The rise and fall (and rise) of investment returns

Published 21 July 2022

When markets fall and you are a long-term investor, one of the best courses of action could be to do nothing. That can be hard to do when it seems all around you are shouting that the sky is falling. This article looks beyond the reasons for the current drop in investment returns to explain that markets move in cycles and that history shows that a fall, in most cases, is followed by a rise.

The reasons behind the fall in investment returns since the start of the year have been well canvassed. In a nutshell, central banks have raised interest rates in an effort to dampen high inflation caused by supply chain constraints arising from the COVID-19 pandemic and made worse by the war in Ukraine. Prices of equities and bonds – which together make up the majority of UniSaver’s portfolio – have fallen recently, leading to negative returns.

However, it’s important to remember that asset price corrections are a normal part of investing. If investors’ forecast of future economic conditions has worsened, they might revise the fair value of shares, bonds, and other investments downward. Prices retreat usually to some sort of equilibrium where they better reflect corporate earnings and/or the dividend yield looks more attractive. In the case of bonds, price corrections can equally be triggered by a particular economic or financial development. More frequently, as is the case in the present situation, they are triggered by central bank action to contain rising inflation.

As mentioned, sometimes markets react sharply to a single event causing a sudden drop in prices. Fear sets in that prices will fall further. Investors try to get out of markets in anticipation of further falls. This happened in equity markets in March 2020 as COVID-19 spread around the world (followed by a sharp rebound in prices shortly after). Many investors learned the hard way that selling low and buying high was a poor strategy if they were aiming to build wealth in the long term.

The correction in asset values currently being experienced has been a more orderly retreat with prices declining over an extended period. With reference to equities, it comes after the longest bull market in US stock market history, which began during the global financial crisis and ended with the onset of the COVID-19 pandemic – 11 years of more or less steadily rising prices. With share prices falling more than 20% off their recent highs, we are now in a bear market. We don’t know when the turning point will come, but history tells us it will happen – eventually (see S&P 500 example below).


US bull markets since 1990

S&P500 chart showing US bull markets since 1990.

This chart shows the ebb and flow of share prices over the past 30 years as measured by the Standard and Poor’s 500 (S&P 500). The S&P 500 is an index tracking the share performance of 500 large companies listed on stock exchanges in the United States. It covers 80% of the US equities market (by capitalisation). The index is widely seen as an indicator of the health of the US economy.

The tide has turned on the fortunes of so-called ‘growth stocks’ prized in many cases for their potential for future earnings growth rather than current profitability. In a bear market, this shouldn’t be a surprise – the higher something rises, the further it’s likely to fall. In recent years, growth stocks have become synonymous with technology companies, which is not surprising as we live increasingly in a digital world. Value stocks, on the other hand, tend to provide more stable returns over time. For example, pharmaceutical company Johnson & Johnson has never reached the valuation heights of, say, streaming service Netflix. However, Netflix’s share price fell more than 70% in the first 6 months of 2022. On the other hand, Johnson & Johnson’s share price was up 3.5% over the same period. Of course, some investors will have done very well investing in Netflix – if they timed their run perfectly, but this is notoriously difficult to do.

To take an example closer to home, Fisher & Paykel Healthcare might be considered a growth stock. Its share price has fallen nearly 40% over the first 6 months of 2022. Spark New Zealand is a value stock. Its share price has risen nearly 7% over the same period. UniSaver holds both these stocks in its portfolio.

These examples are illustrative. Not all growth stock prices have fallen as sharply as Netflix, and value stocks have fallen in price this year as well. However, it helps make the point that growth stocks tend to be more volatile, and sometimes slow and steady wins the race. UniSaver has benefited this year from having a higher weighting in value stocks than many New Zealand schemes.

Whatever the specific catalyst for the current downturn, it is useful to remember that markets are cyclical. Picking when markets will turn up or down is nigh on impossible. This quote from veteran US investor and billionaire Warren Buffett is apposite: “People that think they can predict the short-term movement of the stock market – or listen to other people who talk about [timing the market] – they are making a big mistake.”

It’s better not to be unnerved and to keep saving. The silver lining of a correction in markets is that prices become cheaper so the new money you invest goes further. At the moment, your contributions are buying more assets than they were 6 months ago. In time, these assets are likely to be worth more than when you bought them. You just need to be patient and have the nerve to be one of those long-term investors who buys low and sells high – and not the other way around.