BLACK Friday on 26 November was supposed to be all about consumers enjoying a hard-won shopping spree – the last before Christmas. It won’t, however, be remembered for that.

The advent of the Omicron coronavirus variant cast a long shadow over the day, causing world stock markets to rapidly switch into risk-off mode.

The days since have seen volatile swings in share prices as markets have grappled with a new array of possibilities. What we know about Omicron is that the risks are thought to be serious enough for the government to tighten up travel and social restrictions and accelerate its plans to roll out booster jabs.

What we don’t yet know is whether this new variant is more transmissible or aggressive than its predecessors, or quite how well our vaccines will work against it.

The bull case is founded on the idea that high vaccine doses will make up for the lack of an exact match between virus and vaccine, and that new vaccines customised to disable the new variant can be developed in fairly short order.

If these conclusions are true, the latest government restrictions and dent to people’s confidence should prove short-lived. The risk, of course, is that something fundamentally new is happening that will plunge the world into another period of uncertainty and depressed economic activity.

An additional concern for investors was exemplified on Wednesday, after the governor of the Federal Reserve Bank in America, Jerome Powell, signalled a faster winding down of the Bank’s massive bond buying programme.

Powell also retired the word “transitory” when describing the inflation outlook. Both developments are consistent with the Bank conditioning markets for a future rise in interest rates.

From a short-term perspective, the market fall at the end of November might be explained away as month-end selling simply amplified by the latest coronavirus concerns. Certainly, markets have entered the final month of the year on a comparatively more stable footing, suggesting the “Santa rally” that has seen us through many previous Decembers may yet unfold.

In any case, there are a number of reasons to expect markets to be more volatile in the year ahead than they have been in 2021. The sentiment see-saw caught between signs of strong economic growth on the one hand and fears of a gradual withdrawal of central bank support for asset prices on the other is set to intensify as central banks move closer to adjusting their policies.

Moreover, the very strong recovery in corporate earnings we have seen over the past year looks set to diminish, as easy year-on-year comparisons with lockdown periods in 2020 pass by.

When markets are volatile it can prove more difficult for investors to keep their sights set on their goal of participating in the attractive longer-term returns of stock markets and it can complicate the decision-making of savers moving closer to retirement.

This is a time when the value of expert advice becomes even clearer. It can help both types of investors make judicious plans and ensure their portfolios are sufficiently diversified, not only in terms of geographies and the types of assets employed, but also via the phased investment or drawdown of available funds.

What does the volatility mean for your clients’ pensions?

Stock market volatility is a particularly important issue for personal pension savers nearing retirement, as the amounts available for income drawdown at and after retirement will vary as share prices fluctuate. Phased withdrawals negate some of this risk, but it is also important to ensure that your clients’ portfolios are diversified and skewed away from inherently volatile assets.

In general, that means favouring developed over emerging markets; shares in companies with defensive earnings; investments where dividend income makes up an appreciable part of overall returns; and a proportion of other assets that have a tendency to be decoupled from shares – bonds, property and gold, for example.

Workplace pensions’ default investment strategies generally reduce exposure to shares in the years leading up to retirement and buy more bonds, which reduces the risk of seeing investment values fall. However, this also limits the ability of a portfolio to bounce back when conditions improve.

What does the volatility mean for your clients’ savings?

There are good reasons to maintain the faith in the stock market, but diversification is the key here. The aim should be to maintain a portfolio with the capacity to be resilient in the face of the unexpected. In practice, that really means having exposures to a diverse range of equities and other assets. When individual shares and markets begin to diverge from one another due to an adverse news event, a diverse portfolio begins to work straight away, cushioning the blow.

Your clients may also be able to achieve a smoother ride by investing regularly as opposed to all in one go. A regular savings plan will automatically buy more fund units or shares in months when markets are down and fewer when markets have risen. That leads to lower average buying prices over time.

What does the volatility mean for your clients’ mortgages?

It looks likely that we are now moving towards a period of higher mortgage rates after an extended period where rates have been held down by an historically low Bank of England Bank Rate, increased competition among lenders and a glut of bank cash due to quantitative easing.

Markets have recently been indicating they expect the Bank Rate could reach 1.3% by the end of 20221, from its current historical low of 0.1%.

Fluctuations in the share prices of banks with large mortgage books like Barclays and Lloyds Banking Group as well as bond yields over recent days suggest the market currently believes the range of possible outcomes for interest rates has been increased by the Omicron variant.

But interest rate rises are much more likely to be determined by responses to inflation rates which, because of fragile supply chains and labour shortages, could remain at somewhat elevated levels even in the face of a loss in consumer demand. Thus, volatile financial markets may have even less of an impact on the decision-making processes of policymakers than might otherwise have been the case.

It’s important to remember through all of this that the backdrop for shares remains largely positive. The world’s economies are expected to continue to grow at a healthy pace over the next two years – by about 4.5% in 2022 then 3.2% in 2023 according to the OECD, as of yesterday – and that should help to drive corporate earnings further northwards.2

Finally, shares continue to represent good value in relation to the other major asset class – bonds.   An earnings yield of 5.9% and dividend yield of around 3.6% for the UK stock market tower above the 0.8% yield available from benchmark 10-year government bonds.3 That’s a big difference in favour of shares.

1 Bank of England, 4.12.21
2 OECD, 2.12.21
3 MSCI, 29.10.21, and Bloomberg, 2.12.21

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