Talk of stagflation is all the rage. Sort of. Most of the articles I read about the subject focus primarily, if not exclusively on inflation.
Where’s the ‘stag’ part? The word ‘stagflation’ is a handy portmanteau that came about in the 1970s when, for the first time in modern history, we experienced stagnant economic growth coupled with high and persistent inflation. Those two circumstances were thought to be mutually exclusive. In fact, they represent the worse of both worlds. Normally, if the economy is stagnant, there’s no inflation. Alternatively, if there’s inflation, it was always assumed that it was because the economy was overheating and growing too quickly.
In the second half of 2021, it seems everyone is piling on the stagflation narrative. Nouriel Roubini of NYU was talking about the circumstances being right for stagflation more than a year ago already, but it was only around the middle of 2021 that a narrative like his began to gain traction.
Lynchpin is Inflation
The lynchpin of the story is inflation. Everyone has a view on whether it is transitory or not, even as no one can really deny that we’ve already experienced more inflation for longer in the past 7 or 8 months than in any period in modern history. I’m more worried about stagnant growth, yet far fewer people seem inclined to openly share that concern. Continue Reading…
Portfolio Manager, Director of Credit Research, Franklin Bissett Investment Management
(Sponsor Content)
The phrase “hunt for yield” is by now a well-worn cliché among fixed income investors. Persistently low yields have led many investors to take on additional risk, and some have considered abandoning fixed income altogether.
We think this is a mistake. Even amid fluctuating yields, inflation jitters and pandemic-driven economic upheaval, fixed income can help maintain stability and preserve capital: if you know where to look.
Why Short-term now
For increasing numbers of investors, the short end of the yield curve is the place to be in the current environment. Short-term rates reflect central bank policy actions. Since the pandemic first took hold early in 2020, central banks have taken extraordinary measures to keep liquidity pumping into the marketplace, all without raising rates. Both the Bank of Canada and the U.S. Federal Reserve have so far left their overnight lending rates unchanged and have indicated their intent to continue along this path well into next year, and possibly longer. This predictability has stabilized, or anchored, short-term rates. In contrast, longer maturities have been prone to volatility as the stop-and-go nature of the pandemic has influenced economic reopening, inflation expectations and financial markets.
Franklin Bissett Short Duration Bond Fund is active in short-term maturities, with an average duration of 2-3 years. About 30% of the portfolio is held in federal and provincial bonds; most of the remaining 70% is invested in investment-grade corporate bonds.
Beyond stability, investments need to make money for investors. In this fund, duration and corporate credit are important sources for generating returns. Historically, the fund has provided investors with better returns than the FTSE Canada Short Term Bond Index1 or money market funds, and with comparatively little volatility.
In It for the Duration
Duration is a measure of a bond’s sensitivity to interest rate movements. Imagine the yield curve as a diving board, with the front end of the curve, where short-term rates reside, anchored to the platform. Like a diver’s body weight, pandemic-driven economic forces have placed increasing pressure further out along the curve. The greatest movement ― expressed as volatility ― has been at the long end, especially in 30-year government bonds. Currently, the fund has no exposure to these bonds.
Cushioned by Corporates
Corporate debt provides a cushion against interest rate volatility, and a portfolio that includes carefully selected corporate securities as well as government debt can therefore be a bit more protective. In addition, the spread between corporate and government bonds can provide excess returns.
We believe it is not unreasonable to anticipate stronger Canadian economic and corporate fundamentals in 2021 and 2022, as well as continued demand for bonds from yield-hungry international investors. These conditions support a continuation of the current trend of a slow grind tighter in spreads, with higher-risk (BBB-rated) credits outperforming safer (A and AA-rated) credits.
Credit Quality is Fundamental
In keeping with Franklin Bissett’s active management style, in-house fundamental credit analysis is a key element of our investment process for the fund. Unless we are amply compensated for both credit and liquidity risk (particularly in the growing BBB space), at this stage of the economic cycle we prefer higher-quality credit. We look for strong balance sheets, good management teams, excellent liquidity, clear business strategy and larger, more liquid issues. Continue Reading…
It is probably the greatest (and potentially dangerous) misconception in the investing landscape, that stocks protect you from inflation. That’s simply not true. While stocks have a long term history of besting inflation, they can fail in many periods, short and extended. Stock markets do not always work as an inflation hedge. And Vanguard suggests that their effectiveness will wane as the types of stocks that can work against inflation no longer have strong representation in the broad market stock indices. We’ll show you how to protect against inflation on the Sunday Reads.
Let’s cut to the chase. It’s something I’ve known for quite some time and I’m more than happy to see Vanguard beat the drum. If you want to protect your portfolio from inflation or stagflation (its evil stag cousin) own commodities.
When you own commodities or a commodities index fund or ETF, you own the raw materials that make the products, foods and energy needed to sustain life and society as we know it.
And that’s during a period when we’ve mostly had muted inflation. Stocks don’t like unexpected inflation, like the kind we’re having in 2021. That is, inflation above recent trends and expected trends.
If we go back to the stagflation period of the 1970’s and into the early 1980’s it’s a complete mess for stock investors. Have a look at MoneyChimp and be sure to hit that inflation button. This shows a negative real (inflation adjusted) return from 1968 through 1982, for US stocks. In real dollar terms, $1.00 became 94 cents.
Global stocks did not perform much better. And surprisingly neither did the Canadian stock market that was more commodities and energy-concentrated for the period.
Here’s global stocks for the period showing no return premium vs inflation. The chart is courtesy of ReSolve Asset Management.
And in this post on the Permanent Portfolio, you’ll see that even the traditional stock and bond balanced portfolio failed for an extended period during stagflation. There are other periods of ‘don’t work’ for the balanced portfolio (and for different reasons) within that chart.
Commodities hedge is strong and consistent
While stocks are not a consistent hedge for inflation, commodities have been, historically. And once again, this is during a period of mostly muted inflation, save for a few periods of unexpected inflation. Luckily for investors, that inflation has been transitory in the last few decades.
From that Vanguard post …
Over the last three decades, commodities have had a statistically significant and largely consistent positive inflation beta, or predicted reaction to a unit of inflation. The research, led by Sue Wang, Ph.D., an assistant portfolio manager in Vanguard Quantitative Equity Group, found that over the last decade, commodities’ inflation beta has fluctuated largely between 7 and 9. This suggests that a 1% rise in unexpected inflation would produce a 7% to 9% rise in commodities.
Here’s a great chart that shows gold, commodities and REITs as inflation hedges in periods of meaningful inflation. The orange bar is the commodities index.
While gold was the most explosive during the bulk of the period of stagflation, we see that a commodities basket is more reliable. Admittedly, gold can fall down as an inflation hedge in certain periods. That said, there are other reasons for holding gold as a hedge against declining real bond yields and as a form of disaster insurance and a long term hedge against ongoing currency debasement.
Lance Roberts from RIA Advisors
In the above chart we see gold working in all of the stock market failures for the period shown. Again, most notably during stagflation.
I like to also hold some gold and gold stocks on the side in addition to commodities baskets. Readers will also know that I am also investing in bitcoin – that new gold or digital gold. Continue Reading…
One thing that many economic historians often overlook is that one’s worldview is shaped by life experiences. That includes matters like love, marriage and divorce, money and savings and attitudes toward political risk – to name a few. If our values, likes and dislikes are shaped by our experiences, it stands to reason that our perceptions of what the future might hold could be largely informed by what we have already experienced. That’s especially true of the things we experience in our formative years.
In the summer of 2021, for the first time in over a generation, there’s been some talk of inflation being a going concern. Inflation was wrestled to the ground in the 1980s and hasn’t been heard from since – until now. As the debate rages about the degree to which we should be concerned (if at all) about inflation coming back in a meaningful way, it is noteworthy that while there are credible economists on both sides of the debate, virtually everyone in the “inflation will be a problem” camp is at least 70 years old. Stated differently, those people who experienced inflation in their adult lives are concerned and those who did not are not.
Transitory inflation?
For about 30 years now, the goal of central banks in the west has been one of price stability, which they define as inflation at 2%, give or take 1%. Basically, anything between 1% and 3% is okay. Now, we’ve experienced inflation above 3% for a couple of quarters and people naturally wonder what that might mean. Central Bankers have been assuring us that the uptick is “transitory,” that it is just a situation where awful data from the early days of the COVID crisis is working its way through the system. Nothing to see here. Move along.
Although I am technically old enough to remember inflation, I never had to deal with it personally or directly. I was a teenager when my parents built the family home on their property in 1979. I heard about their astronomical, double-digit mortgage rates, but never had to experience anything of the sort as the payor. My sense is that young people – especially millennials – cannot relate to anything close to what I’m about to say: the inflation rates, and therefore the mortgage rates and interest rates you have experienced throughout your entire lives, may not be around for much longer. Furthermore, if that is true, the consequences could be enormous.
5% constitutes “Real inflation”
As mentioned, there are competing views on inflation. I have not come down on either side, but I enjoy the exchange of ideas. If the doves are right and the inflation we’re seeing now is little more than a passing phase, there’s not much to say because little will change. If, however, real inflation is coming sooner than later and for longer than just a phase, we need to prepare. What constitutes ‘real inflation’, you may ask. My guess is something like 5%. At that level, no one can pretend that the inflation rate is not a concern and does not need to be dealt with. For this discussion to be meaningful, inflation needs to be at least 2% above the high end of the traditional range and to stay there for at least a year. At that point, both the logic behind it being transitory and the facile dismissal of it being above the target by an inconsequential amount disappear. At that level, something needs to give. Continue Reading…
As oxymorons go, you have to love the phrase “Transitory for Longer,” which comes up in my latest MoneySense Retired Money column. It looks at inflation, which of course is in the news virtually every day this summer, and one reason why stock markets are starting to weaken again (along with renewed Covid fears). You can find the full MoneySense column by clicking on the following headline: How might Inflation impact your Retirement plans?
As with trying to divine short-term moves in stocks or interest rates, I view predicting inflation — whether near-term, medium-term or longer-term — as somewhat futile. So the column preaches much the same as it would about positioning portfolios for stock declines or rises in interest rates: broad diversification of asset classes.
Asset Allocation for all Seasons
The ever useful four asset classes of Harry Browne’s Permanent Portfolio I find may be a good initial mix of assets to prepare for all possibilities: stocks for prosperity, bonds for deflation, cash for depression/recession and gold for inflation. Browne, who died in 2006, famously allocated 25% to each.
That’s a good place to start, although as I point out in the column, many might add Real Estate/REITs and make it a five-way split each of 20%. Some suggest 10% in gold (both bullion ETFs and gold mining stock ETFs), which might be expanded to include other precious metals like silver, platinum and palladium. Some might add to this a 5% position in cryptocurrencies like Bitcoin and Ethereum, which some view as “digital gold.”
To the extent stock markets and interest rates will forever fluctuate over the course of a retirement, such a diversified approach could help you sleep at night, as some asset classes zig as others zag. Seldom will all these assets soar at once, but hopefully it will be just as rare for all to plunge at once.
Annuities and new “Tontine” approaches
Another approach to this problem is not so much Asset Allocation but what finance professor Moshe Milevsky has dubbed “Product Allocation.” Continue Reading…
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