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Friday, May 20, 2022

Inflation, not COVID, is now keeping investors up at night

However, if an increase in inflation comes as a surprise, we can expect rate hike expectations to rise as well. The cash rate is expected to reach 1.5 per cent by the end of 2023, at the start of the tightening cycle, and to end at 2 per cent by the middle of 2024. Ultimately, regulators and central banks want a healthy debt market and will want to avoid shocking markets that are too tight of monetary policy relative to market expectations.

With the massive rate hike, investors now turn to two key questions. Will economic growth in 2022 reach the market’s high consensus expectations, or will cyclical growth disappoint? Another important question is the speed at which the central bank will eliminate the impact of its bond purchase program and the liquidity and risk premium.

The market has high expectations for global growth – almost double the trend rate of the past five years, leaving much room to be disappointed should growth return to normal.

Consumer confidence is already down due to high inflation and a flattening of the yield curve in the bond market, both of which can indicate disappointing growth that could be just around the corner.

Should central banks be forced to raise rates to manage inflation, while growth is below expectations, it is likely to create more volatility in the market. Additionally, the Fed has indicated that it may end its bond buying program at a faster pace than previously thought. We saw a preview of this in 2018, when the Fed raised rates closely after a quantitative tightening, which resulted in a 20 percent market correction in equities and eventually eased back into 2019.

This time around, the Fed has indicated that it will employ these monetary tools together. If we see a slowdown in central bank bond purchases in a slowing economy, it could lead to a fall in share prices as the market demands higher risk returns for stocks in such periods.

What does this mean for investors?

We have already started seeing some volatility in equities, but this could be just the tip of the iceberg.

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One easy way that investors can begin to position for further volatility is to focus on low beta, defensive sectors within the market, such as health care stocks, locally and globally, consumer staples and non-cyclical technology sectors. It’s also important to focus on a quality balance sheet and earnings growth. Downside hedging through the derivatives market, such as options, is also a highly effective and cost-effective way of protecting against risk and volatility.

Lastly, investors should always follow the golden rule – diversification. Hold a variety of assets so that your portfolio can continue to perform throughout the economic cycle, including during times of recession.

The past three years have seen double-digit equity returns on the back of economic growth, with rate cuts and central bank bond purchases boosting liquidity. While the next 12 months may be a different story, if economic growth misses market expectations, investors can take comfort in the fact that both the RBA and the Fed committed to signaling policy changes well in advance. That is, leave time to adjust the portfolio when necessary.

However, by diversifying a portfolio, including portfolio hedges and defensive sectors, investors can prepare themselves for increased uncertainty and a volatile year ahead.

The advice given in this article is general in nature and is not intended to influence readers’ decisions about investments or financial products. They should always take their own professional advice which takes into account their individual circumstances before making any financial decision.

Peter Moussa is the Senior Investment Specialist at City Australia.

World Nation News Deskhttps://www.worldnationnews.com
World Nation News is a digital news portal website. Which provides important and latest breaking news updates to our audience in an effective and efficient ways, like world’s top stories, entertainment, sports, technology and much more news.
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