Market volatility – the wider context and long-term considerations

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Reaction to the UK government’s mini-budget continues to be a major challenge to hit markets. However, it’s just one of many longer-term economic and political challenges causing uncertainty and volatility. It’s a lot for members to cope with. But it’s not all bad news. Read our perspective on what’s driving markets and what it means for defined contribution (DC) pension investments.

There’s been a whirlwind of financial news for investors and members to get to grips with. Events following the UK government’s mini-budget would challenge those with the steadiest of nerves.

Due to a combination of the cost of living crisis, rising interest rates and mortgage rates, members of DC plans may take action that inadvertently hinders their long-term pension benefits. This could include reducing or stopping pension contributions, or accessing pensions early to pay for essentials or to reduce debt (such as a mortgage).

It’s crucial to take a step back, however, and understand what’s driving the markets and pension investments, and remember the long-term nature of a pension investment. This way, we can seek to reassure members so that they don’t make costly decisions where they don’t need to.

We spoke to Gareth Trainor, Head of Investment Solutions, to get his perspective on what’s driving markets over the short- and longer-term and what it means for pension investments.

Standard Life is part of Phoenix Group, the UK’s largest long-term savings and retirement business. We work closely with our colleagues at Phoenix Asset Management to determine the outlook for markets and the investment strategy for our pension solutions.

Gareth, what’s going on?

A combination of short and long-term economic and political factors is driving investor uncertainty and considerable fluctuations in markets.

The reaction to the UK government’s mini-budget was dramatic. But it’s a continuation of financial markets jostling to take account of broader economic and political challenges. These include our emergence from Covid-19, the war in Ukraine and increasing inflation concerns in most major economies.

This is a lot of unsettling news for members to cope with, and it’s natural they may feel tempted to react to what’s going on in the short-term. You can find educational and reassuring messages for members in, "Uncertain times and market fluctuations – what does it mean for your pension investments?" that you may find useful.

What’s happened since the UK mini-budget?

There was a swift fallout from the UK government’s mini-budget on 23 September. Most of the initial reaction came down to investor concern about how the government would pay for its proposed tax cuts. This added to existing investor concern about how inflation is being managed.

A series of headline-grabbing events saw everything from the pound plummeting to a 37-year low, a UK gilt (government bond) sell-off, criticism from the International Monetary Fund on the UK government proposals, and Bank of England intervention. The government then – over the course of three stages – reversed almost all of the previously announced changes in a bid to stabilise markets. The resignation of Prime Minister Liz Truss followed days later.

Although the value of the pound has recovered at the time of writing, we expect market volatility to remain. This will be the case until investors feel more confident about the government’s plan for tackling high inflation and the cost of living crisis – and until global economic uncertainty settles.

So this is about more than the recent events in the UK?

Yes, what happened in the UK following the mini-budget is not the main driver of the markets currently. Equities have been going through a period of decline in value, mainly driven by wider geopolitical and economic factors. Although they enjoyed a brief respite over late summer, they’ve since dipped. Generally speaking, higher interest rates tend to negatively affect earnings and stock prices. So with the aggressive interest rate hikes we’re seeing globally to try to combat inflation, equity valuations are being impacted.

Similarly, bond prices have been falling, which means their yields (the amount of income the investor gets as a percentage of its price) have been rising. In fact, a broader repricing of bonds has been underway all year in both government and corporate bonds. Rising yields globally are being exacerbated by rising interest rates and monetary policy tightening.

It’s also a similar case for most currencies, which have been weakening against the US dollar all year. The dollar has been gaining due to the relatively stronger economic growth outlook in the US (compared to the Euro-bloc and UK, for example), and more aggressive interest rate rises in the US than in Europe or the UK.

Is a weaker pound good news for some?

UK stock markets can be a net beneficiary of a weakening pound. This is because a large proportion of revenues for the largest listed UK companies is generated outside the UK – so a weaker pound can translate into a boost to sterling-based profits.

And if the pound is weaker, it means that global currencies such as the US dollar are stronger. Given most of our investment solutions are diversified globally, this means members can benefit from the overseas holdings in their plans rising in value just because of the currency moves – it’s an example of why it’s sensible to diversify between regions and asset classes.

Is there any other good news?

Yes, especially for members early on in their contributions journey. The current climate means that many investments are essentially cheaper than normal – selling at less than they’re likely to be worth in the long term.

So the money you and your members pay into their pension is effectively buying some investments at a cheaper price. In other words, your members are getting more for the money invested in their pension.

How is this affecting investment solutions?

With many asset classes experiencing falls at the same time (positive correlation), it’s been a challenging year for most multi-asset funds, which have suffered negative performance on an absolute basis.

As I mentioned earlier, the weakness of sterling has been beneficial to those funds with overseas currency holdings, especially exposure to the US dollar. This positive from currency has offset falling values in some of the same markets. Higher-risk funds, with typically higher foreign currency exposures will have benefitted more from this than lower-risk funds. Higher-risk funds also have a much lower allocation to gilts.

How does the Standard Life investment strategy respond to the challenges we’re seeing?

Our rigorous governance framework means we’re constantly monitoring our solutions to ensure they continue to meet their objectives. Given their long-term nature, we’re wary of making knee-jerk changes to our solutions in response to short-term volatility, particularly when asset class performance is so closely correlated.

Working closely with our investment colleagues at Phoenix Asset Management, we take account of market cycles in producing our long-term forecasting across asset classes and risk. This analysis is not showing that changes are needed to our asset allocation currently. However, we are closely monitoring the evolving landscape and will act where necessary.

During our last strategic asset allocation review, we took steps to minimise (to some extent) the impact of rising interest rates in our bond holdings. For example, in our Sustainable Multi Asset Growth portfolios, we introduced short-duration (meaning lower interest rate sensitivity) corporate bond holdings in our fixed income allocations.

What’s the outlook for markets?

We expect to see more volatility in the months ahead, due to the many economic challenges.

As I’ve mentioned, investors are grappling with more than what’s happening in the UK. Coming out of Covid-19, the war in Ukraine, continuing high levels of inflation, plus rising interest rates will affect many types of investments.

Sterling and government bonds are likely to remain volatile until investors regain faith in the government’s approach to tackling inflation.

Equity markets have seen valuations reset. However, we’ve not yet seen the impact of the worsening economic conditions fully flow through to corporate earnings and profitability.

Gareth, is there anything you’d like to sum up on it?

When markets are volatile it’s easy to focus on the short term and lose sight of longer-term goals. Our default options for employers like you are managed as long-term investments, and are reviewed regularly. So it’s important to reassure members about the long-term nature of their DC pensions and the dangers of reacting in the short term if they don’t need to.

The information here is based on our understanding in early October 2022 and shouldn’t be regarded as financial advice. The value of pension plans and other investments can go down as well as up and may be worth less than what was paid in.