Why are financial markets continuing to weaken?

We last reported on investment markets about a month ago. Since then, global share markets have continued to weaken significantly. For instance, the US share market (the world's largest) has fallen about 8% and is now down around 24% (as measured by the S&P500 Index) from its peak only about six months ago.

Closer to home, the New Zealand share market is a bit more insulated from global markets but is not immune to the declines we're seeing overseas. The NZ market is down about 6% (as measured by the S&P/NZX50 Index) for the past month and is down about 23% since its high in late 2021. 

These share market falls are on a scale not seem since the outbreak of COVID-19 or the depths of the Global Financial Crisis in 2007-09.

Inflation wakes from its multi-decade slumber

The primary driver of the weakness in international share markets continues to be what we noted in our previous communications - multi-decade high levels of inflation forcing central banks to respond with rapid interest rate rises, which in turn is increasing fears over the outlook for economic growth. 

Only a few weeks ago, investors thought that inflation, while up sharply from a year ago, might be nearing a peak. However, the latest inflation statistics from the United States, the world's largest economy and reference point for all financial markets, saw annual inflation for the 12 months ended 31 May 2022 rise to 8.6%, with broad-based increases across many categories. More worryingly, separate data showed households' expectations for where inflation could settle over the longer-term spiking higher too, highlighting the risk of higher rates of inflation becoming entrenched. The scale of the recent explosion in inflation is evident in the chart below, which illustrates the consumer price index (CPI) percentage change (over a 50-year period) across various countries and economic regions:

CPI inflationCentral banks have responded to inflation developments by becoming more aggressive in their plans for raising official interest rates to try to crimp demand and reduce inflation. For instance, this month the US central bank - the Federal Reserve Board (Fed) raised its official policy interest rate by 0.75% - the largest single move since 1994. Further large increases appear likely in the near-term. 

This expectation has led to further significant increases in long-term interest rates (bond yields), which are illustrated in the chart below for various 10-year Government Bond Yields over the last seven years:

10-year government bond yieldsMany other central banks have joined the Fed in raising their policy interest rates as they struggled to contain inflation. The sharp increase in interest rates impacts share markets in many ways.

Directly, interest rates (or bond yields) are an important input when calculating a company's long-term value. All else being equal, the higher the interest rate (or discount rate), the lower the valuation. Indirectly, central banks are using higher interest rates to cool economic activity, which then impacts companies' profitability or earnings.

For investors in funds with an allocation to fixed interest (bonds), higher interest rates have led to falls in bond values and negative returns as the price or value of a bond moves inversely to changes in interest rates. While these declines in bond prices will be recovered over the remaining term of the bond, boosting future returns, they have created a highly unusual situation of both shares and bonds delivering negative returns during 2022. More commonly, at least over recent decades, negative returns from shares will be partly offset by positive returns from bonds (and vice versa). 

Based on current levels of share markets and interest rates, it appears that investors now fear a worst-case scenario whereby central banks, in seeking to quell inflation, overshoot and cause economies to slide into recession. 

The outlook

With global share markets having fallen considerably from their highs in late 2021, our investment manager JBWere, judges them to be arguably beginning to offer an attractive risk/return proposition for long-term investors. However, JBWere is not yet prepared to change much in the way of exposure to share markets right now given that global economies are at a delicate juncture for their inflation and growth outlook. 

If inflation shows signs of beginning to fall, shares (and probably bonds too) are likely to increase in value strongly as a lot of bad news on the inflation front is already priced in by markets. However, if inflation proves more persistent, central banks are making it quite clear they are prepared to drive their economies into recession in order to tame inflation, which is hardly a favourable backdrop for share markets (although this would be expected to benefit bond investments). Ultimately, the near-term performance of financial markets hinges on this balance between inflation and growth, which remains highly uncertain. 

As a result, JBWere currently thinks investing in line with funds' long-term target asset mixes, rather than holding fewer or buying more shares, is the appropriate strategy until we have further clarity on the inflation and growth outlook. 

What does this all mean for Members?

Share markets can be unpredicatable, and your investments will perform differently over time. So, it's important to keep the long term in mind and see past any shorter-term peaks and troughs.

All this uncertainty can be unsettling for Members, and that's why it's reassuring to know that you can speak face to face to your dedicated MAS adviser who will work with you to develop a sound investment strategy and help you stick to it during challenging times. There is no additional cost to speak to a MAS aAdviser and they don’t receive commissions.

To book an online or phone meeting, please complete this form and we will be in touch. 

We also have useful online tools to help you:

If you want to find out more about how your investment is performing, you can see weekly updates on fund unit prices and returns on our website here:

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This article is of a general nature and is not a substitute for professional and individually tailored advice. Medical Funds Management Limited and JBWere (NZ) Pty Ltd, their parent companies and associated entities do not guarantee the return of capital or the performance of investment funds. Returns indicated may bear no relation to future performance. The value of investments will fluctuate as the values of underlying assets rise or fall.  

Medical Funds Management Limited is the manager and issuer of the MAS KiwiSaver Scheme and the MAS Retirement Savings Scheme. The PDS for each of the Schemes can be found at mas.co.nz/investments

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