Tag: Inflation

Seriously and Literally

In 2016, Donald Trump supporters said that you should take him seriously, but not literally. His first press secretary, Anthony Scaramucci said “don’t take him literally, take him symbolically.” This defense of Trump was meant to highlight that while he may have said incredibly controversial things, much of that was just talk, and it was his message behind the words that you should really pay attention to.

But Trump himself has contradicted this view more than once, frequently saying “I don’t kid” when challenged on policy (the exact comment came about in 2020 over coronavirus testing). In other words, Trump has let people know that you shouldn’t be surprised when he does do things that seemed initially outrageous. For the wider world this has meant that you should take Trump at his word, and that even if some of his rhetoric is just that, rhetoric, you would be foolish to ignore the substance of his messages.

Since his re-election Trump’s focus has been squarely on tariffs, promising them on China (a further 10%), on BRIC nations (100%) and Canada and Mexico (25% each). He’s suggested that some of the tariffs can be avoided for Canada and Mexico over better border controls on drugs and illegal immigrants, but whether this is true is unknown. Political commentators like David Frum have pointed out that Trump’s views on trade have been consistent since his first considered run for the presidency in 1987, that he is hostile to trade and sees it as a zero-sum game.

A close-up of a piece of paper Description automatically generatedIn 2025 world leaders and policy shapers believe Trump should be taken both seriously and literally. While the current political situation in Canada has been turbulent, the view of the government and provinces is almost unanimous (Quebec and Alberta remain the perennial opponents to joining the band wagon). Doug Ford took the initiative to announce that Ontario could stop energy exports to the US in the event of a trade fight, a position seconded by BC’s premier David Eby.

But in the United States the threat of aggressive and expanding tariffs have also been taken literally, notably by Jerome Powell of the Federal Reserve. On December 18th, in a move that shook markets, Jerome Powell did announce a final rate cut for 2024, but stressed that future cuts were heavily dependent on inflation, which will likely rise if Trump enacts his regime of trading tariffs. Markets were quick to react, and though 2024 will be remembered as a pretty good year for investors, the speed and size of the market sell-off was newsworthy, being the largest since August.

The next morning and markets began on a relatively positive note, continuing a trend of brief panics followed by long yawns as markets simply resume their upward momentum. Little seems to have dissuaded the bull market since 2022 and with the US economy still showing itself to be very strong there’s every chance that the brief panic on December 18th was just that, a moment of panic at the end of 2024. But Trump, like the rest of us, doesn’t live in longer and slower news cycles. Instead market panics live on in social media, and run the risk of coalescing into counter narratives that Trump might hurt the economy more than help it (its notable that the economy has been very strong under Biden, but that didn’t change the perception that Trump had been the better economic steward).

In 2018 Jerome Powell began raising rates to blunt the sharper edges of a hot economy and return interest rates to somewhere near a historic norm. Since 2008 rates had remained at emergency low levels, and there was a genuine concern that markets were becoming addicted to cheap cash. In October of that year Jerome Powell made clear that rate hikes would continue until the Fed felt they’d reached a neutral rate, news not well received by the stock market. From October to the end of the year the S&P 500 lost 18% by December 24th, before rebounding slightly by the New Year. Markets had posted decent returns to the end of September, but wiped out those gains and finished the year -6.24% . During the last months of the year Trump made repeated efforts to pressure Powell to halt or cut rates, often publicly over Twitter.

My opinion is that Trump likes the ambiguity surrounding his pronouncements. Whether he actually intends to implement all the tariffs he’s discussed, whether they are bargaining positions, or whether he can be talked out of them is a grey area that offers him a position of strength. Politicians may be particularly vulnerable to his vagaries since they often wish to protect the status quo while Trump feels free to be a disruptor. But that grey area only works as a negotiating tactic so long as people believe that deals can be reached. If nations come to believe that Trump is serious and literal about tariffs and don’t believe they can be avoided, you are only left with a trade war. Similarly if you are in charge of the Federal Reserve and believe that Trump will do what he says, then you have every reason to pursue positions that curb inflation.

Following Trump’s election Jerome Powell was asked whether he would resign as the Federal Reserve chair, and was clear in his response; he will not, he is not required to leave, and cannot be compelled to. Trump already has a difficult and publicly hostile history with Powell, and its easy to imagine that if Powell is taking Trump seriously, he will move into direct conflict with Trump because of his policies, not in spite of them. Similarly conflict may be around the corner on diplomatic issues for the exact same reason. If Mexico feels it can’t avoid a trade fight with the US, you can assume that Mexico might be less interested in working to curb migrants at the US border. In Canada the same might be true, negotiating with someone who has no intent to make a deal (or honor the one already made) is not likely to build support for concessions.

Today Trump will take office following his inauguration, and he’s expected to sign a number of executive orders kicking off his next term. He has posed as a disruptor, and has nominated a number of other unusual thinkers and people opposed to the status quo to make up his cabinet. Whether they all take those roles and can do what they say they plan too is yet to be seen, but on December 18th we may have gotten some insight into what that future might look like, a future where Donald Trump is taken at his word, both seriously and literally.  

Aligned Capital Partners Inc. (“ACPI”) is a full-service investment dealer and a member of the Canadian Investor Protection Fund (“CIPF”) and the Canadian Investment Regulatory Organization (“CIRO”).  Investment services are provided through Walker Welath Management, an approved trade name of ACPI.  Only investment-related products and services are offered through ACPI/Walker Wealth Management and covered by the CIPF. Financial planning services are provided through Walker Wealth Management. Walker Wealth Management is an independent company seperate and distinct from ACPI/Walker Wealth Management.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Why is Inflation So Hard to Beat?

April was a turbulent month for markets. Having begun 2024 with an abundance of enthusiasm about the prospect of (very near) interest rate cuts from central banks, an improving economy both domestically and abroad, and resilient employment, 2024 promised the fulfillment of a long-held dream; for the central banks of Canada and the United States to tackle inflation without causing a recession.

Though recessions seem to not be lurking in the immediate vicinity, the best-case scenario for the year is now fully off the table. Several months of higher-than-expected inflation numbers have caused markets to reconsider their earlier optimism and contemplate some of the more pessimistic predictions for economies.

In turn, US markets shed several percentage points through the first two weeks of April, not wiping out the year’s gains but reducing them by about half. Bond markets, having placed bets on rate cuts and longer duration bonds have retreated as well, wiping out gains for the year and forcing bond traders to retrench into safer, shorter duration positions.

Markets have steadied since then, and have been encouraged by Jerome Powell’s statements that the Fed still intends to cut rates, but the earlier optimism about many cuts totalling more than 1% for the year seem unlikely, and even now we will need more data in the coming months to trigger the first cut that had been anticipated for the early year.

Why is this, and why have markets been so easily convinced that rates were bound to fall so quickly?

There’s no obvious single answer. Like many issues surrounding complicated problems a multitude of events, including human bias and the best of intentions have formed the foundations for a great deal of misunderstanding. For the Fed’s part, it has remained committed that data will drive all interest rate decisions, a sensible argument but one that has tied their hands. Investors and analysts have shown a natural bias of optimism, and have assumed that with the bulk of inflation easily defeated through 2022 and 2023 that the final pieces would fall easily into place. This optimism has not learned from the recent past, as 2023 began in much a similar way, with anticipation of rate cuts happening in the second and third quarter of the year only to have rates start increasing in May.

But after these more human problems, what remains are a series of headwinds that will likely be with us for the foreseeable future. While prices of many commodities have fallen from their peaks, and “supply chain constraints” are no longer choking the global trade network, the world is fundamentally different than its was before 2020. China’s relationship with the West is now more openly antagonistic, and a combination of “reshoring” or “friend shoring” is ensuring that costs will be higher than they were in the past. Food prices have continued to rise, with sometimes opaque reasons. In some instances there are clear justifications for higher costs, like bird flu affecting American egg prices or higher gas charges pushing up the cost of shipping. But other times it seems that prices have risen because grocery stores simply can. Finally, commodity prices, while lower than they were in 2021/2022, remain above pre-covid levels. This applies especially to the price of energy, which seems set to stay elevated for the near term.

Performance of the 1 year WTI contract – Source: Bloomberg

Underlying this remains some larger issues about inflation’s presence in our lives before 2020. As I’ve previously written, many parts of our society were experiencing inflation long before CPI began to worry economists and other experts. Prices of physical goods had been falling for decades, but price of homes, child care, education, and food had all been climbing over that same period. The price of housing might be better if governments took a more active role in getting the cost of development down, but permits and other government fees now account for anywhere between 20% (CMHC estimates) to 60% when all taxes, red tape, permit costs and development charges are accounted for, a lucrative source of funds for municipal budgets.

From blog Carpe Diem by Mark Perry:
Source: https://www.aei.org/carpe-diem/chart-of-the-day-or-century-8/

 Additionally, since 2008 interest rates had been at “emergency levels”, the lowest borrowing costs of any time in history. Those near zero rates, which were intended to help remove slack from the economy and encourage large capital expenditure instead stimulated enormous share buybacks among major corporations. Instead of new jobs and a hotter economy we got increasing share prices and more corporate debt.

Problems that take a long time to form do not get fixed quickly. Repeatedly markets have shown an impatience for corrections and are quick to assume that pauses in inflation must mean that the trend of higher prices has both been beaten and that interest rates can fall back to previous emergency levels. Even if interest rates are at sufficient levels to regain control over the direction of inflation, it still doesn’t mean that rates can fall quickly, and the longer rates stay elevated above the emergency levels of the past, the deeper and more costly current interest rates become to the economy.

In Canada low interest rates helped stimulate an enormous increase in property values through the 2010s and into the pandemic. Higher interest rates threaten those gains and as we go through 2024, almost 60% of mortgages will have renewed into more expensive loans since rates began climbing. Even if interest rates begin to fall, homeowners can expect that the cost of borrowing will be much higher than they’ve been for many years. Between the desire of home owners to keep house values high, municipalities to keep their tax bases stable, and banks to ensure that the value of properties they’ve underwritten don’t move too much, the pressure to get inflation down runs squarely into our own self interest.

The urgency and desire for lower interest rates are real, but so are the headwinds that keeps inflation pressure high.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)* – if applicable ACPI is regulated by the Investment Industry Regulatory Organization of Canada (http://www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (http://www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and

bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Revisiting Inflationary Heat Waves

About 12 months ago I had reflected on a summer of global heat waves and how rising global temperatures would ultimately be inflationary as citizens and governments would be stressed in a multitude of ways to tackle heat waves, flooding, and health issues. But as it turns out there were other (not considered) ways that global warming might become an inflationary issue for countries.

If you’ve never stopped to look into global shipping, you’re missing out on one of the most impressive global logistical challenges that has been tackled by human civilization. The ubiquity of cargo containers and the ships that move 90% of everything we use across oceans, renders both the novelty of this achievement and its impressiveness invisible. It wasn’t that long ago that shipping things (anything) was a cumbersome and wasteful endeavor where the distance something could be shipped, its speed in getting there, and the amount that would arrive unspoiled was a pitiful fraction of what travels today. The creation of standardized shipping containers and the development of ever larger ships to carry them has been a cornerstone of globalization.

But the speed of shipping is also dependent on two enormous infrastructure projects of significant historical importance; the Suez Canal and the Panama Canal. The histories of these mega projects are impressive and they retain essential roles in cutting down transportation times for ships crossing from one side of the planet to the other, speeding raw materials and finished goods to markets faster and for less money.

As I like to point out, most stories involving global warming are really stories about water. The Panama Canal, though it connects two oceans, is in fact a freshwater canal and relies on tributaries and rainfall to maintain its depth. But 2023 has delivered a serious drought to Panama and left tributaries and rivers dry, leading to a shallower draft in the Panama Canal. The managers of the canal have taken several measures to deal with this, the most notable has been reducing the draft limit of ships by six feet.  

Six feet may not sound like a lot, but each foot reduced equates to a reduction of between 300 to 350 cargo containers per ship. Six feet is about 2000 fewer containers per boat, or around 25% of a typical cargo ship. This has meant that ships have to carry less cargo, or manufacturers are paying a premium to ensure their cargo is on an earlier scheduled ship. Other options include unloading and shipping some of the cargo by train and reloading it at another port, or travelling around the southern tip of South America, adding weeks to the voyage.

As if this wasn’t enough, lower water levels have also meant fewer ships allowed to transit the canal, with daily transits dropping from 40 to 36 to 32 trips a day, while fees for those crossings have risen to $400,000 per trip. For ships that have set travel times and book passage through the Panama Canal in advance, the impact of these changes has been less pronounced, but other types of shipping, like bulk and gas carriers that must wait for a slot in the canal are now waiting an average of 10 days (an increase of 280% since June) to make it through.

Inflation has many sources, but one we’ve been assumed would recede quite quickly was inflation due to infrastructure and shipping. Initially global supply chain stresses came from China, pandemic shutdowns, and backlogs. But time would ultimately fix these issues as China reopened and ports cleared the backlog of ships. The challenges of the Panama Canal show that climate change will likely remain a source of inflation, unanticipated and requiring considerable money to manage. Since water infrastructure is something that we typically underfund, there is almost no place, rich or poor, that isn’t looking at considerable future costs to improve and maintain existing infrastructure, let alone new infrastructure.

As we head into the winter, its very likely that the drought in Panama will ease, and shipping costs may come down while transportation times shorten. But this marks another change in the environment that may become a reoccurring pressure point on economies, and one that may become so regular as to recede into the background even while it impacts our daily lives. The lesson to investors should be that global warming remains inflationary and will demand ever more money for infrastructure.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Inflationary Heat Wave

In his book “The Ministry for the Future”, author Kim Stanley Robinson imagines a heat wave impacting India, pushing temperatures ever higher for an extended period of time. Eventually temperatures exceed the “wet bulb temperature”[1] for human survival, the point when a human body can not cool itself down by sweating, sitting in the shade, or drinking water. The death toll is unimaginable. Millions die. So begins Robinson’s account of a world in the throes of global warming.

This year contained many headlines that echoed Robinson’s book. There were heat waves in Australia, India, North America, Europe, the Middle East, Africa, and Asia. It comes on the heels of energy and food shortages, exacerbating already stressed pressure points for global security and worsening inflation. To date I’m not aware that there have been any places where the WBT has gone above 35C, but that doesn’t mean people, economies, and nations aren’t being pushed to the breaking point. Forest fires are common after such an extended period of heat. Crops suffer and efforts to stop agricultural failure are expensive. Water patterns are disrupted, with sudden downpours and earth so parched it can’t absorb rapid deluges leading to flooding. Electrical grids are increasingly stressed to their breaking point as demand surges. And of course, people die due to heat exhaustion.

How hot are these heat waves? In January temperatures in Buenos Aires reached 41.1C and 700,000 people lost power. In Australia a town called Onslow reached 50.7C, tied now for the hottest temperature recorded in the Southern Hemisphere. The city of Perth had 11 days of temperatures over 40C. In the same period (early February), Palm Springs in California reached 34C.

In March and April 90 deaths would be recorded across India and Pakistan, a number almost certainly (and deliberately) inaccurate. Cities across the subcontinent saw temperatures more than 42.8C, and one city in Maharashtra state recording over 45C. Pakistan saw temperatures in excess of 49.5C and 47C in various cities. Birds fell from the sky in Gujarat, and a bridge collapsed in Pakistan following glacial flooding. While the official total was only 90, other more recent heat waves across Europe reveal those numbers must be much higher, with some of the most vulnerable in the society simply going uncounted as victims.

In June heat waves hit much of Europe, pushing temperatures up to 40C, or higher across much of the continent. That same heat wave reached the UK, pushing the temperature in London to 40C as well, a first in living memory for the country. While that spike was short lived, it was a reminder of just how dependent populations are on the infrastructure built on certain climatic expectations. Air conditioners, while not totally uncommon, are not used by the majority of Europeans, and often homes or apartments cannot easily accommodate their introduction by design.

Our thinking can also be quite constrained by experiences, but the extreme temperatures we’ve seen affect more than people. Heat waves and their accompanying droughts can also create problems we wouldn’t consider. In France the temperature of rivers (specifically the Rhone and Garonne) rose so much that they were too hot to cool nuclear reactors, forcing shutdowns. In Germany the Rhine was so low in early August that it was in danger of being shut to cargo, potentially hindering delivery of the coal now needed to meet energy needs. And in China, Foxconn, a major industrial supplier for companies like Apple and Toyota, suspended plant operations as the region suffers from hydropower shortages due to low water levels in the Yangtze.  

We’ve just passed the end of summer, but across much of the world heat waves have left significant impacts on economies and peoples.  I started writing this piece while in Spain with my family in July, where everyday temperatures had remained above 40C. Since then I have been returning to this essay only to note that things have gotten worse. The high temperatures being faced by people in countries like India, Pakistan and Bangladesh have been compounded by surging demand for electricity, forcing governments to have structured rolling blackouts. Protests have been erupting in Pakistan as energy prices have continued to soar despite the ongoing blackouts. In Bangladesh production in the garment industry has struggled as a result of the mandatory power cuts, efforts to curb the rising prices faced by the nation in energy and food.

If water levels were low in China at the beginning of August, they were positively dire at the summer’s end. China’s largest freshwater lake, Poyang Lake, nearly dried up forcing extensive trench digging operations to keep water flowing to farmland. In France portions of the Loire River ran dry (the government is quick to point out the river is still open to traffic and is not at its historic lowest point) while in Nevada the artificial lake created by the Hoover Dam, Lake Mead (the primary source of water for Las Vegas) is at its lowest levels since 1937 (Lake Mead has had a small rebound since the end of July, driven in part by reduced demand downstream of the dam). The heat wave affecting California is now thought to be one of the worst and most persistent in history. Meanwhile in Pakistan heat waves have given way to unparalleled flooding. An estimated 33 million people have been displaced, 15% of the country’s population, as its crumbling infrastructure has proven no match for extreme weather.

Global warming has much the same effect on economies like black holes do on physics, warping everything around them until the laws we assume that govern things become unrecognizable. In the period of a week or so, roughly 900 people died in Spain from the heat, including the death of a sanitation worker who dropped dead on the job in Madrid due to heart failure. Reportedly his internal body temperature was above 40C when he was attended to by paramedics. In the face of tragedies like this, what are governments likely to do? What will citizens do?

They will be forced to act, encouraging the use of air conditioners, building more resilience in the electrical grid, directing public funds to deal with vulnerable individuals who are at risk in high heat conditions. If crops start to be affected, you can also bet that governments will be more predatory when it comes to protecting grain supplies and working on minimizing the effects of climate related inflation. If energy rationing becomes more common it will force more top down restrictions, more public money towards expensive infrastructure projects, and contractions in living standards.

For my own part I remain unconvinced that governments will be proactive with regards to these challenges, and instead I expect them to be reactive to a fault with only the richest nations able to potentially solve more than one problem at a time. But short-sighted self interest is not unique to kleptocratic dictatorships. In the United Kingdom, which came under numerous “hosepipe bans” in the summer, selling off reservoirs for new developments while not investing in any new significant water infrastructure for 30 years goes hand in hand with climate change impact. Countries across Europe, Asia and North America have been robbing Peter to pay Paul, and now the bill is coming due.

Winter is coming, and before us lies the potential for further difficult months. Heatwaves have raised food prices and taxed electrical grids. Winter promises to see further pain as energy needs traditionally met by Russian oil will now need alternatives. Coal, a major contributor to the climate crisis, is the current favourite choice both across the developing world, but now also in wealthier western countries facing the pinch of oil and natural gas shortages. The demand is so great that coal use is expected to be at an all time high in 2022. In Germany people are buying electric heaters, but being so inefficient they actually use more electricity and will likely increase energy prices further for Europe’s most beleaguered industrial powerhouse.

Headlines in 2022 have been dominated by central banks raising interest rates to combat inflation. The risk of this strategy is a recession, potentially globally, but the cost of failure is an inflationary environment where food, energy, utilities, and consumer goods become more expensive. And yet that is exactly what has happened; over confidence, short sightedness and a fundamental misunderstanding of resilience planning has made us all “richer” in the short term, but promises to make us pay more in the long term. Heatwaves are baking in our inflation.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)* – ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). Adrian Walker is registered to advise in securities and mutual funds to clients residing in British Columbia and Ontario.

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service.

[1] You may never have heard of the wet bulb temperature before, but it will be something we all come to know. The temperature is determined by having two thermometers side by side, one covered with a “sock” soaking in water. As air moves over the wet bulb of the second thermometer, moisture will evaporate and lower the temperature, giving you a different reading from the unadulterated thermometer. The first tells you the outside air temperature. The second tells you how much cooler you can be if water is evaporating off you. If in a heat wave the WBT reaches or exceeds 35C, the human body can not survive for an extended period outdoors.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Unravelling

In his book Fooled by Randomness, Nassim Taleb says of hindsight bias “A mistake is not something to be determined after the fact, but in the light of the information until that point.”  With this guidance we can forgive some of the covid precautions and restrictions governments imposed on populations in 2020, a period of great uncertainty. 

But in mid-2022 assessing the course of action by governments and central banks as they attempt to tackle a number of non-pandemic related crises (as well as still managing a pandemic that is increasingly endemic) I think its fair to say that mistakes are being made. From political unrest, to cost of living nightmares and finally inflation dangers, the path being plotted for us should be inviting closer scrutiny by citizens before we find ourselves with ever worsening problems. 

Let’s start with the twin risks of inflation and interest rates. Inflation is high, higher than its been in decades, and central banks the world over are attempting to stamp this out with aggressive rate hiking. It is easy to point to Turkey, a country whose inflation rate is 70%, and see that their recent cutting of interest rates is a mistake in the face of such crippling inflation. But what are we to make of North American efforts to slow inflation, even at the risk of a recession? Inflation for much of the West has been tied to economic stimulus (in the form of government action through the pandemic), supply chain disruptions and low oil and gas inventories. The economy is running “hot”, with lots of businesses struggling to find employees. But inflation, measured as the CPI is a rear-view mirror way of understanding the economy, also known as a lagging indicator. But here is one that is not. The price of container freight rates, which have fallen substantially from the 2021 highs.

We can count other numbers here too. The stock market, which is having a bad year, has fallen close to pre-pandemic highs. A $10,000 investment in the TSX Composite Index would have a return of 6.1% over the past 28 months, or an annualized rate of 2.6%. In February of this year that annualized rate was 8.85%, a 70% decline in returns. The numbers are worse for US markets. While US markets have performed better through the pandemic, the decline in the S&P500 is roughly 75% from its pandemic high in annualized returns (these numbers were calculated at the end of June, offering a recent low point in performance).

For many who felt that the stock market was too difficult to navigate but the crypto market offered just the right mix of “can’t fail” and “new thing”, 2022 has wiped out $2 trillion (yes, with a “T”) of value. 

In fact speculative bubbles are themselves inflationary and their elimination will also help reduce inflation. Writes Charles Mackay in his famous book Extraordinary Popular Delusions and the Madness of Crowds (1841) on the Mississippi Bubble in France, “[John] Law was now at the zenith of his prosperity, and the people were rapidly approaching the zenith of their infatuation. The highest and lowest classes were alike filled with a vision of boundless wealth…”

“It was remarkable at this time, that Paris had never before been so full of objects of elegance and luxury. Statues, pictures, and tapestries were imported in great quantities from foreign countries, and found a ready market. All those pretty trifles in the way of furniture and ornament which the French excel in manufacturing were no longer the exclusive play-things of the aristocracy, but were to be found in abundance in the houses of traders and the middle classes in general.”

Evidence today indicates that supply chains are beginning to correct, an important component of taming inflation, while trillions of dollars have been wiped out of a speculative bubble. Even oil, which seems to be facing structural issues that would normally be inflationary has had a significant retreat, along with other commodities like copper, lumber and wheat. Some of these declines may only be temporary as markets react to recession threats, but these declines do not happen in a vacuum. They are disinflationary and should be treated as such.  

But central banks seem ready to trigger a recession in the name of defeating the beast of inflation even as it seems to be bleeding out on the ground. In June the Federal Reserve raised its benchmark interest rate by 0.75%, and the current view is that the Bank of Canada is likely to do the same in July. All this is sparking deep recession fears that seem to be driving markets lower. 

In the background remain genuine issues that seem to be addressed at best haphazardly. Inflation is a real issue making food prices go up, but its been crushing people in housing for years. Even as interest rise and house prices moderate lower, average rents in the GTA were up 18% over the last year. The Canadian government’s response to the mounting costs of living has been to propose a one time payment of $500 to low income renters. That is just a little more than the average increase in rent over the previous 12 months. 

In the face of such mounting housing pressure the city of Toronto has done the following things:

  1. Ban the feeding of birds.
  2. Consider the leashing of cats.
  3. Raised development fees 49%. 

For the record, Toronto is believed to have the second biggest property bubble globally. 

Globally Europe looks to be on the cusp of a serious recession. If North American central banks are looking too aggressive, Europe is struggling to chart a path for its shared currency. Rates have been at record lows but recently the ECB has said it will begin raising rates to tackle inflation. Across the continent the rate of inflation is over 8.1%, but it varies widely country to country, with Germany closer to the average, while Lithuania is at 22%. In the face of mounting inflation the ECB hasn’t raised rates once yet this year, though its expected to this month, even has the European economy and stock markets have been doing worse and worse. 

Coincidentally, Germany, who is now both the linchpin in NATO support for Ukraine while simultaneously its weakest link, has seen its economic health crumble due to decisions made years ago to pin Germany’s energy needs to Russian energy supplies. Will Germany today be able to make political decisions that support NATO and the EU even if it means further economic pain for a country that has grown accustomed to being the beneficiary of these arrangements?

It is not just Western or developed nations that are struggling. China is in the middle of some kind of debt bubble in its real estate market, whose impact is harder to know, but will likely be long lasting given its size. Numerous developing nations are on the cusp of debt defaults, the tip of the iceberg being Sri Lanka.

A small island nation off the southern tip of India, Sri Lanka has been reasonably prosperous over the past few decades with an improving standard of living. Yet government mismanagement, graft and a haphazard experiment in organic farming have left the country destitute. Literally destitute. Out of money, gas and food. In the past few days protests have moved beyond general unrest into a full blown revolution, with the Sri Lankan people storming the government and the political leaders fleeing for their lives.

Behind them is El Salvador which has decided to embark on an experiment in making Bitcoin an official currency, a move designed to liberate the country from the tyranny of the World Bank and the US Government. It has instead likely led to a default, financial instability, and a more regressive and authoritarian government. 

This year stands out for the complex problems that have grown out of the pandemic, but if we’re serious about the kinds of big problems politicians regularly say that must be tackled, then it raises a question as to whether we are handling them properly, or whether we are making mistakes given what we know right now.

For the last few years I have written or touched on many of these topics; on housing, inflation, crypto currencies and the fragile nature of many of our institutions. And while I am cautious about making grand predictions, it remains worth asking whether we are making smart choices given what we know, and if we are not we should be making greater demands of our elected leaders. And if our elected officials continue to make poor decisions, we as investors should plan accordingly.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Control Your Soul’s Thirst for Freedom

Since late February the bulk of global attention has been focused on the Russian invasion of Ukraine. The invasion remains ongoing, and will likely last for months, potentially even years, and represents the most dangerous geopolitical situation we are likely to face until China tries to enforce control over the South China Seas or invades Taiwan.

But while our attention has been narrowly focused, interest is growing about how the world’s second largest economy is choosing to mange the late stages of the pandemic, a series of choices that have ramifications for much of the world.

China has had mixed luck with Covid. By the end of 2020 it looked as though China might be the only winner economically from the pandemic, but 2021 turned out to be a year for the West. First, Western vaccines, particularly the mRNA vaccines were highly effective, while the Chinese vaccine produced domestically had only a 50% success rate. The Chinese government also was hyper critical of the more effective Moderna and Pfizer vaccines, essentially precluding them from Chinese use. This has left the country in a difficult spot. Chinese mandated lockdowns have been brutal but effective, leading to uneven vaccine use. The low infection rates that the “Covid Zero” policy has delivered has also robbed the country of natural immunity. Today China, already struggling economically, is still locking down whole cities in the hopes of containing outbreaks.

Shanghai is the current major city to be shut down, but the lockdowns are spreading. Complaints about food shortages and people trapped in apartment buildings, offices, and closed off from their places of work have led to some fairly strange places, including protests and at least once the use of “speaking drones” urging citizens to comply with rules and reprimanding the citizens singing in protest one night to “Control your soul’s thirst for freedom. Do not open your windows and sing.”

This image came from early April

Chinese lockdowns are also worsening global inflation. The supply chain disruptions caused by the most recent lockdowns in Shanghai are dramatic to say the least. In the above picture each yellow dot represents one cargo ship waiting to be docked and unloaded. Supply chains were already deeply stressed when Shanghai went into lockdown last month, and the global impact of further supply disruptions is something we’re very likely to notice.

This image came from early May

Lastly, some months ago (October 2020) I had detailed how China’s foreign policy, which was heavy handed and often petulant, was angering nations all across the globe. China may not view the world the way its geopolitical rivals do, but its inability to grasp at least what might be considered fair or just by other nations is damaging its own ability to wield soft power, an essential part of being a global hegemon. China’s decision to back Russia in its invasion of Ukraine likely reflected China’s near-term goals of retaking Taiwan and its general contempt for the current world order. However, the global resistance to the Russian invasion, the support shown Ukraine and the barrage of negative publicity (as well as realizing that an untested military in countries with lots of corruption may not be able to score quick military victories) must serve as a wake-up call to China’s ruling class. As of 2022 China seems to have squandered much of its international good will and is unlikely to find many willing allies for its global ambitions.

China seems to be suffering on all fronts. 2021 was a bad year for China’s economy, cumulating in the public meltdown of one of its biggest developers in November. But everything, from its politics to its public health policies are working against it. The world’s second largest economy, one that is the largest trading partner to 130 countries, can’t seem get out of its own way, and as it falters it can’t help but impact us.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

What’s Happening With Markets?

Markets have been falling through the year, and despite some encouraging rallies the trend so far has been decidedly negative. The NASDAQ Composite, one of the three big indexes heavily tilted towards technology companies had a -23.86% YTD return as of Monday, May 16th, a minor recovery after it had reached a low of -27% on Thursday of the previous week. The Dow Jones and the S&P 500 have YTD returns of -10.31% and -14.82% respectively. The question for investors is “what to do?” in such markets, especially after some of the best years despite the pandemic.

A closer inspection of the markets however shows that while there have been some steep sell offs reflected in the broad market, the real market declines have been far more concentrated. And while there are many different market headwinds to choose from when it comes to reasons for the recent selling action; inflation, interest rates, geopolitical strife, COVID-19, maybe even Elon Musk, the sector that has been sending markets lower has been the tech sector.

Over the past couple of years the companies posting the biggest gains in the markets have been tech companies. Apple stock (AAPL) was up 88.97% in 2019, 82.31% in 2020, 34.65% in 2021, and is down -11.6% so far in 2022. Amazon (AMZN) was up 76.26% in 2020, and has fallen -30.18% this year. Facebook, now META Platforms (FB) gained 56.57% in 2019, 33.09% in 2020, 23.13% in 2021 and has lost -38.08% in 2022. Netflix was up 67.11% in 2020, and a further 11.41% in 2021 but is down -68.74% this year. Tesla, which had an astounding 743.4% gain in 2020 and another 49.76% return in 2021 is so far down -17.36% in 2022, how long can it resist gravity? (All prices and YTD performance were collected from ycharts.com on May 6th, 2022).

I predict that we may never fully understand how the pandemic changed thinking and why stock prices climbed so much, but the reality was that many tech companies benefited from people staying home, going online and the changing priorities that coincided with not having to be in offices and commuting. Tech companies that became huge like Shopify (SHOP), which allowed traditional retailers to become online retailers, benefitted immeasurably from the lockdowns. But it too has seen its stock decline this year by -69.59%, pushing the price back to where it was in December 2019.  

Because the tech sector has become so large, particularly in the NASDAQ, the retreat of these companies carries big implications for indexes and by extension the wider market as well. As markets fall, it encourages investors to panic sell, aided and abetted by the army of computers that help multiply the effects of momentum selling. This is especially true as investors have migrated to low-cost passive index ETFs, a trend so noticeable that experts worry it might be warping the market as investors worry less about the value of individual companies and instead pile money into broad indexes with no quality filters.

Markets are facing other risks too. Inflation, which seems to be running at about 8%, can threaten economies as people buy fewer items due to cost increases. Interest rate hikes, which are meant to ultimately curb inflation by restricting monetary supply and reduce lending/economic activity have hit bond markets particularly hard. Higher interest rates mean higher borrowing costs, and its here we might hypothesize about some of the unintended consequences of the incredibly accommodative monetary policy that the pandemic introduced. That might be that investors were able to borrow to invest, and the threat of both rising interest rates and stumbling returns will only hasten the exit of money from the market by some investors. Higher borrowing costs will also have another impact on markets, as a sizeable amount of stock market returns over the past decade have come from share buy backs, funded in part by low-cost borrowing.

Having said all that, economies are still looking very strong in the present. Earnings have remained high, jobless claims continue to fall, and while we’ve seen a spike in costs the ability to address those inflationary pressures may not be something that can be easily done through monetary restricting.

There are many different sources of inflation, but two significant issues are not connected to “cheap money”. Instead we have issues that are primarily structural and represent the failure of political foresight. The first among these has to do with oil. Since the price of oil fell in 2014, infrastructure development has stalled, heavily indebted producers have retreated, and now Russia has been closed off from much of the global market. This confluence of events has unfortunately arrived as economies are reopening, global use nears pre-pandemic levels, and global refined supply is at historic lows. There is no simple solution for this, as the only remedy is time (and development). In theory, Canadian and US oil could make up much of the global need, but for a multitude of reasons neither country is in a position to rapidly increase production.

Similarly, supply chain disruption and the heavy reliance on offshore manufacturing have meant that there is no simple solution to production problems occurring in other nations. China is the key issue here, with an enormous grip on much of global supply on many items and their current insistence on a “Covid Zero Policy” China is effectively shut to global business. This means ships can’t get into port, and with-it products cannot make it to market.

Higher borrowing costs seem unlikely to handle this problem. High gas prices and lack of supply may be inflationary, but high borrowing costs can’t target those issues. Instead, higher interest rates and the threat of more in the future are hitting the parts of the market that have been pushed higher by cheap credit. The stock market and the housing market.

If markets seem to be moving independently of economies, its possible that won’t stay that way for long. As previously mentioned, higher energy prices are not controllable by higher lending rates. But higher energy prices can introduce demand destruction, a fancy way of saying that economies shrink because prices get out of control. Oil is still in high use and its needs go far beyond powering cars. In fact internal combustion engines only account for 26% of global oil need, meaning those higher prices for crude, if they get too high, can have wide inflationary impacts to the entire economy.

Higher lending rates may also lead to a substantial economic reset, especially for Canadians who have much of their net worth tied up in their homes. With almost 50% of new mortgages in Canada variable rate mortgages, home prices having skyrocketed in the past few years and with most Canadian debt connected to homes, the risk to home owners is very real. Can the Bank of Canada tame inflation, orchestrate a soft landing for the housing market and keep the economy chugging along? Such a question invites highwire act comparisons.

So what’s happening with markets? Perhaps we are simply correcting a narrow subset of the market that got too hot through 2020-2021. Perhaps we are seeing the dangers of printing too much money. Perhaps we are seeing the realities of people buying too many index ETFs. Perhaps we are witnessing people being too fearful about the future. Perhaps we are too fearful of inflation or interest rates. Perhaps we are on the brink of a recession.

Perhaps, perhaps, perhaps.

But let me offer a slightly different take. Investing is frequently about connecting your needs as an investor with the realities of the world. As Warren Buffet famously said, in the short term the stock market is a voting machine, in the long term a weighing machine. If you can afford risk, you can be risky, and with that comes the potential for significant market swings. If you can not afford risk, then your portfolio should reflect that need. If you cannot stomach bad days, potentially weeks or even months of bad news, then you need to find a way to keep your investment goals aligned with your risk tolerance.

When I started this essay we had just completed one of the worst weeks of the year, which bled into the second week of May. As I finish this piece markets are in the process of rallying for a third day, posting modest gains against the backdrop of significant losses. It would be nice if I could end this with some confidence that we’ve turned a corner, that markets had bottomed and that the pessimism that has led to so much selling is evaporating as people come to recognize that stocks have been oversold. Yet such prognosticating is the exact wrong tack to take in these markets. Instead, this is a good time to review portfolios, ensuring that you are comfortable with your risk, that your financial goals remain in sight and that the portfolio remains positioned both for bad markets, and for good ones too.

If you have any concerns about how your portfolio is positioned and need to review, please don’t hesitate to contact us today.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Looking Back on 2021

Its traditional that the end of a year should stimulate some reflection on the past and the future, and so in the spirit of tradition I thought I’d take some time to look over some of the stranger and more surprising aspects of 2021.

China

While 2021 brought the pandemic *closer* to an end through the distribution of vaccines, markets underwent some fairly dramatic reversals over the course of the year. For instance China looked to be the principal economy in January. Following its own strict enforcement of Covid restrictions and solid economic performance, China seemed to be an earlier winner by the beginning of 2021, and set to enjoy robust growth through the year.

By March the tide was shifting however. China’s leader, Xi Jinping, proved to be every bit committed to his past comments about protecting and strengthening the CCP over free market concerns. Several billionaires, notably Jack Ma the founder of Alibaba, disappeared for long periods before reemerging only to publicly announce that they would be stepping down from their roles.

However, even while China was shaking down its billionaires and upsetting foreign nations, a new economic threat appeared in the form of a housing bubble looking ready to burst. Evergrande, one of the country’s largest property developers announced that it could not finance its debt anymore and looked likely to default. This news was unwelcome for markets, but for China hawks it fit their long standing belief that China’s strength has been built on a mountain of unsustainable debt, with property one of the most vulnerable sectors of the economy.

The finer points of China’s housing market are too nuanced to get into here, but it’s enough to know that the property bubble in China is large, built on sizeable debt and could take some time to deflate (if it does) and no one is sure what the fallout might be. Combined with China’s ongoing policy of “Covid Zero” – an attempt to eradicate the virus as opposed to learning to live with and manage it, we head into 2022 with China now a major outlier in the Asian region.

Inflation

Inflation was probably the other most discussed and worrying trend of 2021. Initially inflation sceptics seemed to win the argument, as central banks rebuffed worries over rising prices and described inflation as transitory. That argument seemed to wane as we entered late Q3 and prices were indeed a great deal higher and didn’t seem to be that “transitory” anymore. Inflation hawks took a victory lap while news sites began to fill up with worrying stories about rising prices on household goods.

The inflation story remains probably the worst understood. Inflation in Canada, as in other Western nations has been going on for sometime, and its effects have been under reported due to the unique nature of the CPI. But some of the concern has also been overwrought. Much of the immediate inflation is tied to supply chains, the result of “Just-in-time” infrastructure that has left little fat for manufacturers in exchange for lower production costs. Bottlenecks in the system will not last forever and as those supply chains normalize that pressure will recede.

The other big pressure for inflation is in energy costs, but that too is likely to recede. Oil production isn’t constrained and prices, while higher than they were at the beginning of the pandemic are lower than they were in 2019. In short, many of the worries with inflation will not be indefinite, while the issues most worrying about inflation, specifically what it costs to go to the grocery store, were important but underreported issues before the pandemic. Whether they prove newsworthy into the future is yet to be seen.

*Update – at the time of writing this we were still waiting on more inflation news, and as of this morning the official inflation rate for the US over the past year was 7%. Much of this is still being chalked up to supply chains squeezed by consumer demand. An unanswered question which will have a big impact on the permanence of inflation is whether this spills into wages.

This political advertisement from the Conservatives ruffled many feathers in late November

Housing and Stocks – Two things that only go up!

If loose monetary policy didn’t make your groceries more expensive, does that mean that central bankers were right not to worry about inflation distorting the market? The answer is a categorical “No”. As we have all heard (endlessly and tediously) housing prices have skyrocketed across the country, particularly in big cities like Toronto and Vancouver, but also in other countries. The source of this rapid escalation in prices has undoubtedly been the historically low interest rates which has allowed people to borrow more and bid up prices.

In conjunction with housing, we’ve also seen a massive spike in stock prices, with even notable dips lasting only a few days to a couple of weeks. The explosion of new investors, low-cost trading apps, meme-stocks, crypto-currencies, and now NFTs has shown that when trapped at home for extended periods of time with the occasional stimulus cheque, many people once fearful of the market have become quasi “professional” day traders.

Market have been mercurial this past year. Broadly they’ve seemed to do very well, but indexes did not reveal the wide disparities in returns. Last year five stocks were responsible for half the gains in the S&P 500 since April, and for the total year’s return (24%), Apple, Microsoft, Alphabet Inc, Tesla and Nvidia Corp were responsible for about 1/3 of that total return. This means that returns have been far more varied for investors outside a tightly packed group of stocks, and also suggests markets remain far more fragile than they initially appear, while the index itself is far more concentrated due to the relative size of its largest companies.

Suspicious Investment Practices In addition to a stock market that seems bulletproof, houses so expensive entire generations worry they’ve been permanently priced out of the market, the rapid and explosive growth of more dubious financial vehicles has been a real cause for concern and will likely prompt governments to begin intervening in these still unregulated markets.

Crypto currencies remain the standout in this space. Even as Bitcoin and Etherium continue to edge their way towards being mainstream, new crypto currencies trading at fractions of the price, have gotten attention. Some have turned out to be jokes of jokes that inadvertently blew up. Others have been straight-up scams. But all have found a dedicated group of investors willing to risk substantial sums of money in the hope of striking it rich.

NFTs, or non-fungible tokens have also crept up in this space, making use of the blockchain, but instead of something interchangeable (like a bitcoin for a bitcoin, i.e. fungible) these tokens are unique and have captured tens of thousands, sometimes hundreds of thousands of dollars for unique bits of digital art. Like cryptocurrencies, much of the value is the assumed future value and high demand for a scarce resource. However, history would show that this typically ends poorly, whether its housing, baseball cards or beanie babies.  

Lastly, there has been a number of new investment vehicles, the most unusual of which is “fractional ownership”. The online broker Wealth Simple was the first to offer this in Canada and it has been targeted to younger investors. The opportunity is that if your preferred stock is too expensive, you can own fractions of it. So if you wanted to invest in Amazon or Tesla, two stocks that are trading at (roughly) $3330 and $1156 respectively at the time of writing, those stocks might be out of reach if you’re just getting started.

This is a marketing idea, not a smart idea. The danger of having all your assets tied up in one investment is uncontroversial and well understood. The premise behind mutual funds and exchange traded funds was to give people a well-diversified investment solution without the necessity of large financial position. The introduction of fractional ownership ties back to the market fragility I mentioned above, with younger investors needlessly concentrating their risk in favour of trying to capture historic returns.

The End

For most investors this year was largely a positive one, though markets went through many phases. But while the pandemic has remained the central news story, the low market volatility and decent returns has kept much of us either distracted or comfortable with the state of things. And yet I can’t help but wonder whether the risks are all the greater as a result. Many of these events, the large returns in an ever tightening group of stocks, the growth of investors chasing gains, the sudden appearance of new asset bubbles and the continued strain on the housing market and household goods add up to a worrying mix as we look ahead.

Or maybe not. Market pessimists, housing bears, and bitcoin doubters have garnered a lot of attention but have a bad track record (I should know!) Many of the most pressing issues feel as though they should come to a head soon, but history also teaches us that real problems; big problems that take years to sort out and lead to substantial changes are often much longer in the making than the patience of their critics. The test for investors is whether they can stand by their convictions and miss out on potential windfalls, or will they become converts right as the market gives way?

Next week, we’ll examine some of the potential trends of 2022.   

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The End of the 60/40 Split?

For the past few weeks I’ve been struggling to capture what’s been happening in markets since late January. There has simply been so much that it is hard to succinctly cover it all in a single blog post.

So instead, toady I hope to touch on one thing that should stand out to us, the potential end of an investing strategy that is so standard it is reflected in almost every corner of the financial services world, from mutual fund companies to robo-advisors to banks.

The 60/40 split, or balanced portfolio, is the general go to solution for steady returns. The principle is simple: 60% of a portfolio is weighted towards equities, that is stocks in companies, mutual funds or ETFs, and the remaining 40% goes towards fixed income; a collection of bonds or other “safe” investments that pay some income in the form of mutual funds or ETFs.

This is a wide space to play in. Within the stock or equity portion, a portfolio may have exposure to any number of companies, sectors, or geographies. Similarly, the fixed income component can have government debt, corporate bonds, T-bills, mortgage securities, either domestic or foreign, in short or longer durations. The individual positions may have short term impacts on performance, as some investments will outperform for limited stretches, but the general architecture of the portfolio should see relatively stable and consistent returns over time with an acceptable level of risk for the majority of investors.

This wasn’t just speculation. It had some math behind it, explained in the form of the “Efficient Frontier”, a curve that showed the relation of risk to return and aimed to help identify an optimum portfolio based on these two metrics. The goal was to maximize the amount of return for the risk undertaken. Its easy to get lost in the weeds here, but if you’re ever interested you can read up on Modern Portfolio Theory or Harry Markowitz. Put simply, the lesson the industry took was that a diversified portfolio of investments, with rough weightings of 40% in fixed income and 60% in equities would largely suit most people.

It’s worth asking why this is. And the answer has a lot to do with buying a house in the late 1970s and early 1980s.

As anyone who remembers 8-tracks will tell you, buying a house in the early part of the 80s was expensive. 5-year fixed rates were 20%, or more. According to the website ratehub.ca, the prime lending rate in Canada peaked at around 21.75% in August of 1981. By comparison, my current 5-year mortgage is a whopping 1.8%. In 1981, you could buy a Government of Canada 10-year bond with a coupon rate of 15.3%, and a 5-year GIC with a rate of 15.4%. Today a 10-year government of Canada bond has a yield of 1.51% and the most generous GIC I can sell is 1.96% from Haventree Bank with a minimum deposit of $50,000.

Figure 1 From London Life – Looking Back at Historical Returns

Okay, so what’s the connection?

The issue here is not just that buying a house cost more when it came to lending in the 1980s, but that the cost of lending itself has been falling for the last 40 years. We tend to think of bonds as an investment you buy, when in reality they are a loan you are making that can be traded on an open market. So imagine you were building a bond portfolio in the early 1980s, and the average yield of that portfolio (the interest you will receive based on what you paid) is 15%. It’s very safe, made entirely of Canadian 10-year bonds. Now, three years pass and a new 10-year bond from the GoC has a rate of 12.3%, what’s the effect on your bond portfolio?

It’s good news! It’s worth more, because for the next 7 years your bonds will pay 3% more than any new bond issuance. By 1986 a 10-year bond was paying 6% less per year than your portfolio. For the last 40 years the cost of borrowing has continued to decline, and the result has been to make bonds issued in previous years more valuable. And so, while there may have been fluctuations in returns over short periods of time, by and large a portfolio of bonds returned not just income, but also capital gains as older bonds were worth more with each decline in the cost of lending.

Figure 2 From http://www.Ratehub.ca/prime-mortgage-rate-history

Today the cost of lending is low. Very low. Central bank lending rates for Canada, the United States, and the ECB are 0.25%, 0.25% and 0% respectively. A 30-year government of Canada bond has a current yield of 1.948%. In other words, were you to buy that bond today, the most you would earn is 1.948% on whatever you paid for the next 30 years.

But remember, bonds are traded on an open market. This means that the value of a bond fluctuates with its demand, and with it the return the bond gives. So, if you think that 1.948% is not enough interest to warrant buying the bond and the broad market agrees with you, the price of the bond should fall enough to push up the yield (for reference, the yield is the interest paid by the bond, divided by its price) until it pays enough interest to warrant investing. And that is what has been happening this year. Government bonds in the United States have been dumped as investors expect stock markets to do well and bond yields are considered too low. And as the bond price falls, the yield the bond pays goes up in relation to the decline of the price, and with it sets a borrowing rate investors are more comfortable with.

What this means for portfolios is that the 40% allocated to bonds is now very vulnerable to both investor sentiment and future rate hikes by central banks. With borrowing rates already at rock bottom both of these risks seem likely, and it’s left the traditional “balanced portfolio” exposed when it comes to reducing risk through different asset classes.

You might assume that this is a new problem, but it isn’t. Risk has been growing and portfolios have been evolving in complexity to meet the needs of investors for the last few decades. Much of this has happened on the equity side of portfolios, with investors demanding, and ultimately gaining access to a much wider range of investable products since the 90s. The period where you could have a portfolio made up of just Canadian dividend paying stocks ended long ago, and in its place, portfolios now hold a variety of investment products with access to large cap, small cap, US, North American, global, international, Emerging Markets, Frontier Markets, sector specific investing, thematic investing, commodities, dividends, value, growth, and growth at a reasonable price. Bonds have undergone a similar transformation, with investors moving from government bonds, to corporate bonds, to junk bonds (bonds with lower quality ratings and potentially higher default rates) both domestically and globally.

Today, to achieve a return of about 6.5%, the average investor is taking on risk at a much higher rate than they would 20 years ago. In 2000 a 6.5% return could be achieved with a portfolio of exclusively bonds. 20 years later a 6.5% return would require a much larger range of positions, including US stocks (large and small cap), real estate, private equity and would have a relative level of risk of more than double (almost three times!) the 2000 level. The above changes to the bond market will only mean more risk and more volatility for investors.

I’m reluctant to ever declare something “dead” or “over”. That language betrays too much confidence about tomorrow, but financial history is much longer than most people appreciate and is filled with disruptions and the ending of economic certainties followed by the arrival of new paradigms. Whether it is the bankrupting of the Medicis, or the popping of a tulip bubble, economic realities can change.  The “balanced portfolio” with its 60/40 mix, has been a cornerstone of simplified investing, a “go-to” solution that has made mass investing using discount platforms affordable and easy.

Figure 3 From Wealth Simple’s web page, simply choose your risk comfort and get a portfolio with more or less bonds. No need to think, no need to worry.

In an ideal world we might wish that investing was more “set it and forget it” than not, but long-term data and averages obscure the reality for many people. In the last ten years we’ve seen two serious “once in a lifetime” events that have shaken markets and governments. Investors, no matter what their stripe, whether they prefer robo-advisors, bank products or a personal financial advisor like myself, should be cautious that the rules to successful portfolio building are immutable.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Threads of 2020

The end of the year always brings on reviews of the biggest stories, but its probably more accurate to say that the biggest stories of any year are really the consolidation of events and ideas from many years prior. So as we look ahead, what events from the past might come to their rightful end in 2020?

Fragile Worlds and Global Challenges

Corona 1
Figure 1 People wearing protective masks arrive at a Beijing railway station on Tuesday to head home for the Lunar New Year. NICOLAS ASFOURI/AFP via Getty Images

News of the rapid spread of the “novel coronavirus”, the dramatic quarantining of multiple Chinese cities and the wall to wall media coverage have made the new disease an inescapable part of life. But while the ultimate severity of the virus remains unknown, the larger impact on the global economy is slowly coming into focus. An interconnected planet that is dependent on economies functioning half a world away can find itself in serious trouble when 40 – 50 million people are suddenly quarantined. Consumer spending in China has dropped off significantly, and expectations are that the government may have to take dramatic action to ultimately support the economy. However, the impact of such a large public effort will not only hurt the Chinese economy, but may hamper the already minor commitments that they have made to the US in the new “Phase 1 Treaty”, which will also hurt the US economy, one that has already showing signs of weakness over the last year. The long-term threat of the corona virus may not be its impact to our bodily health, but to financial health.

The Missing Inflation

For years economists and central bankers have been puzzled by the lack of inflation from the economy. No amount of economic growth or declining unemployment seemed to move the needle on inflation, and it remained stubbornly and frustratingly at or below the 2% target most banks wanted.

Labor Participation RateOne explanation for this is that the labor participation rate has been very low and that the unemployment rate, which only captures workers still looking for work and not those that have dropped out of the workforce altogether, didn’t tell the whole story about people returning to the workforce. The result has been that there has been an abundance of potential workers and as a result there really hasn’t been the labor shortage traditionally needed to begin pushing up inflation.

But there are some signs that inflation is coming back to bite. First, and interesting article from the CBC highlighted just how many vacancies there are in trucker  . There is currently a shortage of 22,000 drivers, and that’s expected to climb to 34,000 in the next few years. Trucking pays well, but maybe it doesn’t pay well  enough. In a universe where many Canadian university educated citizens can’t get work outside of Starbucks, how is it that people haven’t jumped at the chance to get into this lucrative practice?

Trucking isn’t the only trade lacking employees. Nursing and pilots are another two trades that are facing severe shortages. How long can some major industries resist raising wages as shortages start to pile up?

Canada’s Economic Problems

Insolvency RatesThe short version of this story is that Canadians are heavily in debt and much of that debt is sensitive to interest rates. Following a few rate hikes, insolvencies started to creep up in Canada and 2020 may be a year in which the historically high personal debt rates of Canadians start to have an impact on the Canadian economy. According to the Toronto Star and CTV News Canadian insolvency rates are   highest they’ve been since the financial crisis, only this time there isn’t a crisis.

As I wrote before Christmas, economic situations create populist movements, and if Canadians are facing a growing economic problem, widespread and with many Canadians vulnerable we should be mindful that an economic problem may become a political one.

A Crisis in Education and Generations

Student Debt w SourceWalking hand in hand is the increasing cost of education, and the declining returns it provides. In the United States the fastest growth in debt, and the highest rate of default is now found in student debt. According to Reuters the amount of unpaid student debt has doubled in the last   to about $1.5 trillion. The financial burden can be seen in the age of first-time home buyers which has been creeping up over the previous decade and is now pushing 35. The primary step in building a life and the pushing of that life off explains some of the current disaffection with politics and economy that has led a growing number of younger people to hold a favorable view of Communism.

Debt and DelinquencySource for consumer loan growth

The Recession Everyone is Waiting For

Following three years of growing trade wars, a decade of uninterrupted economic growth, and market valuations at all time highs, the expectation of a recession has reached a fever pitch. With 2020 being an election year it seems likely that Trump will try and sooth potential economic rough patches, the first of which will be with China, where his trade war is as much about getting a better deal as it is about winning political points with his followers. The first phase of the trade deal is to be signed very soon but details about that deal remain scant. It’s likely that the deal will do more for markets than the wider economy as there is little benefit for China to go for a quick deal when a protracted fight will better work to their advantage.

MSCI vs PriceEfforts to hold off an actual recession though may have moved beyond the realm of political expediency. Globally there has been a slowdown, especially among economies that export and manufacture. But perhaps the most worrying trend is in the sector that’s done the best, which is the stock market. Compared to all the other metrics we might wish to be mindful of, there is something visceral about a chart that shows the difference in price compared to forward earnings expectations. If your forward EPS (Earnings Per Share) is  expectated to moderate, or not grow very quickly, you would expect that the price of the stock should reflect that, and yet over the past few years the price of stocks has become detached from the likely earnings of the companies they reflect. Metrics can be misleading and its dangerous to read too much into a single analytical chart. However, fundamentally risk exists as the prices that people are willing to pay for a stock begin to significantly deviate from the profitability of the company.

Real Price vs Earnings
Figure 2 http://www.econ.yale.edu/~shiller/data/ie_data.xls

Market watchers have been hedging their bets, highlighting the low unemployment rate and solid consumer spending to hold up the markets and economy. But the inevitability of a recession clearly weighs on analysts’ minds, and with good reason. In addition to the growing gap between forward earnings expectations and the price people are willing to pay, we now see the largest spread between the S&P 500 Stock price Index and the S&P 500 Composite Earnings (basically more of the above) ever recorded for the S&P 500. While this tells us very little about an imminent recession, it tells us a great deal about the potential for market volatility, which is high in a market that looks expensive and overbought.

Climate Change

Picture1
Photo by: Matthew Abbott/The New York Times via Redux

Climate change has garnered much attention, and while I believe that more should be done to deal with the earth’s changing biosphere, I fear that the we are having a hard time finding the most meaningful ways of doing that. In the wake of our inaction we will witness the continued economic costs of a changing environment.

Australian TemperatureAustralia, which has had years of heat waves, has recently faced some of the worst forest and brush fires imaginable (and currently bracing for more). At its peak in early January, an area of land roughly the twice the size of Belgium was burning, and an estimated billion animals had died. Some towns have been wiped out and the costs of all this will likely come somewhere into the billions once everything has been totaled. What’s important, and the bit hard to get your mind around, is that this is not A FIRE, but is a season of fires and there were more than 100 of them. And it is happening every year. It’s now a reoccurring problem in California, as well as Western Canada, and in the rainforests of Brazil. As I’ve said before, the story of climate change is about water, and the cost of that will be high.

Australia Burning
Figure 3 Image copyright EU COPERNICUS SENTINEL DATA/REUTERS

More of the Same

There is a lot of focus on the growing disparity between the very wealthiest and poorest in our society. This renewed interest in the level of inequality is a conversation worth having but is frequently presented in a way that isn’t helpful. For instance it’s been pointed out that the concentration of wealth at the very top of society has only continued to intensify, and a recent report from the Canadian Centre for Policy Alternatives (Published January 2nd, 2020)  points out that a “top 100 CEO” saw their pay increase 61% over the last decade. However, to muddle matters, the “top 100 CEOs” remains a fairly non representative group and within Canada wealth concentration for the top 1% has been falling since  2007 (which also represented the highest concentration since 1920).

Trillions of Wealth

Canadian 1% Wealth

This isn’t really about wealth inequality, so much as how unhelpful it is to sling statistics back and forth at one another every day endlessly. A better way to understand what’s happening is to see where is winning rather than who is winning. In the United States, which has seen a long period of job growth, 40% of new jobs were created in just a handful of cities (20 to be precise).

City Jobs
Figure 4 Source: Reuters analysis of Bureau of Labor Statistics data

Those cities, like Seattle, Portland, LA, Atlanta, Austin, Dallas, and, Miami, have all been rewarded in the 21st century, while many of the remaining 350 metropolitan areas had to share the other jobs, and many of those areas saw their share of jobs decline in the same period. An even smaller group of five cities have picked up the bulk of new innovation businesses, a key issue as traditional industries like retail and manufacturing falter, but Computer System Designers are thriving in the new economy. The issue of wealth inequality is not going to be easily dealt with by simply taxing billionaires. Inequality is a geographic story and one likely to persist into the future.

City Job Share

Conclusion

The stories of 2020 are likely going to hit many of the themes we’ve been touting over the last 8 years. Cities, affordability, resiliency, aging populations, environmental change and reckless speculation will remain central to news reporting. But the biggest story will likely be how well we responded to these issues…

Did I miss anything? Let me know! And as always if you have any questions, wish to review your investments or want to know how you can address these issues in your portfolios, please don’t hesitate to email me! adrian@walkerwealthmgmt.com

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc