Despite some recent volatility, stocks have continued to move higher over the past few months. We’ve seen record gains as corporate earnings in the U.S. have recently surprised almost all analysts.
On the S&P 500, a standout 87% of corporate earnings beat expectations. That goes a long way to justify historically very expensive price-earnings multiples.
With the increased profitability, we’re also seeing substantial stock buybacks occurring again in corporate America. This also has the effect of lowering PE multiples.
Ironically, while still an area of concern, valuations are not today’s greatest worry – inflation and the likelihood of increased interest rates is. We talked about this a year ago.
Basically put, you can’t print Trillions of dollars in stimulus money and not expect it to go somewhere. Of course, it’s not just basic consumer goods that go up with inflation. In this case, it’s also ended up in the stock market (stock market inflation), in real estate (housing inflation), and yes, also in the price of raw materials and consumer goods.
And while substantial gains are always nice to see, there is a justifiable concern that along with the inflation will come higher interest rates which may start to reverse the generation-long decline in rates we’ve seen since the 80’s. Given we’re still in a highly uneven recovery, higher rates thus threaten the ongoing economic recovery and also pose real danger for large groups of indebted consumers. They also forecast a significant widening of the wealth gap which will continue to exacerbate social problems.
How Close Is This?
The US Federal Reserve has repeatedly said that they will start to put interest rates up once an inflation rate of 2% is showing in the consumer price index. Those numbers are now apparent.
We’ve always been highly skeptical about stated inflation rates. And this go-around is no different.
How, for example, we can see a 350% increase in the price of lumber without seeing a mere 2% increase in overall inflation is difficult to fathom.
But economists being what they are, tend to ‘tilt’ the data to meet their own needs. We think they’re likely to start nudging rates upwards sooner rather than later assuming U.S. coronavirus infection rates continue to fall.
Pressure on the bond market
The concern of rates rising has already hit the bond market to a degree. Bonds work inversely with interest rates. So when rates are expected to fall bond prices rise.
While your portfolio managers have a mixed portfolio of regular and inflation index bonds, there still has been some pullback in income portfolios as of late. It has somewhat dampened the overall portfolio performance from the gains made in equity markets.
All of that said, given that we’re in the midst of a global pandemic, things could be decidedly worse.
While third-world countries are being ravished by its devastation Canada has respectively been left comparatively unscathed.
The strong ‘Goldilocks’ like recovery in the U.S. has so far been just like economists favor – not too hot and not too cold.
As long as the recovery continues on a similar pace we may be able to avoid dramatic swings in the market which could be expected in such times – particularly given large-scale inflation that we have not seen in a generation.
The last year’s performance, however, which has exceeded most investors’ expectations, shows just how important it is to stay fully invested during times of turmoil.
Successful investing is never easy, pandemic or not. The price we pay is not just the management fee to have professionals watch over your money, but the volatility and worries that fluctuations can weigh on us.
It’s in our human nature to want to see things grow slowly and steadily. Unfortunately, that’s not the nature of the markets.
This is why it makes so much sense to leave decisions to professional managers who are usually able to take advantage of volatility in the long run.
It’s important to remember that the natural state of the world is one of growth, not stagnation.
That’s once again shown true with the success we’ve had this year.
Despite the turmoil, despite the panic, despite the massive economic downturn, we saw 18 months ago, that natural state of growth is showing itself again.
Keep calm and carry on. And of course, if you want to talk about things, we’re always here. All the best.
Mark. Sean. Cass.