Inflation

Inflation

The TSX Composite Index: No longer a Second-Class Citizen?

Posted By |
Photo courtesy of rawpixel.com.

By Noah Solomon

Special to the Financial Independence Hub

Canadian stocks have had a very decent run since the global financial crisis of 2008. From December 31, 2008, through the end of last year, the TSX Composite Index returned an annualized 10.1%. This pales in comparison to the performance of the S&P 500 Index, which has risen at an annualized rate of 16.1%. Had you invested $1 million in the TSX Composite Index at the end of 2008, your investment would have been worth $3,477,264 at the end of last year. By comparison, the same investment in the S&P 500 Index would have a value of $6,873,269, which is a stunning $3,396,005 more than the Canadian investment.

Looking for Love in all the wrong places

The composition of the Canadian stock market is dramatically different than that of its southern neighbor. As the table below illustrates, there are a handful of sectors that feature either far more or less prominently in the TSX Composite Index than in the S&P 500. Specifically, Canadian stocks are far more concentrated in financial, energy, and materials companies, while the U.S. market is more concentrated in the technology, health care, and consumer discretionary sectors.

TSX Composite Index vs. S&P 500 Index: Sector Weights (Dec. 31, 2021)

In 1980, the song “Lookin’ for Love,” by American country music singer Johnny Lee was released on the soundtrack to the film Urban Cowboy. The tune’s iconic lyric, “Lookin’ for love in all the wrong places,” serves as a fitting description of the dramatic underperformance of the TSX vs. the S&P 500. The majority of disparity in performance between the two indexes can be explained by their different sectoral weightings. When financial, energy, and materials stocks outperform their counterparts in the information technology, health care and consumer discretionary sectors, it is highly likely that the TSX will outperform the S&P 500, and vice-versa.

Over the past two years ending December 31, 2021, the information technology sector has been the star performer both in Canada and the U.S. Interestingly, the TSX technology index fared better than its U.S. peer, returning 113.9% vs. 92.4%. However, due to the far greater weighting of tech companies in the S&P 500 than in the TSX (23.2% vs. 5.7% as of the end of 2019), tech stocks have had a far greater impact on the returns of the S&P 500 than on the TSX. On the other hand, financial, energy, and materials stocks were all underperformers on both sides of the border, which served as a drag on the performance of Canadian relative to U.S. stocks.

Macro Drivers and Tipping Points: It’s About Growth & Oil

Given that differing sector weightings account for the lion’s share of performance disparities between Canadian and U.S. stocks, it is essential to determine the macroeconomic factors that have historically caused certain sectors to out/underperform others, and by extension TSX outperformance or underperformance. Continue Reading…

Growth Opportunities in Challenging Times

Posted By |
Franklin Templeton/iStock

By George Russell, Institutional Portfolio Manager, Franklin Equity Group

(Sponsor Content)

The first few years of the 2020s have been challenging, to say the least.

Just as optimism was building that the worst days of the pandemic may be behind us, war in Eastern Europe erupts. Hopefully the conflict in Ukraine can find some sort of resolution sooner rather than later, but it’s a worrying time for sure.

Amid the geopolitical turmoil, markets have experienced some wild swings so far in 2022. The conflict in Ukraine has created extra uncertainty for investors who were already concerned about runaway inflation levels, and what higher interest rates may mean for their portfolios. The Bank of Canada has announced its first hike since 2018, and the expectation is that more increases are to follow throughout 2022.

In this tumultuous environment, Growth stocks have had a difficult time. While the first year of the pandemic largely benefited Growth names, particularly in the tech space, there has been a reversal of fortunes in recent months. As inflation concerns increased hawkish sentiment among central banks, a Growth to Value rotation occurred across markets. The question many investors are now asking is just how much the U.S. Federal Reserve or Bank of Canada  will ultimately raise rates.

This decision will  be contingent on whether inflation continues at such a rapid rate, which won’t be helped by higher energy prices arising from the war in Ukraine.

Permanent or Temporary Change?

U.S. consumer prices were up 7% year-over-year at the end of 2021, a 40-year high, while Canada’s 4.8% annual inflation at the end of the year marked a 30-year high. In his recent paper on the subject, Franklin Innovation Fund portfolio manager Matt Moberg identified two main themes that will dictate market performance this year: which companies have experienced permanent change due to the pandemic, and the duration and magnitude of inflation. Continue Reading…

Big questions about Investing and Personal Finance

Posted By |

By Michael J. Wiener

Special to the Financial Independence Hub

 

We spend a lot of time worrying about interest rates, stock markets, inflation, gold, and cryptocurrencies, and how they affect our investment portfolios and personal finance.  Here I explain how I think about these issues.

Are interest rates going up?

I don’t know.  But the answer can’t end there.  We have to make choices about our mortgages and investments, and interest rates matter.  Some will express predictions confidently, but they don’t know what will happen.

I prefer to think in terms of a range.  Let’s say that we think interest rates will average somewhere between 0% and 7% over the next decade.  This range is wide and reflects the fact that we don’t know what will happen.  Because current interest rates are still low, the range is shifted toward rate increases more than decreases.  The goal now is to balance potential downside with potential upside over this range.

With mortgages, the main concern is the downside: will we be okay if mortgage rates rise to 7%?  We may not be happy about this possibility, but we should be confident we could handle such a bad outcome without devastating consequences.  This is why it’s risky to stretch for a house that’s too expensive.

Bonds and other fixed income investments are a good way to moderate portfolio volatility.  However, long-term bonds have their own risks.  If you own a 25-year bond and interest rates rise two percentage points, anyone buying your bond would want to be compensated for the 25 years of sub-par interest.  This compensation is a drastically reduced bond price.  For this reason, I don’t own long-term bonds.  I stick to 5 years or less.

But can’t we do better?  Can’t we find some useful insight into future interest rates?  No, we can’t.  Not even the Bank of Canada and the U.S. Federal Reserve Board know what they’ll do beyond the short term.  They set interest rates in response to global events.  They do their best to predict the future based on what they know today, but unexpected events, such as a war or new pandemic, can change everything.

If we get overconfident and think we have a better idea of what interest rates will be than somewhere in a wide range like 0% to 7%, all we’re doing is leaving ourselves exposed to possible outcomes we haven’t considered.

Is the stock market going to crash?

I don’t know.  With stock prices so high, it’s reasonable to assume that the odds of a stock market crash are higher than usual, and that a crash might be deeper than a typical crash.  But that doesn’t mean a crash is sure to happen.  The stock market could go sideways for a while.  Or it could keep rising and crash later without ever getting back down as low as today’s value.

People who are convinced the market is about to crash may choose to sell everything.  One risk they take is that the crash they anticipate won’t come.  Another risk is that even if stock prices decline, they may keep waiting for deeper declines and stay out of the market until after stock prices have recovered.

Those who blissfully ignore the possibility of a stock market crash may invest with borrowed money.  The risk they take is that the market will crash and they’ll be forced to sell their depressed stocks to cover their debts.

I prefer to consider both positive and negative possibilities.  I choose a path where I’ll still be okay if stocks crash, and I’ll capture some upside if stocks keep rising.  If we could fast-forward 5 years, it would be easy to see whether we’d have been better off selling everything to cash or leveraging like crazy.  But trying to choose between these extremes is not the best approach.  I prefer to invest in a way that gives a reasonable amount of upside with the constraint that I’ll be okay if stocks disappoint.

Is inflation going to get worse or return to the low levels we’ve had in recent decades?

I don’t know.  Either outcome is possible.  Higher inflation is bad for long-term bonds, which is another reason why I avoid them.  With short-term bonds and cash, you can always choose to invest these assets in a different way without taking as big a hit as you’d take with long-term bonds.

I choose to protect against inflation with stocks.  When prices rise, businesses are getting higher prices for their goods and services.  However, this protection only plays out over long periods.  Over the short term, stocks can drop at the same time that inflation is high.  Some people like to look at historical data and declare that stocks offer no inflation protection.  These people are usually playing with mathematical tools they don’t understand very well.

All of these considerations play into the balance I’ve tried to strike with my allocation levels to stocks, bonds, and cash.  I’m trying to capture some upside from good outcomes while protecting myself from disaster if I get bad outcomes.

Is gold going up?

I don’t know.  You might think my balanced approach would mean that I’d have at least a small position in gold, but I don’t.  I have no interest in investing in gold.  It offers no short-term protections against inflation or anything else.  And over the long-term stocks have been far superior.

Gold produces nothing, and it costs money to store and guard.  Gold’s price has barely appreciated in real terms over the centuries.  In contrast, millions of people wake up every day to work hard at producing profits for the businesses that make up the stock market, and money invested in stocks over the centuries has grown miraculously. Continue Reading…

Inflation and the new ways of diversification

Posted By |

 

 

Photo Credit: CCL Private Capital Ltd.”

By Duane Ledgister, vice president, Connor Clark & Lunn Private Capital

Special to the Financial Independence Hub

Inflation has moved to its highest level in decades, with higher prices resulting from strong economic growth led by pent-up demand for goods and record levels of government spending.

At the same time, strong demand is leading to supply shortages. When we look at the components of inflation, we see recent price increases are largest in industries hurt the most during the pandemic, such as energy. These industries are cyclical and are pulling inflation readings higher as prices recover after a period of decline.

Higher prices in the short term are expected to be tempered as supply adjusts and demand returns to more normal levels, and while policy actions such as higher spending and larger debt levels have increased short-term inflation, the same forces are deflationary long-term. This is because more money goes to paying down debt as opposed to future investment. The caveat is that higher debt levels encourage policymakers to allow inflation to move higher than it has been in recent cycles. Accordingly, inflation will be higher but not at the disruptive levels we saw in the 70s and 80s.

Impact of inflation on your investment allocation

Now is a good time to consider its effect on different asset classes that make up a portfolio. Real diversification is much more involved today than you would have been told before.

Stocks can generally do well in a period of moderate inflation, whereas fixed income is hurt the most. Alternative asset classes — which most investors have little exposure to, and should begin evaluating — also have some natural protection from inflation.

Equities

Moderate inflation is a double-edged sword for stocks: increasing corporate cash flows while decreasing the real value of investment returns. Companies with high valuations tend to underperform as their valuations are based on future earnings growth long into the future. In a period of higher inflation, these future earnings are now worth less today. Companies with lower valuations, called value stocks, do better in a period of above-average inflation. Strategically it makes sense to hold both growth and value styles within your equity allocation.

Fixed Income

The bond allocation of a portfolio is the one that is hardest hit by inflation, because most bond coupon payments do not increase with inflation, and bond yields tend to rise when inflation is moving higher. The result is both a temporary decline in the price of bonds and lower long-term real return. The negative effects of rising inflation and yields can be managed by holding short-term bonds and higher coupon bonds. The former is less sensitive to changes in inflation and yields. This protects capital when inflation is rising. The latter have more income to offset price declines.

Having a view of the economic backdrop and managing a bond portfolio’s sensitivity to changes in yields and inflation is important to delivering risk-adjusted returns, particularly true when inflation is on the rise.

Alternatives

This is where real diversification can pay off. The alternative asset classes in a portfolio are attractive since they generate strong levels of income relative to traditional equities and bonds. They also tend to be the least sensitive to risks in the broader economy, including inflation. Private market investments (real estate, infrastructure, and private loans) should have natural inflation stabilizers. For real estate, rental income tends to rise with inflation and infrastructure contracts may have ongoing inflation adjustments. Finally, private loans income rises as yields and inflation move higher. Continue Reading…

Ukraine invasion underlines investors’ need for super diversification

Posted By |

It’s scary times for everyone, investors included. As this site focuses on Financial Independence, I’ll try in this blog to direct readers to some useful sources of financial advice.

We’ll start with MoneySense, since in my role as Investing Editor at Large, I’m on top of much of the investing content there.

First, I’d point to Allan Small’s article that appeared over the weekend: The Meaning of market swings and why you should care. Allan recaps current trends in rising inflation and rising interest rates, noting that geopolitical uncertainties can create buying opportunities on certain stocks:

“The key is to make sure your portfolio is diversified. It’s the best — and cheapest — strategy to protect your portfolio in any environment. Balance it with different sectors of the economy.”

Second, Dale Robert’s weekly market wrap for MoneySense always has plenty of good insights into up-to-the-minute market action. His February 27th instalment of Making Sense of the Markets is particularly instructive. Hub readers will be familiar with Dale’s own site, Cutthecrapinvesting, as we regularly republish Dale’s blogs here on the Hub (with his kind permission, of course!).

Here’s Dale’s recent blog on the Ukraine situation. Here’s an excerpt:

“Even a few weeks ago it was easy to predict what would help investors make their portfolios more battle-hardened. Gold and energy certainly rose to the unfortunate occasion.”

Ever since Covid hit, Dale has been furnishing sound investment ideas, often ahead of the rest of the financial blogosphere. For example, he was one of the earliest to sound the alarm that Covid would be a serious problem for investors. He was also early in recommending energy plays like Eric Nuttall’s Nine Point Energy Fund (NNRG) and inflation-fighting recommendations like the Purpose Real Assets ETF (PRA.) That’s one reason why we included Dale as a panelist in MoneySense’s yearly ETF All-Stars feature: the 2022 edition will be out this spring, albeit under the direction of a new writer, Bryan Borzykowski.

No one ever made a dime panicking

How am I responding to the financial aspect of this crisis? Well, as Mad Money’s Jim Cramer often reminds readers in such times, “No one ever made a dime panicking.” Just yesterday, The Successful Investor publisher Patrick McKeough reminded Hub readers that short-term investment decisions all too often sabotage long term returns.

Patrick has been hugely consistent over the years with the following three-fold guidelines, which are as relevant during this Ukraine crisis as in they are in sunnier times:

1.) Invest mainly in well-established, dividend-paying companies;

2.) Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities);

3.) Downplay or avoid stocks in the broker/media limelight.

In his Inner Circle Advice bulletin issued after Tuesday’s market rout, McKeough titled one section “Putin goes for broke” while urging investors to stay the course if they adhere to the three points above:”In the past third of a century, Russia has gone from dictatorship to fledgling democracy and back to dictatorship. If his Ukraine venture goes awry, it could be the end of the Putin era and the start of a new try at western-style government for Russia.

“Meanwhile, we advise sticking with your portfolio if your investments are in tune with our Successful Investor directives. Now, though, is a good time to re-emphasize that recent IPOs tend to be a poor investment choice, on average. But that’s especially so in a market situation like this one, in which volatility is likely to be above average for some time.”

Some other newsletters to which I subscribe recapped historical market action in advance and during prior outbreaks of war and invasions; generally they found that investors who “bought the invasion” eventually did well.

On the other hand, in an article in the Globe & Mail this Monday, veteran commentator Gordon Pape suggested it wouldn’t hurt to raise cash where you have significant capital gains: while they’re still gains. You can find the article, albeit paywalled, by clicking on this highlighted headline: Investors should take these steps to protect their portfolios from  the Russia-Ukraine conflict.  Pape also warned, as have many pundits, that if Russia does get away with its Ukraine invasion, it may embolden China to make a similar move on Taiwan.  Continue Reading…