March Wrap Up: A month of uncertainty

It was a chaotic month in geopolitics and in global financial markets. The Iran conflict and the effective closure of the Strait of Hormuz, a global oil superhighway, sent oil prices higher and threatened the supply of numerous systemically important industrial commodities. 

Investors are rightly concerned that this may lead to higher inflation and weaker economic growth. Not good news for asset prices. The MSCI All Country World Index, a broad measure of global share performance, fell 7.13% for the month in local currency terms. The global equity sell-off was compounded by headwinds facing other assets, like fixed income, that typically cushion portfolios in difficult times. According to reporting from the Financial Times, this "perfect storm" resulted in the largest monthly drop for the traditional 60/40 portfolio since 2022. 

It can be hard to know how to respond in times like this. Confusion abounds, headlines change every day and sage advice of what's going to happen next and how best to respond comes at us from every corner of the internet. Most of this turns out to be wrong. 

As hard as it is, in my view, this is the time to slow down decision making, to think carefully about what we are trying to achieve with our investments, and to adopt a long-term mindset. 

This doesn't mean ignoring events like the Iran crisis, but ensuring we see these in a broader context. Separating signal from noise isn't easy, but it is a critical element in achieving long-term investment success. 

I focus on three things in times like this.

Being clear about why you are investing helps perspective. This is particularly useful in difficult times but can also help avoid overexuberance in good times too. 

We invest our hard-earned capital today to be able to prepare for the future. This highlights two important aspects of our likely investment objectives and speaks volumes about how to respond to challenging markets. 

Two considerations for your next steps:

1. The first is time. Since 1928 the US share market has fallen by 10% or worse 56 times.  Each one felt scary at the time, but that didn't get in the way of the market marching progressively higher over the years. The numbers paint a picture. After a fall of 10% or more the US market has been higher a year later 83% of the time, and higher after three years 93% of the time. Patience is rewarded.
   If your investment objective is long-term, you have time to absorb bumps in the road. It may not be easy, but it is profitable.
   
   
2.  The second important aspect to consider is that our investment strategy is designed with the future in mind. This means that the impact of inflation, higher prices for those goods that we seek to consume in the future, needs to be at the centre of our investment decision-making. 

We bake inflation protection into portfolio design. Shares, infrastructure securities, gold and inflation-indexed bonds all help provide inflation protection, but all deliver returns that are more volatile than defensive assets like cash or nominal bonds. Defensive assets, and in particular cash, have delivered less than inflation over long periods of time when the impact of tax is considered. 

Being too defensive makes achieving our objective of consuming more in the future very hard to achieve. Keeping this in mind in difficult times is a useful reminder that while avoiding volatility might feel comfortable, it is not a recipe for long-term investment success.

While every event that shakes financial markets is different, history can still be a useful guide on how events typically unfold and translate through market prices. 

While we touched on the broader history of market returns above, we have gone one step further as we consider the Iran crisis. We did this by looking at the market impact of previous conflicts.  The key takeaway from our analysis is that the average conflict results in a short-term drawdown of roughly 5% (using the S&P 500 as a proxy), with the market recovering its losses over an average of 47 days. After 12 months, the S&P 500 has been higher 68% of the time following these events, mirroring its standard long-term return distribution.

Broad market history, as well as the history of markets through conflict, suggests patience will be rewarded.

The final touchpoint for me when markets are difficult is investment process. Process helps position portfolios for a crisis before it happens, to the extent that is possible. It also helps guide decisions as markets sell off, helping avoid knee-jerk reactions and giving confidence to embrace any opportunities that may surface as prices fall.  

While we claim no prescience for the Iran crisis, we have, for some time, been considering the risk of geopolitical fragmentation in our investment approach. This mega force has wide reaching implications, increasing the risk of conflict as well as driving up defence spending and changing the wiring of global supply chains.

We have responded to geopolitical fragmentation by including an allocation to gold in our portfolios, which is a good geopolitical risk hedge. Gold performed incredibly well in the lead-up to the conflict adding value in portfolios. It performed so well, in fact, that our process led us to reduce exposure prior to the outbreak in hostilities, a move that proved right, as investors took profit in gold once conflict broke out.

Increased geopolitical risk, persistent fiscal deficits and the onshoring of supply chains also led us to favour inflation protection in portfolios. Being positioned for higher inflation has proven useful in this crisis with higher prices for oil and other industrial commodities reverberating throughout the global economy. 

Where to from here? Our process focusses on the medium-term return outlook for broad asset classes like shares, fixed income and cash. As prices change our outlook for the returns of those asset classes change. Should they move sufficiently we will respond and change the positioning of our portfolios. 

While this is a live consideration, to date our outlook hasn't changed sufficiently to warrant a change to portfolios.  

Our process helps keep us focused on the signal, not the noise - ready to respond when material opportunities or risks present themselves, rather than responding to every news headline.

Frank Jasper
Chief Investment Officer, ASB