The economic and coronavirus news remains grim, yet the markets have remained on largely an upward trend. Why? Inflation is coming.
With the news last week that the U.S. economy shrank at a historically annualized rate of almost 33% in the April to June quarter along with news that the U.S. Federal weekly unemployment benefit of $600 has been cut in half with a legally questionable move to defer U.S. payroll taxes, one might expect panic on Wall Street.
But this has not been the case. While the economic and profitability numbers may be understandably unsettling – despite the avalanche of bad news which includes riots, an out of control pandemic and ongoing layoffs, equities have remained remarkably strong. They’ve recovered in almost a V shape from the massive pullback this past spring.
Given the widespread understanding that the world is going to be in this mess for quite some time, this obvious question is why? Why are equity markets holding together with such tenacity when everything around looks bleak.
The answer we believe can be found in deficit financing. Or more precisely, the historically inevitable reaction to it.
Around the globe, governments have been printing money at historic rates.
With interest rates at virtually 0%, the ability to stimulate economically by lowering rates has evaporated. This is leaving governments no choice but to reinflate their economies by printing money.
So governments are (and can be expected to continue to) printing record amounts of money through Quantitative Easing in order to try and restart the economy. But as opposed to consumers and companies using the newly minted Federal bailout money for consumer spending and hiring, much of this money has actually been used to pay down debt (consumers) and purchase existing investments (companies).
As discussed, traditionally governments use the leverage of reducing interest rates to restart economies in recession. With interest rates at or close to 0%, they can’t do that now. They’re forced to print money. Don’t expect this to change soon. This will have the inevitable longer-term result of driving inflation. That’s a good part of what has been keeping the prices high.
As we’re figuring out that the health of the economy is inextricably tied to the health of a nation, it’s now evident that this Coronavirus problem is going to be a problem for at least a couple of years. So there’s a begrudging acceptance forming that inflation is coming. Like it or not.
And with that, the understanding comes the counter-intuitive realization that the only thing that keeps up in that environment are equity-based investments – or those tied to inflation such as inflation-indexed bonds.
Printed money is not free.
Though it may seem like it costs nothing for central banks to print up some more dollars to spend on sustaining people and projects, the reality is that there are no free lunches. Printing money is really a form of taxation through future inflation.
As governments add to their debt in order to cover current unemployment, stimulus and debt repayment schedules needs, the price to be paid is through inflation.
Want a local example? Consider the price of the steak today versus five years ago.
Although that’s a micro example, the paradoxical realities of a pandemic driven economic collapse is that it can drive asset prices higher. Because historically, they’re the only things that retain value over the long term in any inflationary market.
That doesn’t mean it’s not going to rough. It means we need to take advantage of the opportunities as they avail themselves. That’s why we’re sticking with our strategy of maintaining balanced portfolios while suggesting clients with cash or monthly investments to aggressively buy the dips.
In this no growth or low growth environment (that we will continue to be in for a number of years), it’s exceedingly important to ensure proper diversification of portfolios.
Lastly, while we can count on central governments to continue printing money to ensure social control, what can’t be guaranteed is our currency values.
Thus with countries like Canada reflating aggressively, even in the light of abysmal commodity prices, what we can expect is a weakening Canadian dollar – eroding our purchasing capabilities.
Remember that irrespective of the shorter term direction stock markets take, portfolio managers are in the business of taking advantage of misfortune.
Thus when companies start selling for pennies on the dollar we can count on our professional money managers to take advantage of the situation in order to maximize the opportunity.
Giving the continued deterioration in economic fundamentals and a U.S. election just around the corner, we can expect greater volatility than we have seen to date. And this volatility will continue to provide opportunities for your managers to purchase undervalued companies.
Let’s look at just a few that have happened in the last six months.
Ford Motor Corp hit a low of $4.01 in March. It is now trading at $6.94 per share. Canadian Mutual Fund Company AGF was selling as low as $2.57 a share in March, it’s now at $5.50. And Apple stock, which fell to $224 a share in March has recovered to $446 as of this writing.
All of these examples show how volatility is really the friend of the investor – if you have professionals watching for the opportunities on a day-by-day basis. That’s why professional management of your money works, so well. During the times that we might be afraid to take advantage of opportunity because it looks like the sky is falling, the portfolio managers are not. They understand the macro trends and the longer-term implications of deficit-financed economies.
Finally, to keep this all in a long term perspective, the chart below shows in the long run, the real risk is in holding cash. A dollar in 1900 is now worth less than $.03.
Expect greater volatility ahead. If you’d like to talk to us we’re always around.
We appreciate your patience and your business.
Mark, Sean, Cass, Nancy and Simone.