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(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • It was an extremely difficult week for markets with equity indices in Canada, the U.S. and globally falling along with the Canadian dollar, gold and oil. 

  • Positive news on the jobs front suggests that the Bank of Canada and the Federal Reserve may act more quickly to raise interest rates to reign-in inflation.  Fears of an economic slowdown associated with higher rates was bolstered by uncertainty of the Omicron variant, which has caused several countries to enact restrictions.

  • The latest jobs data was released with 154,000 jobs added in Canada.  The unemployment rate fell again by 0.7% to 6.0%.  Employment exceeds the February 2020 level by 186,000 jobs and the unemployment is just 0.3% below its level at that time.  Total hours worked increased by 0.7% and have returned to pre-pandemic levels.  The ending of support programs in Canada was seen as a contributor as more individuals sought to move to earned income.  More than 80% of women aged 25 to 54 were employed in November, which is the highest level since the data was first collected in 1976, with growth spread across multiple industries.  By comparison 87% of men of the same age are employed, exceeding February levels by 0.5%. (Source1, Source2, Source3)

  • In the U.S., 210,000 new jobs were added in November and the unemployment rate fell by 0.4% to 4.2%.  “Notable job gains occurred in professional and business service, transportation and warehousing, construction and manufacturing.  Employment in retail trade declined over the month” according to the report released by the Bureau of Labor Statistics.

What’s ahead for this week?

  • In Canada, merchandise trade balance and third quarter capacity utilization will be announced.  The most important update of the week will be the latest release of the Bank of Canada’s monetary policy.

  • In the U.S., third quarter productivity, October’s goods and services trade deficit and consumer credit, and November’s Consumer Price Index (CPI) will be released.

  • Globally, China’s trade surplus, CPI and producer inflation, Germany’s factory orders and CPI, industrial production will be announced along with Eurozone real Gross Domestic Product.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


IAIC Market Communication

Omicron, Inflation and the Impact on Our Investment Strategy

 

After bouncing off new all-time highs in early November, the past two weeks saw markets make a U-turn back towards late September levels on news of a new Covid-19 variant and indications from the US Fed that inflation may persist. 

 

With the early reports of the new Omicron variant spreading to Canada and around the world, the markets were reminded that we have not yet put Covid behind us. The uncertainty about Omicron’s transmissibility and severity, and whether current vaccines will be effective against it, has shaken markets, at least temporarily.

 

Persistent inflation continues to be a concern for the markets, as treasury-bond yields and the US dollar surge higher. U.S. Federal Reserve Chair Jerome Powell said earlier this week that if inflation proves not to be transient the Fed will have to prepare to end its bond-buying program ahead of schedule next year. This action would normally mean interest rates will rise.  Fears of higher interest rates, combined with the Omicron variant news, resulted in the S&P 500 experiencing one of the biggest bouts of volatility it has seen in over a year.

 

On other fronts, the price of oil has been correcting over the past several weeks as the US seeks to release oil stockpiles and China is also said to be tapping into emergency reserves. Closer to home, the Bank of Canada warned there is a risk of a sudden price drop in housing prices as Canadians continue to look to purchase homes before interest rates rise.

 

Further volatility ensued following the recent scandal involving Bridging Finance. As a result of this, we thought it prudent to remind you that IAIC does not have any direct exposure to private debt or private debt funds.  For our debt instruments, we purchase investment-grade corporate, government bonds, or GIC’s in client portfolios.

 

 

Source: Factset

 

S&P 500 over the past 6 months is still up over that period, despite recent volatility.

 

The future is impossible to predict and these recent events are reminders that investors should avoid reacting emotionally to daily news updates.  As investment managers, we remain focused, stick with quality investments that can ride out economic uncertainties, and resist deviating from our long-term investment strategy.

 

We focus on valuation, fundamentals and facts. We assess the impact of new information and events on the value of our core names and their long-term prospects. We do not believe the intrinsic values of great businesses are fluctuating nearly as much as their stock prices have recently. We continue to scan the markets for additional opportunities to grow our core pick list of ideas. It is markets like these that can create dislocations between price and value, and as a result, new opportunities can emerge.

 



IAIC Disclosures
This material has been prepared by Independent Accountants’ Investment Counsel Inc. (IAIC). The information presented herein, including forecast financial information, should not be considered as advice or a recommendation to investors and does not consider a client’s particular investment objectives or financial situation. Before acting on any information you should consider the appropriateness of the information and consult your portfolio manager.
©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved
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November 22-26: Last Week in the Markets

(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • North American equity indices dropped more than 2% on Friday and drove the grid above to another pandemic-related “all red” week due to fears that renewed domestic restrictions and lockdowns, as well as curtailing the movement of people, raw materials and finished goods could damage the pace of economic recovery.  Global equities represented by MSCI’s All Country World Index (ACWI) was down almost 3% for the week.  The price of West Texas Intermediate (WTI) oil fell by more than $10/barrel and more than 13% on Friday.  Gold held steady on Friday, gaining $1.20 per ounce, which demonstrated its value as a ‘safe haven’, at least for a day.

  • These one-day losses (except for gold) followed the observance of Thanksgiving across the U.S. and continued the tradition of a light trading day with volumes down more than 20% compared with the previous Friday.  This would have been the second consecutive “all red” week had S&P 500 lost value last week.  Two consecutive weeks where all our indicators have lost value has not happened in 2021 and not since the darkest days of the pandemic. 

  • Despite the recent setbacks equity indices in North America are up 14-22% in 2021 and 17-28% from a year ago.

What’s ahead for this week?

  • In Canada, building permits, industrial product and raw materials price indexes for October will be released.  November’s employment report is scheduled along with real GDP for the third quarter.

  • In the U.S., October’s pending home sales, construction spending, factory orders, wage rate and the employment report for November will be announced. 

  • Globally, Germany and the Eurozone will announce their latest data on employment, inflation and consumer confidence.  OPEC+ will conduct another meeting in response to the recent variant news from Africa and the release of strategic oil reserves by several governments to lower the price of oil to soften inflation.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • The markets were mixed with the TSX and Dow losing 1% or more while the S&P 500 and NASDAQ made gains.  The drop in Canadian equites rested largely on the drop in the price of oil.  Energy is the second largest sector comprising the TSX after Financials.  The Canadian dollar also dropped three-quarters of a percent, magnifying the losses in Canadian dollar denominated equities.

  • Much of the negative momentum was propelled, by domestic inflation as October’s Consumer Price Index rose 4.7% over the same period in 2020.  Transportation costs, including gasoline, was a major contributor, however, the recent reduction in the price of oil may help.  Food and housing are continuing their rise as well.  Thankfully inflation is well below the U.S. rate of 6.2%, but this is the highest rate increase for Canadian prices in more than 18 years.

  • The inflation rates on both sides of the border are driving increased speculation that the Bank of Canada and the Federal Reserve will act to increase their benchmark lending rates to cool inflation.  Both central banks have set the average inflation target at 2%, and nearly 5% and more than 6% in Canada and the U.S., respectively, are well beyond the goal.  Early analysis suggested that increased inflation rates were merely temporary as reopening expanded, but price increases are persisting and it appears that it may be well into spring of 2022 before prices become more stable. (Source)

What’s ahead for this week?

  • In Canada, September’s budget balance for the federal government and October’s wholesale trade and manufacturing sales are on the economic release calendar.

  • In the U.S., Thanksgiving will shorten the trading week with markets closed on Thursday.  New and existing home sales, goods trade deficit, durable goods orders, personal spending and income, wholesale and retail inventories for October will be announced.  Also, the Purchasing Managers Indexes (PMIs) from Markit for November and third quarter real Gross Domestic Product (GDP) will be released.

  • Globally, Eurozone and Japanese PMIs that signal purchasing managers’ optimism will be released along with Germany’s consumer confidence, real GDP and business climate survey.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • In a week where bond markets closed on Thursday for the observance of Remembrance Day, the TSX gained while the S&P 500, the Dow and NASDAQ all lost ground.  The TSX has returned almost 25% in 2021 and has edged ahead of the S&P 500 and NASDAQ in year-to-date returns.

  • Equities in the U.S. have been negatively affected by the recent release of consumer and producer inflation numbers.  The Consumer Price Index (CPI) has risen to 6.2% in October and the Producer Price Index (PPI) is at 8.6% in the U.S.  The CPI last reached this level in 1990 and it has been more than a decade since the PPI has been this high.  The Canadian inflation rate will be updated on Wednesday but had been trailing the U.S. at 4.4% in September.  Prior to the pandemic and since 2010 inflation in Canada and the U.S. had averaged 1.6%.

  • Both countries’ inflation rates are well above the desired long-run average of 2%.  In theory, inflation would hover at or near 2%, with equal amounts of time spent above and below the goal of 2%.  When the rate exceeds four, five and six percent, the goal can only be achieved after sustained periods under the goal. 

  • It appears that the U.S. Federal Reserve and the Bank of Canada will be pressured to raise interest rates sooner than were anticipated only a few weeks ago as inflation appears to be more persistent than transitory. (Source1,
    Source2)

What’s ahead for this week?

  • In Canada, September retail sales, manufacturing sales, new orders and wholesale trade, , will be announced.  Existing home sales, housing starts and new housing price index for October will be released along with consumer inflation for the same period.

  • In the U.S., October data will be released for several economic indicators including retail sales, import prices, industrial production, capacity utilization, business inventories, housing starts and building permits.

  • Globally, Gross Domestic Product growth and inflation, through their respective CPIs, will be released for Japan, the Eurozone.  China is scheduled to release its retail sales and industrial production.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • Following last week’s action by the Bank of Canada to eliminate its bond-buying program, the U.S. Federal Reserve (Fed) took a similar and more protracted approach. Both are reducing support for economic recovery to curtail inflation. Additionally, the temporary nature of price increases is being questioned.  As a result, the Federal Reserve will reduce bond purchases by $15 Billion/month from the current $120 Billion/month total.  If this reduction schedule holds, the bond-buying program (known as quantitative easing) will end in June of next year.  The purchases of bonds help to stimulate economic activity by reducing long term interest rates.  Fed Chair, Jerome Powell, indicated that short term interest rates would remain unchanged.  A video of Powell’s announcement is available here.

  • Canada added 31,000 jobs in October and the unemployment rate fell to 6.7%.  September reported nearly five times as many jobs, which may indicate a softening of employment results.

  • In September the U.S. economy underperformed in job creation and has since rebounded by adding 531,000 jobs in October, lowering the unemployment rate to 4.6%.  The American wage rate has increased by 4.9% compared to the same period last year.  Rising U.S. wages along with more persistent housing costs and food prices may have contributed to the Fed’s decision to slow its bond purchasing program to temper inflation.

What’s ahead for this week?

  • In Canada, the economic announcements scheduled are not significant for most retail investors.  Bond markets in Canada (and the U.S.) will be closed on Thursday for Remembrance Day.  It will be an important week for earnings results as several Real Estate Investment Trusts (REITs) will be announcing their performance figures.

  • In the U.S., the most recent inflation numbers will be released through the announcement of the Consumer Price Index.  Wholesale inventories will be announced and the Chair of the Federal Reserve, Jerome Powell, will be speaking at several conferences and will likely comment on the Fed’s decision from last week.

  • Globally, China will announce its inflation numbers for both consumers and companies as their CPI and Producer Price Index (PPI) are released.  Germany will also release its CPI.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • The TSX was the only major North American equity index to lose ground last week.  Even with some high-profile earnings disappointments, like Amazon and Apple, the U.S. indices including the NASDAQ, made strong gains.

  • The most significant negative news for the TSX and most Canadian investors was the announcement by the Bank of Canada that their quantitative easing program of bond-buying would be ending. 

  • Secondarily, the forward guidance that an interest rate increase is predicted for the middle of 2022, not the end of next year, further lowered expectations..  This move and guidance are based on the growing realization that inflation in Canada (and the U.S.) is not as temporary as first suspected.

  • Bond-buying can lower the long-term borrowing rate for businesses and households and may encourage and allow for major investments and purchases that contribute to economic recovery.   Dialing the quantitative easing program back to zero is designed to reduce overall demand and upward price pressures, but may also cause a reduction economic growth.  With the short-term rate at its lowest possible level of ¼%, the ability to spur economic growth with short term rates does not exist, so the Bank of Canada has decided to raise long-term rates now. (Source1, Source2)

What’s ahead for this week?

  • In Canada, October’s manufacturing Purchasing Managers Index (PMI) from Markit, building permits and merchandise trade balance will be released.  The employment report for October is scheduled for Friday.

  • In the U.S., Markit and ISM will announce their manufacturing and services PMIs, along with construction spending, factory orders.  The Federal Reserve will announce its latest monetary policy following the Federal Open Market Committee’s meeting midweek. 

  • Globally, the Eurozone, China and Japan will release their manufacturing and services PMIs, too.  Germany’s factory orders, industrial production and retail sales are on the calendar.  OPEC+ will hold another meeting amid continued increases in the price of oil.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • The TSX and Dow reached new all-time highs last week.  The TSX has had an unbroken series of thirteen daily gains: last losing value on October 4th.

  • Overall inflation rate for September was 4.4%, compared with the U.S. rate of 5.4% for the same period.  The assumption that current inflation is temporary and related directly to the reopening and recovery of economies is beginning to be questioned.  When food, shelter and transportation prices rise, 3.9%, 4.8% and 9.1%, respectively, concern also rises.  Eventually inflation will pressure central banks like the U.S Federal Reserve and our Bank of Canada to slow price increases by slowing economic growth. (Source1, Source2)

  • Evergrande, China’s massive housing builder, continues to struggle with debt repayment issues ($300 Billion) and links to a housing bubble in that country as China’s Gross Domestic Product (GDP) growth stagnates. 

What’s ahead for this week?

  • In Canada, wholesale trade and the raw materials price index for September and two very important indicators for August, the employment report and real GDP, will be announced.  On Wednesday the Bank of Canada will release its latest monetary policy announcement.

  • In the U.S., September’s goods trade deficit, wholesale and retail inventories, durable goods orders, pending home sales and new home sales will be announced.  Personal spending and real GDP, also for September, will be the most noteworthy economic indicators released this week.

  • Globally, GDP, business climate, consumer confidence, unemployment and consumer inflation will be released for Germany.  Eurozone figures for GDP, inflation, consumer confidence and money supply are scheduled to be announced. 

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


Quarterly Commentary

Inflation and Interest Rates... The Story Continues


In our previous Commentary we focused on inflation -- how inflation is tied to interest rates, why central banks focus so closely on inflation and why we as portfolio managers monitor it so attentively. Three months later, inflation and its impact on our clients’ investments continues to be front and centre for our portfolio management team at IAIC, so we thought it best to tackle the issue again in this quarter’s Commentary.


In the quarter ended September 30, 2021, we saw:

 

  • inflation rates rise higher than most economists anticipated
  • a general decline in stock market values during the month of September
  • the Chinese Government become more actively involved in various business segments
  • a federal election in Canada
  • a ‘diplomatic hostages’ exchange between China and Canada; and
  • a Federal Reserve (the “Fed”) meeting outlining how future monetary policy actions may unfold.

Following the Fed’s meeting in September, Fed Chairman Jerome Powell provided reassurance that monetary policy will remain accommodative until its dual goals on employment and inflation have been achieved. In essence, the Fed is walking a tightrope, allowing inflation to continue by delaying its policy response under the presumption that some of the inflationary impacts we are observing are transitory. This delayed response allows more time for the economy and employment to recover. Once these transitory impacts have worked through the inflation data, if the economy and employment are nearing full capacity and the recovery is entrenched, the Fed can more safely ease off on stimulus and increase interest rates.


Closer to home, the Bank of Canada (“BOC”) may move to reduce the amount of monetary stimulus sooner than the US Fed. In August, Canada’s annual inflation rate was running at 4.1%, a rate not experienced for almost twenty years. Add to this the perception that Canada is in the midst of a housing crisis (due partially to cheap credit) and these conditions may lead to the BOC acting before the Fed in removing monetary stimulus. However, such actions can have negative consequences in both government and consumer finances as well as the broader economy. We will be watching these developments very carefully.


Asset Valuations in an Inflationary Environment


One common question we hear from clients is, “How does inflation tie into the price of the investments that I hold?” Corporate profits and stock prices are impacted by inflation and interest rates in a number of ways:


Transitory vs. Permanent Inflation


First, it is important to differentiate between the impacts of transitory inflation and inflation that is more permanent and entrenched in the economy. Transitory inflation is usually the result of temporary economic dislocations due to the volatility in the prices of key economic inputs, such as commodities, basic materials and food. While very disruptive, the market often looks beyond the impact of these disruptions. For example, the market is unlikely to materially change its valuation of a grocery store chain due to a sudden, temporary increase in the price of fresh produce. Compare this to inflation that is more permanent and entrenched in the economy that has a longer-term effect. For example, rising labour costs due to a permanent shortage of workers has the potential to be a more permanent source of inflation. Wages increase when businesses compete for scarce labour resources. If businesses are unable to pass through these costs, margins will fall, and profitability will be negatively impacted. However, if businesses are successful at passing through their higher labour costs, this can create a more entrenched inflationary pressure in the economy. The determination of the type of inflation (transitory or permanent) is therefore very important to the market, as is the Fed’s assessment of which type of inflation it is fighting.


Interest Rates and the Cost of Capital


Rising interest rates will also negatively impact the cost of capital for businesses. An increase in interest rates will not only increase the interest rate on outstanding debt but can also lead to an increase in the cost of equity capital, all of which leads to negative pressure on stock market valuations.


Interest Rates and Future Cash Flows


Generally speaking, rising interest rates can have the effect of reducing the price-to-earnings ratio investors are willing to pay for stocks. This negative impact is more pronounced for companies that have more of their cash flows occurring further out in the future, such as high growth stocks, like technology companies, where the payoff of high profits is many years away. The valuation of these types of stocks is potentially more sensitive to rising inflation and interest rates despite having higher growth prospects.


Interest Rates and Fixed-Income Securities


Rising interest rates also negatively impact fixed-income assets. The contractual stream of cashflow generated by a bond or any other instrument that provides a fixed payment is discounted in the price of that instrument. In general, the longer the investor must hold the instrument until maturity, the more sensitive the price of that asset will be to interest-rate movements. Some income-producing assets may vary the payments they make based upon prevailing interest rates (floating rate instruments, for example). While the price of these assets may be more volatile, during a period of rising rates they can benefit from higher inflation.


Implications for Our Clients’ Portfolios


Even before the pandemic, wealth managers who relied on a mix of fixed-income assets with equities to mitigate market volatility for their clients faced significant challenges. With interest rates at record lows and relatively risk-free assets failing to keep pace with even modest inflation, the economic climate leading into the pandemic produced a widening gap in the spread between traditional fixed-income assets in favour of riskier assets such as stocks. With yields falling to under 1% for many high-quality corporate bonds, the propensity of many asset managers was to shift weighting away from bonds to higher-yielding asset classes including preferred shares, stocks and alternative assets. Of course, each client’s unique tolerance and capacity for risk and need for income must be considered before pursuing any such strategy.


With inflation rising in the latter stages of the pandemic, we are watching developments very carefully, including the central banks’ actions to keep inflation in check and the impacts of these actions on economic growth and its continued recovery. We continue to focus on mitigating the impact of rising interest rates on our client’s portfolios, maintaining the purchasing power of their assets so that the income they require from their portfolios keeps pace with inflation. All the while, we work to produce a reasonable rate of investment return in conjunction with each client’s financial planning objectives.


What strategies are we implementing in this economic environment?

 

  • We maintain a short-term (e.g. generally, a five year maximum term to maturity) equal weight bond ladder to mitigate the negative impact of the potential for rising interest rates. Interest rate volatility has a relatively minor impact on short-term bonds and our strategy is designed so that about 20% of the bond allocation matures in any given year. Our focus is primarily on investment grade corporate bonds that offer yields that are higher than those offered by government bonds. If not needed by the client, the proceeds from maturing bonds can be reinvested back into the fixed-income class at prevailing rates or, where appropriate, moved into higher-yielding alternatives, including preferred shares, REITs and dividend paying stocks.
  • We invest in profitable “value-based” stocks in industries that can adapt to inflationary pressures by passing on their cost increases to customers and maintaining their margins.
  • We focus on stocks that have a track record of consistently paying and raising their dividends over time, effectively providing their shareholders with a ‘raise’ every year via the increasing dividend.
  • We invest, where the valuation is reasonable, in growth opportunities (e.g. the technology sector) for the long-term. We look for sectors and companies that will benefit from emerging trends and shifts in the composition of the broader economy, providing capital gains despite potential higher volatility and sensitivity to interest rates.
  • We invest in strong companies with a dominant global presence. These are companies that enjoy relative competitive advantages with operations that are not denominated in a single currency.
  • We provide exposure to some sectors or assets, such as preferred shares and financials, that can benefit from rising interest rates and the economic climate associated with inflation.

 

Conclusion


We continue to believe that market conditions warrant cautious optimism and a balanced approach. We don’t make large, risky bets with our clients’ retirement savings that can create a binary outcome – a “big win” or a “big loss.” We believe diversification is critical, including exposure to asset classes that can perform well in periods of rising interest rates and inflation.


We believe in the maxim that, “Time in the market, not timing the market,” is what will help us build our clients’ wealth. We continue to monitor the markets and take actions that we believe will not only produce reasonable long-term returns but will also reduce risk in client portfolios.

 


(source: Bloomberg https://www.bloomberg.com/markets, MSCI https://www.msci.com/end-of-day-data-search and ARG Inc. analysis)

 

What happened last week?

  • It was a very positive week in the markets:

    • Equities rose 1.5% to 2.5% with the major indices approaching or setting new 52-week highs. 

    • The Canadian dollar rose along with the price of oil.  Oil has doubled in the past year, which is good news for Energy investors, but will increase consumer and producer inflation. 

    • Gold, which gained last week, is still down more than 7% in the past year. 

    • The positive performance for stocks and oil was achieved despite the mixed news that was announced:

      • The International Monetary Fund (IMF) released its “World Economic Outlook” with the headline “Global recovery continues, but the momentum has weakened, and uncertainty has increased”.  The slowdown has been attributed in part to supply disruptions in advanced economies and worsening pandemic conditions in developing countries. (Source)

      • Consumer inflation rose 5.4% in September. The Federal Reserve has been maintaining that the higher inflation rate situation is temporary.  Concern is growing that inflation may not be as transitory as hoped based on recent data from the housing market. 

      • Expectations to taper Federal Reserve bond purchases, which would increase the cost of long-term borrowing is continuing to grow.  The move to taper is being driven by increasing inflation, but also potentially delayed by stalling Gross Domestic Product and employment numbers.  Based on the Fed’s announcements an increase to the benchmark interest rate is not expected until 2022 or 2023. (Source)

What’s ahead for this week?

  • In Canada, September inflation through the Consumer Price Index will be released, which will heavily influence Bank of Canada actions.  The central bank’s Business Outlook Survey, housing starts, manufacturing sales are all on the calendar.

  • In the U.S., industrial production, capacity utilization, building permits and housing starts and existing home sales for September will be released.  A number of Purchasing Managers Indexes (PMIs) that predict upcoming business and wholesale activity are also on the schedule.

  • Globally, important economic indicators from China will be announced with real Gross Domestic Product, trade balance, retail sales and industrial production scheduled for announcement.  Japan’s CPI and Eurozone inflation and consumer confidence will also be announced.

For more information contact: [email protected]

www.iaic.ca | Tel (519) 291-2817 | 135 Main Street, East | PO Box 68 | Listowel, ON N4W 3H2

 

This report is produced by Independent Accountants' Investment Counsel Inc (“IAIC”) in conjunction with ARG Inc.  All graph and chart statistical data contained in this report has been supplied by ARG Inc. The views and opinions expressed in this report are based on market statistics.  No guarantee of outcome is implied, and opinions may change without notice.  Investors should not base any of their investment decisions solely on this report nor should any opinions expressed within this report be construed as a solicitation or offer to buy or sell any securities mentioned herein.  Although the information contained in this report has been obtained from sources that IAIC believes to be reliable, we do not guarantee its accuracy, and as such, the information may be incomplete or condensed. All opinions, estimates and other information included in this report constitute our judgment as of the date hereof and are subject to change without notice.

Please contact your IAIC representative if you have any questions regarding this report. 

 

©Copyright 2021 Independent Accountants’ Investment Counsel Inc. All rights reserved.


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