Tag Archives: inflation

Inflation and the 5% Solution

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https://advisor.wellington-altus.ca/standupadvisors

By John de Goey, CFP, CIM

Special to the Financial Independence Hub

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…

Retired Money: how to prepare for “Transitory for Longer’ inflation

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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…

How (In)credible is the Transitory Inflation argument?

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

If there’s one thing we’ve all learned in the past two years, it is that central bankers mean business: both literally and figuratively.  In other words, when central bankers say they ‘have our backs’ in both extending the business cycle by promoting fuller employment and doing so without causing meaningful inflation, we should take them at their word.

As such, central bankers “mean business” literally (meaning they will promote business interests) and figuratively (meaning they are serious, determined and dedicated to their mission).  Then again, for the past two years, those two objectives have been mostly aligned.  What if new circumstances were to make them mutually exclusive?

Looking south of the border, we had a modest yield curve inversion in the spring of 2019 and within a few weeks, then President Trump applied some considerable political pressure (something arms-length central bankers are supposed to be immune to) in order to get the federal reserve to cut rates, which they did in three successive meetings that autumn.

At the time, inflation was benign and tellingly, unemployment was at its lowest level in a generation.  In other words, by any reasonable standard, the fed had done a superb job to that point and no interventions or adjustments seemed necessary.  Despite this, there were changes and a purportedly imminent recession was averted.  Or not. After all, there’s no reliable way of knowing what might have happened had rates not been lowered that autumn.

These days, the narrative coming from central banks is that the recent spate of above-average inflation is ‘transitory,’ meaning it will likely normalize around more traditional levels once the artificially low data of the post COVID year (basically Q2 and Q3 of 2020) falls out of the data set.

Skeptical of the Central Bank line on inflation

Of course, no one knows for sure if the inflation we’re seeing now is genuinely transitory or the harbinger of a more prolonged period of elevated prices. There’s a Chinese proverb that states, “to be uncertain is to be uncomfortable, but to be certain is ridiculous.”  I’m not for a moment suggesting that inflation is or is not transitory. Rather, I am respectfully skeptical of the central bank line.

It may indeed be true that the inflation fear will dissipate into nothingness before the end of the year. Then again, Deputy Prime Minister and Minister of Finance Chrystia Freeland has boasted that the fiscal support offered to Canadians over the past 15 months can act as a sort of ‘pre-loaded stimulus’ that will keep the economy humming long after the government cheques stop coming.  What if Freeland is understating the impact?

Specifically, what if Canadians are so euphoric about the economy re-opening that they start buying things and experiences like never before?  Wouldn’t that kind of spike in purchasing activity risk a spike (or at least prolongation) in inflation?

Higher for Longer

There are some who think central banks are managing expectations about inflation being higher for longer to buy time and provide cover for an anticipated period of deliberate bank inactivity.  In essence, what if central banks don’t act to control high and prolonged inflation because doing so (i.e., raising rates significantly and sooner than expected) would destroy both the economic recovery and the bull markets so many are currently enjoying? Continue Reading…

Projected Inflation and investment returns

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FP Canada issues guidelines every year to help financial planners make long-term financial projections for their clients that are objective and unbiased. The guidelines include assumptions to use for projected inflation and investment returns, wage growth, and borrowing rates. It also includes “probability of survival” tables that show the life expectancy at various ages.

The 2021 Projection Assumption Guidelines were of particular interest because, well, a lot has happened since the 2020 guidelines were published last spring. How should we project inflation and investment returns as we get to the other side of the pandemic and economies start opening up again?

Will we see sustained higher inflation? Should we expect any returns at all from bonds or cash? Should we lower our expectations for future stock market returns?

Remember, these are long-term projections (10+ years). That’s very different than guessing the direction of the stock market for 2021, or predicting whether we’ll see a short burst of inflation in late 2021, early 2022.

The inflation assumption of 2.0% was made by combining the assumptions from the following sources (each weighted at 25%):

  • the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
  • the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
  • results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
  • current Bank of Canada target inflation rate

The result of this calculation is rounded to the nearest 0.10%

Projections for equity returns were set by combining assumptions from the following sources:

  • the average of the assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
  • the average of the assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
  • results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
  • historic returns over the 50 years ending the previous December 31st (adjusted for inflation).

Equity return assumptions do not include fees.

Unlikely that bonds can replicate their projections of last 50 years

Projections for short-term investments and Canadian fixed-income returns included the assumptions from QPP and CPP, the results of the 2020 FP Canada/IQPF survey, but the 50-year historical average rate was removed in 2020 as a data source. This makes sense given that interest rates were significantly higher than they are now and so it would be impossible for bonds to replicate the performance of the last 50 years. Continue Reading…

A discussion about Value and Small-cap Factors with Avantis Investors’ CIO Dr. Eduardo Repetto

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Avantis Investors’ CIO Dr. Eduardo Repetto (Link to YouTube clip is in text below)

Over the years, I’ve encountered several financial advisors who liked to use the mutual funds of Dimensional Fund Advisors or DFA, which was founded by alumni of the University of Chicago and based on research on the long-term return premiums offered by small-cap and Value stocks around the world. Even today I own a DFA International Equity fund that was a legacy of my time with a fee-only advisor: that’s generally the requirement for accessing DFA funds.

So I was intrigued when certified financial planner Mike Bayer [CFP, CIM, FCSI) asked me to help him interview two senior executives of Avantis Investors (a unit of American Century Investments) which for the past 18 months has been marketing Avantis ETFs, which take a similar approach with small-cap and value factors and are more accessible to do-it-yourself investors who can buy the ETFs at discount brokerages, just like any other ETF.

Regular readers of the MoneySense ETF All-Stars may recognize the name Avantis. As you can see here, the Avantis US Small Cap ETF [AVUV] was a Desert Island pick of PWL Capital’s Ben Felix and Cameron Passmore. We are about to publish the 2021 edition and as mentioned in the video interview also linked below, that pick is back along with another Avantis selection, which you can learn by watching the video.  In addition, Felix has just released a 15-minute video covering Avantis: https://youtu.be/jKWbW7Wgm0w

In the end, possibly influenced by the arrival of Avantis, DFA itself brought out three of its own ETFs: https://us.dimensional.com/etfs

Bios

Dr. Eduardo Repetto is Chief Investment Officer of Avantis Investors. Previously he was Co-Chief Executive Officer and Co-Chief Investment Officer of Dimensional Fund Advisors. He earned a Ph.D. degree in Aeronautics from the California Institute of Technology, an MSc degree in Engineering from Brown University, and a Diploma de Honor in Civil Engineering from the Universidad de Buenos Aires.

Phil McInnis is also a DFA alumnus, where he was Head of Portfolio Solutions. Today he is director of investments at Avantis Investors®, responsible for marketing content development surrounding Avantis’ investment approach.

Mike Bayer, CFP, CIM, FCSI, is a Toronto-based financial planner with Strategic Analysis Capital Management and blogger at Free Speech Media.

Highlights from the transcript

So without further ado, here is a link to the full interview, which runs almost an hour. However, you can click on a “transcript” link within YouTube, for those who prefer reading and skimming. Below are some highlights:

Continue Reading…