Happy New Year to you and your loved ones. We concluded 2021 in a strong position, on both an absolute net return and relative performance basis. The fogginess that greeted growth names as 2022 started had to do with an uncertain interest rate outlook, as the Federal Reserve has now prioritized its orderly price stability mandate to lessen the effects of supply chain related inflation, causing uncertainty among some market participants. We want to provide a rational hypothesis for the path of monetary policy over the coming year, and how that may impact company valuations, especially among our growth names, where intrinsic values tend to be more sensitive to the cost of borrowing money to expand and grow.

First, to remind clients, the Federal Reserve (“Fed”) has a dual mandate: 1) Maximum inclusive employment; and 2) Orderly price stability in which inflation is targeted at 1-3% per year. Because the economy is making “rapid progress” (Fed Chair Powell’s words) toward full, inclusive employment, with wage gains shared across demographics, the Federal Reserve’s priorities have now shifted toward containing inflation. While acknowledging this time that the nature of inflation is different – i.e. it is caused by supply distortions rather than an overheated economy – Chair Powell also highlighted a number of economic indicators that have been “really healthy” and “very strong” – mainly citing consumption, savings, strength of the labour market, openings/vacancies, and the unprecedented levels of monetary and fiscal stimulus available. The dot plot, which is a survey of Federal Reserve Open Committee Members, now averages a median of three projected interest rate increases (0.25% each) in 2022 for an overall median federal funds rate of 0.875% in 2022, 1.625% in 2023 and 2.125% in 2024. This backdrop is still highly accommodative for growth names to flourish, and if supply chain disruptions ease in the second half of the year, as the Federal Reserve expects, further interest rate increases may be more restrained. 

Longer term, we would like to remind clients why we believe we remain in a disinflationary environment:

Supply chain distortions are likely temporal in nature. This form of inflation, known as cost-push inflation, is projected to ease as the Federal Reserve modestly raises interest rates and backlogs gradually thaw. The Fed anticipates this will start to be evident by the second half of 2022.

Technology has improved price transparency, reducing search costs, and acting as a disinflationary influence as more purchases are now coming from the inside as opposed to the outside.

Demographics, in an aging world in which there are an increasing number of Baby Boomer retirements, without a commensurate birth rate, have acted to dampen population growth, and therefore inflation.

Finally, relative to decades ago, we live in a more globalized society in which the cost of production has been dramatically lowered, and passed onto the consumer.

This disinflationary backdrop is highly favourable for growth stocks and those companies with emerging growth profiles shaping their own unique niche industries.

Our investment philosophy is to select approximately 30 highly wealth creating companies, with strong forward-looking projections for growth and profit forecasts. We continue to assess the valuation backdrop of our companies in a modestly higher interest rate environment, and have determined that the majority of our holdings still have a healthy margin of safety and strong competitive moats to become the innovators in their respective industries. We would also like to remind clients that risk is not the same thing as volatility: Risk refers to the underlying ability of companies to achieve their financial objectives, whereas volatility refers to stock price fluctuations that often tend to be fleeting and present long term opportunities. Within a given year, it would not be surprising for equity markets to withstand a correction of 10% or even 20%, as has been the historical norm. Clients may be assured that this downside is temporary, and oftentimes, these juncture points produce opportunities to purchase quality assets at reasonable discounts to intrinsic value. While share price performance may fluctuate quarter to quarter, it is the strength, consistency, and longevity of business results that usually gets rewarded in the long term. Furthermore, a long time horizon enables the compounding growth characteristics of companies to fully come to fruition. Finally, we remain highly attuned to changes in valuations, corporate profit outlooks, and the investment climate so that if shifts in the portfolio are warranted, they typically reflect the result of disciplined and methodical thinking.

We welcome comments from our clients and wish you a happy start to the year.

Warmest regards,

Grace, Samuel, Leslie, Jennifer, and Kim