Farewell 2022, welcome 2023! January kicked off another year for which we're learning to expect the unexpected. Despite the many challenges of 2022 - inflation, war in Ukraine and talk of recession, January marked a positive start to the year. Key stock markets were up around the world including the US, NZ and Australian exchanges.

January saw some optimism here in NZ thanks to slightly lower inflation data, the ‘re-opening’ of China, more consistent energy prices and a small shift from talk of “recession” to a “soft landing” both here and abroad. We don't yet know to what extent the devastating effects of the recent flooding and cyclone will impact the economy, however we remain cautiously optimistic for a slow but steady economic recovery as the year progresses.

Every year there are different challenges and opportunities. The prevailing views indicate the path forward is going to be challenging, as it always is. If there is one thing that we can be certain of, it’s uncertainty. Very few would have picked an internet bubble (1999), a housing bubble (2007), COVID-19 (2020), war in Ukraine or inflation (2022). We think picking markets is a fool’s game - because it’s so unpredictable.

We like to make your investments simple, and there are many complicated terms being used in the news around the economy at the moment. So let's clarify three of them:

Recession
There has been lots of talk about “recession”. This technically means two quarters in a row of negative gross domestic product (GDP) which is the economic output of a country. When this decreases, it indicates that the overall economy is making less money. How this may impact your returns is that companies may revise their earnings estimates down, which could result in lower stock prices; and it could also challenge the ability of some companies to pay debt, indicating there is more risk in the market. This is one reason why a “recession” can be problematic for investors, and why you hear about it so often in the media, as it helps draw readers in.

Interest Rates
Related to a “recession” in this case are increasing “interest rates”. The interest rates are set by the Central Bank. An interest rate is the cost of money. In New Zealand, our central bank is called the Reserve Bank of New Zealand (RBNZ) and in the US, it’s called the Federal Reserve (the Fed). This dictates the rates at which the banks will charge interest on loans for residential housing and to businesses; as well as what they pay you on a deposit account. As the Central Bank increases rates, it is good for savers because they can earn more interest, but trickier for borrowers because they must pay more interest on the same amount borrowed.

The impact of increasing rates is that generally there is more money being paid on the loans, which can result in less money leftover for discretionary spending. This can lead to companies in the share market earning less because people are spending less. There is less money going around for everyone.

Inflation
Why would the Central Banks want to reduce the amount of money going around by increasing interest rates? It’s because of our third key term, “inflation”. Inflation refers to the increasing cost of all goods and services. It’s simple economics, if there is more money (demand) in the economy that is chasing the same supply of goods and services, the price will increase. That’s what happened during the pandemic. Now prices are higher than they were, but wages haven’t kept pace with these price increases. Inflation also makes it difficult for companies to set stable prices, which makes conducting business less predictable.

The Central Banks are trying to take the money (demand) out of the economy to keep inflation under control. The Central Bank’s main job is to control inflation, because the cost of not controlling inflation can often be much more detrimental over the long term than a recession in the short term. That’s why we take a long-term view when it comes to investing. We diversify by owning more than 3,000 stocks in 26 countries. Short-term dips or challenges can be our friend. When prices go down, everything is on sale.

The thought of a recession can be scary for many people, and we get it %) but remember to keep saving and stay the course, so that you can be set up to succeed in the long term!

The information provided and opinions expressed in this post are intended for general guidance only and not personalised to you. These materials do not take into account your particular financial situation or goals and are not financial advice or a recommendation. This post is not intended to convey any guarantees as to the future performance of any of the investment products, asset classes, or capital markets mentioned. Past performance is no guarantee of future performance. Information is current at the time of posting, and subject to change without notice.