Investors have learnt some hard lessons this year, after the 13-year-long bull market collapsed into confusion and volatility.
Those who piled into high-risk sectors such as US Big Tech, cryptocurrencies and meme stocks would have learnt the oldest lesson of all, which is that share prices can go down as well as up (and the faster they rise, the harder they fall).
Here are five more lessons that many investors have learnt the hard way — and how to apply them to your portfolio.
Lesson 1: the US Federal Reserve will not always bail out markets
For the past couple of decades, every time the stock market has looked in danger of a serious correction, the US Federal Reserve has raced to the rescue with yet another dollop of monetary easing.
This was originally known as the “Greenspan Put”, after former Fed chairman Alan Greenspan, which gave investors the idea that the central bank would always backstop asset prices.
Central bankers duly raced to the rescue during the financial crisis, slashing interest rates to almost zero in March 2009, and again during the Covid pandemic, flooding the market with stimulus in March 2020.
Now the backstop has gone.
Lavishing investors with fiscal and monetary stimulus worked when inflation was low, but will only fuel today’s inflationary bonfire.
So instead of bailing markets out, Fed chairman Jerome Powell has another priority, according to Joshua Mahony, senior market analyst at online trading platform IG.
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Watch: Federal Reserve's Jerome Powell warns of 'pain' in reducing inflation
US Federal Reserve chief warns of 'pain' in reducing inflation
“Mr Powell is hammering home the point that monetary policy will now address inflation rather than employment or growth concerns.”
He made it clear at last month’s Jackson Hole Economic Symposium that markets must brace themselves for more interest rate hikes, Mr Mahony says. “We remain a long way from the position where rates can be brought under control once again.”
The Fed will also step up the unwinding of its $9 trillion balance sheet, Vijay Valecha, chief investment officer at Century Financial, says. “With higher interest rates putting pressure on equity valuations while an earnings downgrade cycle is under way, more market turmoil may lie ahead.”
The summer stock market rally is gone and forgotten. “Instead of saving the economy, the Fed might trigger a recession,” Mr Valecha adds.
This lesson is going to be a harsh one.
Lesson 2: you do not play games with inflation
It is now 40 years since inflation was at today’s levels and investors are seeing first-hand the damage it inflicts.
Inflation wipes out the real value of savings and squeezes incomes as everyday living costs, such as food and fuel, soar out of control.
The Fed is willing to engineer a recession and stock market crash to defeat it, but its powers are limited, Russ Mould, AJ Bell investment director, says.
“The Fed has spent more than a decade trying to fuel inflation with the blunt instruments of interest rates and quantitative easing [QE] and is now using the same tools to choke it off.”
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Jackson Hole Economic Symposium — in pictures
In 1974, inflation drove the Fed funds rate to 13 per cent. It hit 19 per cent in 1980, after the fall of the Shah of Iran in 1979 triggered a second oil-price shock.
Those interest rates are unthinkable today, with the Fed funds rate in a target range of 2.25 per cent to 2.5 per cent, but the historical echoes are making investors jittery, Mr Mould says.
Bear market falls of more than 20 per cent in the S&P 500, Russell 2000 and Nasdaq Composite may only be the start. “Even those pullbacks only take the indices back to where they were in spring 2021.”
The Fed is set to keep hammering away at inflation, regardless of the pain it inflicts, Mr Mould says. It has no choice.
Lesson 3: Germany doesn't always get it right
Germany is admired for its innovative, export-led economy, but this year even Europe's economic powerhouse has come unstuck.
The country faces political and economic disaster after getting hooked on Russian natural gas, leaving it at the mercy of President Vladimir Putin. It is now in a race against time to secure supplies of liquefied natural gas before winter arrives, after Mr Putin cut all deliveries through Nord Stream 1.
Germany now faces some of the highest gas prices in the world, Mr Mahony says. “Worryingly, consumers appear to be cutting back on spending with a view to braving a difficult winter, which is expected to drive the country into a deep recession.”
Germany's MSCI Index is down 29.6 per cent in the year to July 29, almost three times the fall of 9.61 per cent on the MSCI World Index.
Markets expect Germany’s struggles to continue, says Fawad Razaqzada, market analyst at City Index and Forex.com. “Reduced Russian energy shipments through the Nord Stream 1 pipeline have increased the risk of rationing in the coming months.”
At least Germany is waking up to its mistakes. The Government set a target of achieving gas storage of 85 per cent by October but now says it could hit that total early this month. "If it succeeds, rationing might be averted after all,” Mr Razaqzada says.
Germany has made mistakes before, but it has always bounced back. That’s another lesson history has taught us.
Lesson 4: bonds and shares can fall at the same time
Shares and bonds are supposed to complement each other within a portfolio, because when shares rise, bonds fall, and vice versa.
They are known as “non-correlating assets” and combining them in the classic 60/40 equity/bond portfolio is said to offer investors the best of both worlds.
Until this year, that is, when both asset classes fell at the same time.
It is a misconception that bond and share prices are uncorrelated, Symon Stickney, chief executive of digital asset manager Collidr, says.
“This led investors to believe that if shares fell, then the bond element of their portfolio would offer a partial hedge against that fall.”
As they fall in tandem, investors have no place to hide, he adds.
Inflation is bad for shares but spells “disaster” for bonds, as their fixed rate of income suddenly looks a lot less attractive, David Henry, investment manager at Quilter Cheviot, says. “Particularly when the starting income is basically non-existent, as was the case this time last year.”
Fund managers are “decrying the death of the classic 60/40 equity/bond portfolio” but Mr Henry cautions: “If we look at the historical numbers, maybe the grim reaper should hold on to his horses.”
Since 1986, there were just nine quarters when both bonds and stocks fell in tandem, but they bounced back strongly every time.
Which reminds us of another long-standing lesson, investing is cyclical. “Don’t get too excited on the way up, or too despondent on the way down,” Mr Henry adds.
Lesson 5: Bitcoin is not digital gold
Cryptocurrency enthusiasts have made a lot of big claims, but one of the most outlandish is that Bitcoin is now “digital gold”.
This year has put paid to that, with the price falling by more than two thirds to below $20,000.
Rather than a store of value, Bitcoin has been a destroyer. Instead of mimicking gold, it has been following moves in the US stock market, Mr Valecha says. “Bitcoin’s summer recovery of around 30 per cent was broadly in line with gains on US tech stocks.”
Bitcoin may recover, but only if stock markets do.
So what of real gold? It's also supposed to be a safe haven in a crisis, yet the price has fallen 8 per cent this year.
Gold is priced in dollars and it has been hit hard by greenback strength, which makes it more expensive to buyers in other currencies, suppressing demand.
Even if markets fall further, gold may not benefit, Mr Valecha says. “The US dollar may continue to gain, as US interest rates rise.”
Which brings us to our final lesson. The ultimate safe haven asset is the world’s reserve currency, the US dollar.
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Watch: What is Bitcoin and how did it start?
What is Bitcoin and how did it start?
