OpenMoney Q2 2021 Investment Commentary

The OpenMoney team

July 28, 2021

Don’t fear the Bear

“You make most of your money in a bear market, you just don’t realize it at the time.”

Shelby Davis – Investor and Philanthropist

Bears are animals that most of us would agree are best avoided, unlike Paddington, who is partial to the odd Marmalade sandwich, most real-life bears would happily make a meal out of any human that strayed too close. Thankfully, although scary, Bears in financial markets are not to be feared.

But what does a Bear actually mean in the context of financial markets? Although no universally agreed definition exists, it’s widely accepted that a Bear market represents a price decrease of more than 20% relative to a previous peak. And why do we use the name “Bear” as opposed to something less intimidating? Well, this is due to how Bears attack their prey, swiping their paws downwards; and when markets are on the up, we name them Bulls, as Bulls thrust their horns up while attacking. Markets cycle between Bear and Bull markets but over the long run, there is only one direction that we want financial markets to head: up!  

Source: Timeline (2021)

Of course, a 20%+ decrease in a portfolio’s value would cause even the most seasoned investor some anxiety. It’s only natural to become unnerved when financial markets start to drop, and the 24hour news media predicts nothing but financial Armageddon. However, it’s not the Bear market that will have the greatest impact on the long-term return of a portfolio, rather it’s the actions that investors take during the Bear market that have the greatest impact.

During a Bear market, less disciplined investors seeing the value of their investment fall will be tempted to throw in the towel, to cut their losses. In fact, this is possibly the worst course of action. By doing so the investor locks in those losses and misses the inevitable market rebound. To make matters worse, an undisciplined investor having sold out during the Bear market will be excited by the subsequent Bull market and re-invest. An investment strategy based on selling low and buying high is not a sound strategy!

The hardest part for those investing over the long term is accepting that things will not always be plain sailing; Bears are as natural to the forests as they are to financial markets. What’s more, despite the claims of some, we can’t predict when they will happen, what will cause them, the size of the downturn or the time taken for the market to recover. The chart below serves to illustrate these points.  

As we can see below, over the last 100 years the UK market has endured eleven Bear markets with initial causes ranging from the Great Depression in 1929 to the Dot-com bubble in 2000. What’s striking is the different duration of each Bear market, the path to recover and the time taken for that recovery; each Bear market has been truly unique. Nevertheless, we can take comfort in recognising that markets always do recover.

Source: Timeline (2021)

This chart illustrates the importance of remaining invested, even when things don’t look promising. Let’s examine the deepest and one of the longest UK Bear markets, which started in June 1972 and lasted 58 months. An initial investment of £100,000 made at the start of that market downturn would have fallen by almost 70%, arguably, holding one’s nerve when exposed to such losses would be a difficult task. But remaining invested would have allowed the investor to capture the subsequent 154 months Bull market and would have seen their investment grow to £1,207,159!

In summary, while financial Bears are by no means as harmless as the marmalade loving Paddington, if investors understand their nature and give them the respect they deserve, they need not be feared. Smart investors know that both Bears and Bulls exist naturally in financial markets. Although the Bear has appeared grumpily from hibernation, powerfully swiping at the financial markets on numerous occasions, the Bear inevitably becomes weary, allowing the Bull to re-establish itself as the dominant force over the long-term.

How have different asset classes performed?

The second quarter of 2021 saw a continuation of the global economic rebound which started soon after the initial shock caused by the pandemic early last year. In fact, no longer recovering, the global economy appears to be transitioning from a Bear market into a new Bull market. The sharp decline followed by an equally sharp and sustained rise, within just eighteen months means we have observed the sharpest ‘V-shaped’ economic recovery in history.

Source: IMF (2021)

Vaccinations are essential for the full re-opening of economies and as expected the richer, more developed nations are leading the charge. However, even across the developed world, vaccination rates vary hugely. As of the end of June, the UK had fully vaccinated 49.6% of the population, the USA 47.2%, France 31.4%, Germany 37.3% and lagging far behind, Japan with 12.4%[1]. The importance of vaccination is highlighted by Japan, whose recovery has been hampered by local lockdowns[2] in response to outbreaks of the virus.

The US is still driving the world recovery, with US equities returning 7.5% over the quarter[3]. The IMF has forecast that the US economy will grow by 7% this year, up from a forecast of 4.6% made in April.[4] This would be the fastest growth in the US economy since 1984.  

Source: FE Analytics (2021)[5]

While the Eurozone has lagged the recovery seen in the US due to persistent lockdowns and a slow vaccination programme, European markets appeared to be very much on the up, with equities returning 7.2%[6] over the quarter.  

So, it would seem good news all-round? Well, not exactly. While equities have recovered strongly, bond returns over the 1-year period have been negative; with global bonds returning -6.9%[7] and UK government bonds returning -8.2%[8]. Admittedly, bonds have never been the coolest part of investments but their importance in a well-balanced portfolio is widely acknowledged. Equities are there to drive returns and bonds are there to provide a cushion, as they did in 2020, when times got bad.  

Source: FE Analytics (2021)

Unsurprisingly, bonds have not kept up with the rebound of equities as we would expect. The majority of the negative performance over the last year is restricted to the beginning of 2021. Essentially, we are back to where we were before the pandemic hit.  

While overall the world economy appears to be well on the mend, based largely on the strong rebounds from a few major economies, not all countries have yet to fully recover. Many emerging economies continue to struggle with the pandemic with low vaccine rollouts caused by vaccine hesitancy, supply issues and logistical problems with distribution. China is a notable exception despite a slow vaccine rollout, strict measures to control outbreaks have been effective and economic growth is projected to reach 8.5%[9] in 2021.

Despite the disparity of the economic recoveries between developed and developing countries, the Organisation for Economic Co-operation and Development (OECD) expects global Gross Domestic Product (GDP) to rise 5.8% this year, up from the December 2020 forecast of 4.2%; this would be the highest rate of world economic growth since 1973.[10]

Inflation on the up?

Even with the reassuring second quarter and an encouraging outlook there is one economic indicator that is causing some concern: inflation. Why should investors be concerned about inflation? Well, inflation is the ultimate tax, taking away the buying power of money. Inflation is a concern to investors that hold fixed income investments that are not indexed to inflation. As inflation rises the fixed payments received can buy less and less. This highlights the importance of maintaining a diversified multi-asset investment portfolio, much like OpenMoney’s portfolios.

Inflation is currently rising in those markets which have seen the fastest economic recovery. For example, in the US, inflation hit 5%[11] and 2.1%[12] in the UK as of May with predictions of further increases over the coming year. The consensus amongst Central Banks so  far is that the spike in inflation is temporary  and, given recent events, not unexpected. The Governor of the bank of England, noted in a recent speech:

“It is important not to over-react to temporarily strong growth and inflation, to ensure that the recovery is not undermined by a premature tightening in monetary conditions. But it is also important that we watch the outlook for inflation very carefully.”

Andrew Bailey, Governor of the Bank of England (2021)[13]

Reviewing long-term UK and US inflation data, adds support to the Governor’s position on inflation. While current inflation is elevated, over the last 30 years, historical data shows that even during periods of low inflation, spikes of inflation have occurred and have proved to be temporary.

Source: Federal Reserve Economic Data (2021)

Portfolio Performance(14)

OpenMoney Cumulative Gross Performance

Our portfolio returns continue to build on the momentum which started in late 2020. Returns over 1, 3, 5, and 7 years continue to remain positive  across all three risk levels. All three portfolios have performed well and continue an upward trajectory. Portfolio 3, with its higher exposure to equity, has the strongest performance across all time periods.  

Source: Betafolio (2021)
Source: Betafolio (2021)
Source: Betafolio (2021)

Data sourced 15/07/2021. OpenMoney portfolios have been running since April 2017, therefore returns before this date are simulated based on the performance of OpenMoney's underlying investments. Past performance is not an indicator of future returns.

References

[1] Our World Data. (2021). Statistics and Research - Coronavirus (COVID-19).

[2] BBC. (2021, July 4). Coronavirus: Japan's mysteriously low virus death rate.

[3] MSCI USA: 01/04/2021-30/06/2021

[4] International Monetary Fund. (2021, July 1). United States of America Concluding Statement of the 2021 Article IV Mission.

[5] Global Bonds: Bloomberg Barclays Global Aggregate, UK Gov Bond: Bloomberg Barclays Global Aggregate UK Government Float Adjusted, UK Equities: FTSE All Share, Global Property: FTSE EPRA Nareit Global, Emerging Markets Equity: MSCI Emerging Markets, EU Equities (ex-UK): MSCI Europe ex UK, Japanese Equities: MSCI Japan, US Equities: MSCI USA, Global Value Equities: MSCI World Small Value, Global Equities: FTSE Global All Cap, UK Inflation (RPI): UK Retail Price Index.

[6] MSCI Europe ex-UK: 01/04/2021-30/06/2021

[7] Bloomberg Barclays Global Aggregate Index

[8] Bloomberg Barclays Global Aggregate UK Government Index

[9] [10] OECD. (2021). OECD Economic Outlook, Volume 2021 Issue 1.

​[11] U.S. Bureau of Labor Statistics. (2021). Consumer Price Index. Retrieved from U.S. Bureau of Labor Statistics.

[12] Office for National Statistics (ONS). (2021). Inflation and Price Indices.

[13] Bank of England. (2021, July 1). It’s a recovery, but not as we know it - speech by Andrew Bailey.

[14] All data is up to last price –30 June 2021. Past performance is no guarantee of future return. Data sourced from Morningstar API. Careful consideration has been taken to ensure that the information is correct but it neither warrants, represents nor guarantees the contents of the information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Percentages may not total 100 due to rounding. Performance Periods: 1 Year: 30/06/2020-30/06/2021; 3 Year: 30/06/2018-30/06/2021, 5 Year: 30/06/2016-30/06/2021, 7 Year: 30/06/2014-30/06/2021. Additional performance periods may be accessed with the help of your adviser via the Betafolio Control Centre.

European Parliament. (2021). EU Economic Developments and Projections.

IHS Markit. (2021, June 23). US and Europe report strong growth in June as Japan contracts.