Returns After Severe 3-Month Declines Have Been Very Good

It seems as though Central Banks are fighting yesterday’s battle. Inflation
soared as supply chain issues created a shortage of materials and products.
Then, the invasion of the Ukraine was like a perfect storm causing many
commodity prices to rise even more, especially oil and natural gas. We must
remember that the high inflation rates this spring reflected what happened in the
past 12 months or so. They do not tell us what is going to happen in the future.
We must be careful to not automatically extrapolate what has happened in the past
into the future.

We have to focus on what is likely to happen in the future, not on what is
happening today. This is what Stan Druckenmiller said about investing in the
present. He is referring to individual companies, but much of what he said applies
to the markets as a whole as well.

“Never ever invest in the present. It doesn’t matter what a company is earning
or what they have earned. You just visualize the situation 18 months from now,
and whatever that is, that is where the price will be, not where it is today.”

So, what might inflation be like 18 months from now? Natural gas is up 51.6%
YTD (year to date) but is down 33.8% in the last month. Crude oil is up 40.6%
YTD but is down 7.8% in the last month. Local gasoline prices were at CAD$2.20
a litre two months ago and are at CAD$1.71 today. That represents a decline of
22%.

The price of copper is a good barometer of economic growth. It was down
16.9% YTD and is down 13.6% in the last 30 days. In the past, many have
invested in gold bullion to protect themselves from inflation. Yet, gold is down
1.2% YTD and is down 2.2% in the last month. While there is definitely fear and
uncertainty, it seems as though there is little conviction that inflation is a longer term
problem. In fact, the trend of copper prices is telling us that economic growth
could be more of a problem in the future than inflation. US and Canadian real
estate prices are falling too.

The Turning Point Report states, “The Fed is reacting to a Q1 2022 (Q1 is the
first quarter) problem while Q2 global recession and recession risks are moving at
lightning speed. We must position ourselves ahead of the monetary policy
response – while the possibility of a fiscal solution is also on the rise.” I have been
saying that the level of inflation could be at 0% next spring and that there could
even be deflation if oil and natural gas prices continue to fall. This would mean
that interest rates might have to fall instead of moving higher early next year.

There are other signs that supply chain issues are slowly improving. The
average cost of shipping a 40-foot container has dropped from a peak of $10,500
last fall to almost $7,500 today. That is still much higher than the cost of $2,000
before Covid swept across the worlds but it is moving in the right direction.

Please see the chart below showing how Canadian real estate prices
have started to decline.

A colleague of mine, Nick Foglietta, provided a chart that shows how US and
Canadian real estate values compare when related to disposable income. Please see
it below.

 

I think there are some unique circumstances that explain part of the reason for
this. For example, there are younger people living in expensive real estate in
downtown Vancouver and Toronto that their parents, who live outside of the
country, purchased for them. Many of these younger people don't have any income
and rely on allowances from outside of Canada to support them. Some involved in
crime and drug trafficking also own expensive real estate and report no income.
Nevertheless, Canadian real estate may be vulnerable now. Canadian real estate
may have been spared from the carnage that the US experienced during the
Financial Crisis, but the tables may be turned in 2022 although financial institutions
in Canada seem to have acted very responsibly. I believe this is another reason why
it is prudent to have more exposure to US stocks than Canadian stocks at this time.

Stocks have been unusually volatile in the last two years. The chart below illustrates this.
Notice how the volatility since Covid in early 2020 has remained elevated
compared to the period from 2012 to 2019. Volatility is bound to return to normal
as time passes.

The chart below from MarketWatch shows that the yield on US 10 Year Bonds has
declined from 3.48% on June 14th to 2.66% today, a drop of 0.82%.

It is always challenging to know what will happen around the world in the months
and years ahead. However, history can show us what has happened when there
have been severe 3 month stock market selloffs over the past five decades.

The decline of 16.1% in the last quarter was not quite as bad as those in the
last 52 years, but it is close. The table below shows that the lowest return 12
months after one of the worst three-month selloffs was 23.3%. Oliver Wendell
Holmes said, “A page of history is worth a volume of logic.” Winston Churchill
said, “The farther back you can look, the farther forward you are likely to see.”
The table below is a good page of history that is looking back over a long time
period. I believe this is a much more useful information than much of the logic
that is available.

The trend of prices we are seeing now seems to be much different than what
has happened over the past year. The expectation of higher interest rates in order
to battle inflation seems to be waning with very good reason. The prices of oil,
natural gas and gasoline prices have declined considerably from the highs a few
months ago. This means interest rates may not increase much more and may even
dip a little next year. Although we do not know exactly what the Fed will do or
what will happen in the economy, history suggests stock prices should recover
smartly from this selloff in the next 6 months, 12 months and two years.

 

SAR Update

 

Our team has been asked for assistance by different agencies almost every day
in the last week for a complete variety of situations. Unfortunately I cannot say
much about them at this time but here is a photo I took while on a recent
shoreline search of Harrison Lake on a spectacular day.

I hope you have a good weekend and a good long weekend for those who
have a holiday on August 1st for BC Day.