Don’t Panic

Scary economic headlines dominate the news, but by the time you read them, the risks are already priced in, explains economist Ed McKnight.

It seems like there is bad news for investors and the economy everywhere you look. Business confidence is approaching record lows, house prices are falling, and consumers are wary of spending more. And the bleak headlines will likely continue for some time. Despite this, there are four reasons why investors should not base their investment decisions on what the mainstream media reports.

1. Markets are forward-looking

Sometimes you read a scary headline, and the impact on the market is exactly nil. That’s because markets already price in known and likely events. If a scary news headline re-states what was already known, then there is no impact. Take the example of rising interest rates. Soon there will be headlines stating that the Reserve Bank has increased the OCR (again). When inflation is next reported, there will be articles about how prices have risen far outside the Reserve Bank’s target band of between 1 per cent and 3 per cent. This would usually suggest that mortgage interest rates are likely to increase further. They won’t. And that’s because the increase in the OCR is already factored in. Banks have already set their interest rates with a rising OCR in mind.

The Reserve Bank knows this. When asked at a recent press conference what impact a rise in the OCR would have on mortgage interest rates, the Reserve Bank Governor Adrian Orr played down the effect.

You tend to want to make changes when things aren’t going your way. But the pain currently being experienced by investors is normal and expected.

“We are just confirming what market pricing had already got to,” Orr said. When speaking about future OCR increases, he added, “Mortgage interest rates are already pricing in that forward look for us.” The danger for many investors is they are caught up in today’s headlines – and the state of today’s economy – as opposed to considering where the economy will go in the future. Be careful, the news contained within those headlines may already be priced in.

2. Economic forecasts are often wrong

No economist puts out a forecast expecting it to be 100 per cent right. (I can say that. I am one.) We know that time will prove our forecasts wrong. That’s because unexpected and unknowable economic events will shake asset markets. And if we didn’t know about an event … it won’t have been included in the projections. When you read a news story quoting an economist with a solid-sounding forecast, think of it more as a technical projection. It’s a scenario based on current known factors, not a reliable forecast you should use to inform your investment strategy. Economists can only hope to get in the right ballpark. They’re never exactly correct and are often proved wrong. As the former Reserve Bank Chief Economist Young Ha said, “Asset prices are notoriously hard to predict.”

3. News articles are short-term focused

News articles are often based on what happened last year or what may happen over the next year. However, investors tend to have longer time horizons than just a year or two. It doesn’t matter whether share prices are up or down today. What matters is the longterm trajectory. You’re investing for five, 10, or 15-plus years. News journalists don’t know your financial goals or investment time horizon. Their job is to report current changes. Let me give you an example. Since the start of 2022, the S&P 500, a popular stock market index, has been down 18.7 per cent. You can imagine the headlines: “Stock market down almost 20 per cent. ‘It’s a bloodbath,’ experts say.” But why should that concern you if you are a long-term investor? You should only be concerned about the ultimate trajectory of your portfolio and its value at the time you sell your position. A more useful – but less attentiongrabbing – headline would be: ‘S&P 500 up 7.1 per cent per year over the last 20 years.’ Short-term blips don’t matter – assuming you’ve purchased the right assets.

4. There’s little alternative to investing

While you could invest in many things, there is little alternative to investing (as a whole). That’s because most Kiwis need to grow their wealth for their retirement, their family and themselves. And over the long term, investors make more money from the compound impact of investing rather than savings alone. Say you put $100 a week into a stock index fund. Then the market increases by 7.1 per cent each year*, as it has done for the last 20 years. After two decades you would have made more from the market going up in value ($129,750) than you’d made from putting money into buying the shares ($104,000). Put simply, the price of not investing is that you are poorer than you would otherwise be. The trade-off, however, is that you must weather the ups and downs of the markets.

Short-term pain, long-term gain

You tend to want to make changes when things aren’t going your way. But the pain currently being experienced by investors is normal and expected. There is a real danger in making a knee-jerk reaction and changing your investment strategy based on news headlines and negative market sentiment alone.