Investors should mind monetary policy
Even if Trudeau doesn’t
During an interview last week, Justin Trudeau was asked if he believed that the Bank of Canada’s mandate was in need of a change since it is set to expire at the end of the year and, therefore, could be his first major post-election economic policy decision.
It was a fantastic question, especially considering the cost-of-living crisis facing most Canadians. His response was stunning, though, almost shrugging it off as irrelevant: “When I think about the biggest, most important economic policy this government, if re-elected, would move forward, you’ll forgive me if I don’t think about monetary policy. You’ll understand that I think about families.”
In the meantime, our consumer price index gained 3.7 per cent in July compared to a year earlier, the highest level in a decade.
But don’t you worry, as it’s all transitory, according to our existing government and the Bank of Canada. But ask yourself: How prepared are you in case it isn’t?
Looking ahead, we agree that certain segments will normalize, such as rising car costs due to a temporary global shortage of semiconductors. But more material factors like housing costs will continue to move higher as long as interest rates (yes, this is monetary policy) remain low.
In particular, we really don’t know how a middleor lower-income family can make a go of it in cities such as Vancouver or Toronto where housing prices are as high as 15 times average income levels. For those who rent, it doesn’t get much better. We recently read that there are now bidding wars for rental units in those two cities.
We also expect core staples like food to continue to stay high for longer than many expect due to strong rebounding demand, continued supply shortages, rising input costs such as fertilizer and higher transportation costs.
Then you have increasing energy prices on the back of pipeline constraints, production challenges expedited by capital allocations flowing out of the sector, and recent policy restrictions preventing drilling in the United States.
It could be an ugly winter for many Canadians, because we will soon face higher home heating costs due to stronger commodity prices as well as preset carbon-tax increases. Don’t even talk to me about rebates, since they pale in comparison to the cost of installing $15,000$25,000 solar panels on top of another $15,000-$25,000 in rubber roofing.
For the icing on the cake, prepare for higher property taxes as municipalities backfill their sizable deficits rather than cutting services.
Something else to consider is that if wages finally respond, which is possible given the worker shortages, how much of those higher labour costs will be passed along to consumers?
Fiscal policy is currently filling in this gap, but the Bank of Canada may be limited in its ability to raise rates to tackle this inflation given the amount of debt in this country. In its latest quarterly update, Fidelity Institutional Asset Management highlighted recent data released by the Bank for International Settlements that showed Canada borrowed more money last year relative to its economy’s size than any other G20 country. Consequently, credit in the non-financial sector is now more than 3.5 times our GDP and is closer to Japan’s rate than the U.S.
Low rates and rising inflation wreak havoc on retirees
living off their portfolio returns, especially those sitting in cash and/or low rate bank guaranteed investment certificates. Many are left scratching their heads wondering what to do with markets trading at new highs and overdue for a bull market correction.
Interestingly, the Bank of Montreal put out a report showing that the S&P 500 performs better when rates rise, especially from low levels, than when they fall, with an average 15.3 per cent gain versus an average 6.5 per cent, respectively. Keep in mind, though, that’s just the S&P 500, and the market you’re in and the local currency play a huge role. For example, according to Charlie Bilello, founder and chief executive of Compound Capital Advisors, the Canadian equity market gained a shockingly low annualized 3.7 per cent (in U.S. dollars) over the past decade.
That said, it is always important to remember that past returns do not guarantee future ones. If one believes the inflation narrative to be more permanent in nature, then commodity-focused regions such as Canada and emerging markets (ex-china) should once again outperform.
Vanguard Group Inc. recently put out some very interesting insight that showed that every one per cent increase in unexpected inflation would produce a seven-to-nine-per-cent rise in commodities. As a side note, this is something to consider for those thinking of relocating to cities such as Calgary, which already has a significantly lower cost of living than, say, Toronto or Vancouver, and should be more protected from inflation risks going forward.
Besides having a strong weighting in commodities as a hedge, we also like having the ability to custom build and deploy alternative investments like structured notes. These strategies allow for some participation in the equity market and provide the potential to earn yields well in excess of even the current inflation rate, while also having some built-in downside barriers ranging from 25 to 35 per cent.
The first step in protecting your family’s well-being is to understand the economic environment we’re in, including both the role and impact of fiscal and monetary policy. Just because our current leadership doesn’t grasp this importance doesn’t mean you should, too, because if you’re wrong, it could cost you a lot more than an election.
Financial Post Martin Pelletier, CFA, is a portfolio manager at Wellington-altus Private Counsel Inc. (formerly Trivest Wealth Counsel Ltd.), a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/ oversight and advanced tax and estate planning.