A lot is going on in the markets today; real estate is down, stocks are down, inflation and interest rates are on the rise, supply chains are still disrupted, and a war is raging in the Ukraine. So with all these major social and economic shifts, are we skating the edge of the dreaded word Recession? Listen today as Senior Financial Advisors Rob McClelland and Mike Connon discuss the role of government, the Bank of Canada, and other foreign and domestic influences on the Canadian market.
Transcription
Rob (00:00):
Hello, this is Rob and Mike from The McClelland Financial Group of Assante Capital Management, and this is Think Smart with TMFG. Today on Think Smart with TMFG, Mike and I are going to be discussing, what is going on with these markets and what should I do about it?
Rob (00:21):
Mike, there’s a lot going on today around the world, stocks are down, we hear real estate’s down, there’s inflation all over the map, interest rates are starting to go back up, we still have supply chain issues due to COVID, we still have a war going on in the Ukraine. It’s hard to put it all together.
Mike (00:45):
Yeah, it’s funny nowadays, when clients say, what do you think about what’s going on? I ask if they could be a little bit more specific about what part of what’s going on.
Rob (00:54):
Well, it’s interesting. I think in our planning, we’ve always used that 3% inflation rate. And for the last 10, 15 years, inflation’s been in that 1 to 2% range, and so we always seemed too high with 3% inflation. Suddenly six months later, we’re now too low, I mean, inflation’s coming in at 8 to 9% in the US and not much lower in Canada.
Mike (01:25):
Yeah. It’s reminiscent of the eighties. I always remember going through the 1980s and I remember even early on when you had mortgages, I think my first mortgage was at 8 or 9%, but I remember my parents had take-back mortgages and they took back one at 18 or 19% back in the eighties.
Rob (01:44):
It is interesting. I think my first mortgage was at 9% and today with some financing on the cottage, I’m at 2%. So things have changed.
Rob (01:56):
Let’s talk about inflation in terms of what the banks or what the government wants. So the central bank ideally would like a little bit of inflation in the economy. Ideally, they like to be in that 1 to 2% range. And if we look 12 months ago, inflation was basically 0.67%, it was less than 1%, and suddenly that’s changed dramatically.
Mike (02:27):
Well, it’s a fine line because sometimes people think of an inflation as a bad thing. Inflation is actually a good thing, because we want GDP to grow. You want to make more next year than you made this year. So inflation is a natural phenomenon that always happens to keep people satisfied, happy, and has always been part of the economy. Deflation is a scary thing. Deflation means next year you can expect to make less money than you did this year, which is a very depressing thought, right? So inflation itself is not a bad thing, it’s just the amount of inflation that’s happening and how quickly it comes on.
Rob (03:01):
So what are governments to do? I guess the first thing they’re starting to do is they are starting to increase interest rates. So in Canada, we’ve had two interest rate increases, one for 25 basis points or 0.25%, another one for 0.5%, and that was back in April, and there are predictions the next one could be another 0.5% or 0.75%, and I’ve seen some good estimates that we could be at 3.6% by some time in 2023. So that’s a long way from where we were at 1%.
Mike (03:44):
I guess the scary thing that you think of is, even with all these increases, you’re still going to have a negative real rate of return on bonds, right?
Rob (03:54):
Definitely. I mean, no matter what, if inflation’s at 8%, even if it comes down to 6%, bonds are in that 3 to 4% range right now, and that’s a big improvement for where it was, bonds were at 1 to 2%. So they’ve jumped up because they’re expecting interest rates to be higher.
Rob (04:20):
I thought it might be interesting, a big part of what Canada does is we import a lot of goods, and so I went and looked, well, what type of goods do we import? And if we look at the top 10 imports of things we bring into the country, I’m going to go through the list, but why is this important? We can’t control the inflation on those goods, these are imports. And in many cases we don’t produce those goods, so it’s the rest of the world that’s going to impact the inflation on those goods. So we can raise interest rates to 8% and we’ll still have no impact on some of these goods.
Rob (05:07):
So let me give you an example. Of Canada’s top 10, the biggest thing we import, machinery, including computers, about $70 billion. And that makes up just under 15% of our total imports.
Rob (05:23):
Next, vehicles. We wouldn’t have cars on the road if it wasn’t for imports. We import $67 billion worth of cars every year, and that makes up about 14%. So that’s huge. So cars are going to go up in price.
Rob (05:43):
We then get into number three which would be electrical machinery and equipment. $46 billion, 10% of the total.
Rob (05:51):
We still import mineral fuels, including oil. That’s about $30 billion. Not quite as big, only 6%.
Rob (06:00):
And then the last one would be plastics, $20 billion or 4%.
Rob (06:06):
What are some of the smaller ones? So that’s the top five. Mike, what are some of the ones that are 6 to 10?
Mike (06:12):
Well, there are things like precious metals that aren’t available in Canada. I know we have gold and nickel, but there are some other precious metals we don’t actually have in Canada, we have to import, and that’s about $18.7 billion.
Mike (06:26):
Pharmaceutical is a huge one, Canada doesn’t have a lot of pharmaceutical companies, we import from Europe and the US. That’s about other $18.6 billion.
Mike (06:37):
Medical apparatus, that’s about $13 billion.
Mike (06:39):
Articles made of iron and steel, that’s about $11.4 billion.
Mike (06:43):
Iron and steel itself is about $10.5 billion.
Mike (06:46):
So yeah, a lot of things. No matter what we do in our economy, we’re not going to be able to control the price of these items.
Rob (06:53):
Let’s go back to discuss, what is the government trying to do? The government’s goal, number one, they want to maximize employment. Well, we’re there. We’re fully employed. In fact in most businesses, in Canada in the US, there is a worker shortage and it’s a big shortage, and it’s a shortage that can’t be fixed very quickly. So the government’s goal has always been to maximize employment and you’ve got to give them full marks on that one.
Rob (07:27):
Second goal is price stability. Whenever you start getting inflation, you think of maybe a third world country where prices are out of control and that becomes difficult because your average individual can’t afford to take on this inflation, so they have to reduce what they’re buying. That’s not good for the economy. As interest rates rise, banks start charging more, so mortgage rates are going up. They start charging more for households if you have a line of credit, they start charging more for businesses to borrow money. So businesses are now under pressure, households are under pressure.
Rob (08:10):
So what’s the response, Mike, what are households and businesses going to do once expenses go up?
Mike (08:17):
They’re going to slow down their spending, which is going to slow down supply and demand. And right now we have lower supply because of just what’s going on with COVID, and we have high demand because we have high employment. So people have money and there’s not enough goods, which creates inflation. So once you start to slow down that demand and people have a little bit less money to spend, you’ll find the prices should work their way down.
Rob (08:44):
I was reading an interesting article this morning in the paper and it just talked about companies are changing things so they’re still keeping the size of the package the same, but the reducing the quantity that’s in the package. So maybe you were getting egg rolls and you used to get to 22 egg rolls in the package, now you’re just getting 20. And we’ve seen that all along. You know, the bag of chips seems half full today when you buy the bag of chips. The bag’s the same size because they don’t want you to think you’re getting less, but you’re actually getting quite a bit less.
Mike (09:22):
What I find very funny is when you go through these times, everyone thinks this is much different, and every time there are different reasons why this is happening, but this is the most typical recessionary series of events you’d ever go through. It’s just standard. It seems different because we have a war in Ukraine, we’ve had COVID, we have all these different reasons behind it, but it’s no different than any other recession we’ve ever seen. Recessions are very odd. I don’t like to predict things, but when you go into recessionary time, the big surprise is everything is going wonderful when you go into it. Everything is going just beautifully along, everyone’s got jobs, there’s a ton of employment, everyone’s happy and thrilled, and all of a sudden, boom, the markets take a fall. This is why the market’s so odd because the market markets actually predict, the markets are a crystal ball into the future of what’s about to happen.
Mike (10:15):
And everyone that’s using the markets, all of a sudden realizes, hmm, we might have a problem in the future here. Unemployment’s at zero, which means everyone has to pay a lot more money for employees, that’s going to bring the company’s expenses up. All of a sudden the government is starting to raise interest rates. The biggest expense for many companies is the debt they have to carry, so the debt carrying charge has gone up. Profits are just revenue minus expenses, and if your two main expenses are going to go up drastically, guess what’s going to happen to your profits in the future? The market’s crystal ball looked and said, “I know these profits are going to eventually go down six months to a year from now,” the market takes a dive and then we go through this natural progression of going into a recessionary time.
Mike (10:56):
And the good thing is we’ve seen the story before we know the ending of the story. Six months to a year out, the market surprised, everyone popped back up, and we’re back into good times again, but every time it feels a bit uncomfortable.
Rob (11:10):
It’s interesting. You’re also starting to see companies raise prices. And every time I get a bill in the mail or I get a note from someone, every expense is up, whether it’s my doctor’s annual fee that I pay so that I can call in prescriptions and do things like that. I just got one the other day from the people who cut the lawn, they say gas prices are up, I’ve got to raise the rates. I don’t have a choice. And so that’s what’s hard, they’re paying more for labour, they’re paying more for materials, that’s inflation.
Mike (11:49):
I ate a $35 steak by myself last night.
Rob (11:53):
You barbecued it?
Mike (11:54):
I barbecued a $35 steak.
Rob (11:58):
Well, just imagine how much it’s going to cost in the restaurant. It’s going to be 60 to $70, that’s for sure.
Rob (12:05):
So let’s discuss a little bit about, if we’re truly in this high inflation period, higher interest rates, we may be going into a recession, how do different investments work? How does cash work? Is it good to hold cash?
Mike (12:24):
It’s safe, but over the long term, it’s going to cause you problems because it’s not going to be anywhere near to inflation.
Rob (12:32):
So you’re getting 1 to 2% on the cash, but inflation is 6 to 8%, you’re losing your purchasing power every year, guaranteed. And we’re not supposed to use that word guaranteed, but if that’s the case, that’s guaranteed. What about bonds?
Mike (12:48):
Bonds, well, it depends if we continue to see interest rates rise like they have been, bonds are going to continue to be a rough place to be. You may see a pop if it does become recessionary and the government decides they’re no longer going to raise interest rates like they planned, you may see a bit of a pop on the bond market.
Rob (13:07):
What is good about the bonds is it automatically adjusts to the higher interest rates. If I look back at back in September, our bond portfolio was yielding about 1.5% to maturity about five years. It’s currently yielding 3.75% to maturity. So bonds automatically adjust with the higher interest rates. They take a bit of a drop on paper, but you’re going to get that back if you hold them.
Rob (13:35):
What about GICs? You used to work in the GIC business, tell me how GICs work.
Mike (13:40):
GICs, the big problem with GICs is a lack of future opportunities. And when you get into GIC and you lock in for a period of time, there might be some great buying opportunities in the market that are going to happen. Like buying a five-year GIC right now is nuts because these things don’t last five years, and you’re going to find some huge opportunity to be in the markets, and if you’re sitting with a 3 or 4% rate of return as the market start to move, it’s lost opportunity.
Rob (14:08):
Especially if inflation remains high for a couple of years.
Mike (14:11):
Yeah. You get a net negative real rate of return and lose all opportunity to change in the future, so that’s what’s really dangerous about them.
Rob (14:19):
Stocks have done relatively well, so whether we talk stocks, equities, companies. And the reason that happens is companies are quick to cut expenses. They see a slowdown coming, they’re going to do layoffs, they’re going to cut their expenses, they’re not going to spend foolishly, and they’re going to be quick to get their profit back to where it was. So that tends to be why they do well. They’re going to be volatile, just like we’re going through now, but they tend to reward investors during these periods.
Mike (14:51):
Short-term volatility. When you look at recessionary periods, nothing does that well, right? And when you get into these types of situations and high inflationary periods, and when you go through the high inflation, nothing is ever shown to be a phenomenal place to be, but stocks have short-term volatility with long-term results.
Rob (15:12):
Should we be buying gold?
Mike (15:13):
Gold is a tricky one because gold has been known as a hedge for inflation, but it’s been a long-term hedge, there is never any evidence that shows it to be a short-term hedge. So when you look over the last 500 years or 10,000 years, when you go back to Jesus Christ’s time, the idea is that you could buy a good man’s suit for an ounce of gold, and still today you could buy a good man’s suit for an ounce of gold. So it’s always had that long-term inflationary hedge, but when we look at in short term, it’s not phenomenal through short-term hedges.
Rob (15:46):
And real estate?
Mike (15:47):
Real estate’s similar, a good long-term strategy, but again in the short term, it doesn’t really have much of a relationship on the short end of things.
Rob (15:56):
So it looks like we’re running out of options. So what should our strategy be? I guess number one, we have always believed in diversifying across all asset classes, and the more asset classes we can put in, the more different companies, the more bonds, the more real estate holdings we can have, the better off we are. Rebalancing is key, and we’ve had to rebalance a lot of clients’ portfolios, some recently where we were able to take some capital losses, but rebalancing, basically make sure you’ve got the portfolio you’re supposed to have. It’s taking from the areas that have done well and put it into the areas that haven’t done well.
Rob (16:37):
Recently, Canadian equities have been doing relatively well, they’re still positive year to date, at least the dimensional Canadian equities are. And so we’ve been having to take some of those profits and put it in areas that haven’t done as well.
Rob (16:53):
And finally, the last thing I think is just stick with your investment policy statement. It’s designed based on your risk profiles, it’s structured so that you’re going to go through these types of things, you’re going to go through bull markets and bear markets and recessions, that’s why you’re in that portfolio.
Mike (17:15):
If we knew we were going to be in bull market for the rest of everyone’s lives, we’d just have them all in equities. There’d be no reason to own anything else. This is the reason for the balanced portfolio, so let it do what it was meant to do.
Rob (17:26):
That brings us to the end of another week, thank you for joining us. This is Rob and Mike with Think Smart from The McClelland Financial Group of Assante Capital Management, reminding you to live the life that makes you happy.
Assante Capital Management (18:01):
You’ve been listening to The McClelland Financial Group of Assante Capital Management Limited. Assante Capital Management Limited is a member of the Canadian Investor Protection Fund, and the Investment Industry Regulatory Organization of Canada. Insurance products and services are provided through Assante Estate & Insurance Services Incorporated. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources. However, no warranty can be made as to its accuracy or completeness. Before acting on any of the previous information please make sure to see a professional advisor for individual financial advice based on your personal circumstances. The opinions expressed are those of the authors and not necessarily those of Assante Capital Management Limited.
