|What Worked in Q3||What Didn't in Q3|
|U.S. Bank Stocks||Chinese Stocks|
|Natural Gas Stocks||Cannabis Stocks|
|Preferred Shares||Gold Stocks|
|Equity Markets||Second Quarter % Change (in Cdn$)||Third Quarter % Change (in Cdn$)|
|Bond Markets||Second Quarter % Change (in Cdn$)||Third Quarter % Change (in Cdn$)|
|REFINITIV Overall Bond Index||1.9%||-0.16%|
The Known Unknown
The trip to the grocer is hurting the pocketbook and our vehicle’s thirsty gas tank is demanding so much more of our money. Oil prices are at a seven year high, and cotton is up 40% year-to-date making back to school shopping expensive. There aren’t enough semi-conductors so there is a shortage of new vehicles with prices of used cars up 20 to 30% as a result. Housing prices – wow! Lumber prices had skyrocketed and so had soybeans (which goes into more stuff than you might think). We expect you too have noticed that the prices you are paying for a variety of goods have inflated some or indeed a lot over the past year or so. Referring to the title of this piece, the known is inflation. The unknown is whether it is transitory or more persistent in nature.
Why we care about this can be explained by looking back at the price movement in equities and bonds. Just this year alone we have seen 3 different phases, all in response to investors view of inflation and its corollary interest rates.
At the beginning of this year a Government of Canada 10-year bond yielded an ultra low 0.7%. This signalled a slow growth environment ahead and a view that inflation would soon turn back down i.e., was transitory. Stock prices of expensive high expected growth companies did well. However, by the end of March the view of economic growth became more positive and with it the chance that inflation would be more persistent. Bond yields quickly increased to 1.6% and there was a sell off of bonds and growthier stocks in favour of financials, commodities, and industrials i.e., the more economically sensitive stocks. By summer the narrative changed again to one of an economy about to slow and so yields began to decline again reaching 1.1% by mid August. When yields declined so did the values of the economically sensitive stocks and investors moved back into technology stocks and bonds. However, not wanting investors to be complacent, yields have now increased yet again to a yearly high of 1.6% as the view of economic growth has started to look more promising. And for the second time, bonds, technology, and other growth stocks have declined in favour of financials and other economically sensitive stocks.
We can explain the why of current inflationary pressures. Low interest rates are stimulating demand, Covid-19 concerns have been abating to unleash pent up demand and government policies have been stimulating demand. However, the supplies to serve this demand have not been able to keep up. Covid-19 caused factory shutdowns have created supply backlogs, safety concerns have increased costs, shipping issues and drought issues have all conspired to raise prices. Supply can take longer than demand to ramp up and especially so in the case of energy and mining multi-year development projects. It is much harder to project future inflation rates.
Strolling down memory lane, Sept 30, 2021, was the 40 year anniversary of the peak in 20 year US treasury yield interest rates. Despite mouth-watering interest rates above 12%, few wanted to buy bonds as the fear was that rates would continue to increase as they had been doing. But as history showed, that was the peak in rates and the best time to buy bonds. Bond prices move in the opposite direction to interest rates and as inflation slowed and interest rates declined, bond prices moved up creating an awesome 40 years for bond holders. Conversely, increasing inflation is a threat to bond investors because it diminishes the value of the ongoing interest payments owed to the investor.
The current environment has made us pause when redeploying funds from maturing bonds. Many of our clients had a bond mature on Sept 1, 2021 and given the difficulty of deciphering transitory versus more persistent inflation, we have decided to keep it in cash-like instruments for the next while. Should inflation prove to be more persistent, bonds will lose value. Of course, it matters to equity investors too as inflation that’s too high tends to reduce equity values.
So, year-to-date, the market has been equally convinced that inflation is transitory and then again more persistent. It has been easy to find numerous ‘experts’ on both sides of this debate and we have recently been hearing more about inflation being temporary but for longer. That seems to walk a fine line between temporary and persistent. Interestingly though, some prices like that of lumber and soybean meal have already started to deflate. We think that due to the substantial amount of debt in the system a high inflationary scenario cannot be sustained for long. We believe in some inflation persistency in some products but not to the extent of an economic calamity and think that by next Thanksgiving, at least the cost of your turkey should not be making any headlines.
|Fixed Income||September 2021||June 2021|
|Cdn 91 day T-Bills||0.15%||0.15%|
|U.S. 91 day T-Bills||0.04%||0.05%|
|Cdn 10 year Bond||1.50%||1.42%|
|U.S. 10 year Bond||1.52%||1.45%|
|Commodities (in U.S.$)||September 2021||June 2021|
|Currency||September 2021||June 2021|