A Rough Start
The market has been weighed down by a host of worries this year.
The market has enjoyed a strong rally so far this year, hitting new highs before inflationary concerns brought the major indexes lower. Year to date, the S&P500 is up <green>+11.50%<green>, while the TSX is up <green>+12.23%<green> .
However, some of the more speculative corners of the market have witnessed vicious downturns lately. And most conspicuously, this has happened in bitcoin; at one point, its price dropped more than <red>-50%<red> from its mid-April peak . In our previous newsletter, we advised clients caution when looking at bitcoin and other cryptocurrency. We want to reiterate our stance on this. We believe cryptocurrency assets, in their current form, are pure speculation. As currency, crypto is far too volatile to be used effectively as an instrument of exchange. For example, why would you buy a $38,000 car, using bitcoin today, when you could wait and that same coin might be worth $42,000 tomorrow? As a seller, why would you accept that $38,000 bitcoin as payment when it might be worth $34,000 tomorrow? Is there money to be made trading in Cryptocurrencies? Sure! Just like, there is money to be made gambling at the track. Since cryptocurrencies, like bitcoin, have no intrinsic value, their real world worth is determined by finding someone else to come along and ideally offer you a higher price than what you would have paid. This, of course, is the very definition of speculation and we caution our clients to stay clear of them despite the selloff.
The global economy continues to recover from one of its worst slumps in recent history . As vaccination ramps up and Covid-19 cases dwindle down in many parts of the world, major economies are beginning to re-open . However, as economic activity picks up, the market wrestles with a new concern: surging inflation. The most recent readings show that the U.S consumer-price index (CPI) increased +4.2% in April from the year before, the highest 12-month level since the summer of 2008 . Canadian CPI also showed a +3.4% rise in April . The CPI index measures what consumers pay for goods and services, such as food, clothing, vehicles, etc.
The recent price surge can be attributed to a host of factors. For instance, the world was in lockdown this time last year, and this not only resulted in a lower base rate for comparisons this year, but it also led to pent up consumer demand waiting to be unleashed as economies re-opened; all the while supply and labor has not adjusted fast enough to fulfill the sudden burst of demand. Furthermore, the unprecedented fiscal and monetary policies that were implemented as a result of the pandemic gave excess cash to consumers, which is further fueling the already voracious demand.
This upturn in inflation has caused a mini selloff in the equity markets as investors feared that a prolonged rise in inflation would force the central banks to raise interest rates in an effort to contain it. Some investors believe central banks will have no choice but to increase interest rates as inflation spirals out of control.
Despite this fear, however, Federal Reserve Chairman Powell stated on numerous occasions that the surge in inflation is “transitory”, and the official Fed stance is that it will be patient with raising interest rates . This stance is mirrored by central banks in other countries as well . Moreover, we must also keep in mind the recent spike in inflation is not altogether surprising to central banks. The Federal Reserve last year adopted an average inflation targeting goal, allowing short term inflation to rise above its long-term target of 2% to make up for the times when it fell below this target . Thus, it could be argued that this inflationary spike is within the tolerance of the Fed, and thus it will not be forced to act.
We are seeing real tailwinds pushing up inflation in the short/medium term. Yet, whether high inflation persists in the long run is debatable. For instance, global economies are just beginning to reopen, and major supply chains have not yet had time to readjust their output, resulting in demand momentarily outpacing supply. However, this bottleneck won’t last forever, and supply will eventually catch up. Additionally, we must keep in mind that inflation had been well short of the Fed’s target in the past decade in part due powerful forces such as tech innovation. Tech innovation has led to increased productivity and automation, allowing the economy to produce more with the same resources, hence exerting a downward pressure on inflation. This powerful force has not disappeared as a result of the pandemic, and it will likely keep inflation lower in the long run.
In the short term, we believe inflation scares will continue to rock the market from time to time. This will, of course, affect the real rate of returns on investments. This is particularly true for bonds and other fixed income investments. Inflation will likely erode much of the paltry returns bonds can deliver in this environment.
However, we had already taken steps that protect your portfolios against the ravages of high inflation over the past year. For instance, we took our bond and fixed income investments down to the lowest allowable bands across all our mandates. Moreover, many of our equities investments are relatively protected from the effects of high inflation. A good percentage of our companies don’t require a lot of assets and capital investments to operate, thus in an inflationary environment, they don’t need to keep investing more and more money to produce the same output, hence shielding them from the effects of inflation.
As it stands now, we are not altogether too surprised or concerned with runaway inflation. However, we will continue to monitor inflation and its effects, and we will make adjustments to your portfolio if the situation requires it.
1 Factset May 25 2021 Price Return – End of Trading Day