cope with, so you stay focused on trying to fulfill your long-term goals.

Markets were already digesting the prospect of further interest-rate rises by central banks before the closure of two US banks sparked a sell-off in global banking shares. This ultimately led to the takeover of Credit Suisse by UBS and has led to fears about further banking-sector developments.

Despite the turmoil, the Bank of England still increased interest rates by a quarter of a percentage point to 4.25% last week, a day after data showed an unexpected jump in the annual rate of inflation from 10.1% to 10.4% in February.

This followed similar rate rises in the United States and euro area.

So what will these latest market and economic events mean for you?

What do rising rates mean for my investments?

At Vanguard, we believe that the Bank of England will continue to raise interest rates to a high of 4.5% as it tries to bring still-high inflation under control. So the peak in rate rises may yet be close at hand.

The volatility in the US and European banking sectors could also further tighten global credit conditions if banks rein in lending to households and businesses. This would help reinforce central bank efforts to tame inflation by restricting activity.

Even so, with underlying inflationary pressures likely to remain frustratingly sticky, we still don’t think rate cuts in the UK are likely before 2024.

The Bank of England was an early mover in raising interest rates – last week’s rate rise was the 11th consecutive increase since December 2021. The impact of higher rates on the real economy operates with a lag and, in our view, will peak in the second half of this year.

We continue to expect a recession in 2023 with the economy contracting by about 1% over the full year. We also expect recessions in the US and euro area – the UK’s two biggest trading partners.

Despite this, investors can draw comfort from the historical tendency for stock markets to begin recovering not long after recessions begin1. Recessions have also tended to be relatively short compared with the time horizons of most investors2, so taking a long-term view can help you to ride out short-term volatility.

Further down the line, once the uncertainty over the state of the economy and the outlook for inflation and interest rates is resolved, share prices may recover more strongly – even at higher rates. And if higher rates make economic growth more sustainable, that can be good news for shares too.

What about the banking sector?

Our baseline view is that recent events represent a temporary shock and the chances of the turbulence spreading to the wider financial sector are limited.

The failure of a few individual banks, and the shakeout in banking shares more generally, is also a reminder of why it’s so important to have a diversified portfolio made up of funds of shares rather than individual shares, as well as funds that represent the broader market rather than the individual sectors.

The table below highlights just how much sectoral performance can jump around from year to year. It’s why investing in the broader market rather than chasing the latest hot trend can better serve you in the long run, by reducing the impact that large falls in any one share or sector will have on your portfolio.

Global stock market performance by industrial sector (2013-2022)

Source: FactSet. Notes: Based on MSCI AC World Indices and MSCI industry classifications.

Past performance is not a reliable indicator of future results.

What should investors do – or not do?

Unexpected and fast-moving economic or financial market events can be disquieting. In most cases, however, Vanguard believes that investors benefit in the long run by avoiding the short-term noise and sticking with their long-term plans.

We believe investors should focus on making sure their asset allocation (their mix of shares and bonds) is in line with their goals and attitude to risk. It’s also important to control costs and take a disciplined approach.

In general, that means changing your portfolio only when there are meaningful shifts in your goals or financial circumstances, rather than in response to short-term conditions. 

 

1 Source: Vanguard analysis of one-year return of the Standard & Poor’s 500 Index in US dollar terms from 1973 to 2021, including performance during the period’s seven US recessions, as defined by the National Bureau of Economic Research. The earliest recovery from recession was just two months into the brief downturn of 2020. Calculations as at 31 December 2021, using data from Refinitiv.

The length of the last seven recessions (as defined above) has varied from 2 to 18 months.

 


 

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Important information

This article is designed for use by, and is directed only at, persons resident in the UK.

The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.  The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.

Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2023 Vanguard Asset Management Limited. All rights reserved.