We live our lives in a state of “perpetual present,” constantly unaware of what the future will bring.  History is always our best guide. But human beings find it difficult to remember the lessons of history when we face a new crisis. For these reasons, we are especially pleased when we look back at the past two years and reflect on how much wealth we have created in bad times by staying resolute in our commitment to own common stocks as the core of our portfolios.  It is my hope that this lesson will serve us well as we continue our campaign to grow the wealth of the one hundred fifty families we counsel.

            Last year at this time I wrote to you that my greatest concern for 2021 was the risk of inflation.  As it turned out, the CPI (Consumer Price Index) ended the year above 7%, the highest reading since 1982.  As expected, equities have done a nice job so far at preserving their value in the face of inflation.  It is very possible that we could see stocks rise in 2022, but rise somewhat less than the rate of inflation.  If central banks make good on their threat to raise interest rates, then that will put downward pressure on currently high price-to-earnings multiples for stocks, even if broad price inflation results in rising nominal earnings for companies.  So stocks could go up while inflation rises at a higher rate. When inflation happens, we cling to our equities like life jackets in deep water. Meanwhile, bond investors are losing money because the miniscule interest rates bonds pay today are being outstripped by broad price inflation.  I expect more losses for fixed-income, which is why it we are decidedly underweight.  To my surprise (and slight annoyance) the price of gold somehow managed to fall in the face of 2021’s inflation.  Gold historically has been a reliable hedge against inflation, and I expect it soon to reassert its well-established identity in that respect.  Recall that in anticipation of inflation I reallocated some capital from fixed-income into direct commodities (including gold bullion). I believe that our portfolios are as well-protected against the current inflation threat as well-balanced and well-diversified portfolios can be. 

            Two recent additions to the portfolio illustrate what we are trying to achieve by immunizing our portfolios from inflation.  Diversified Royalty Corp (DIV on TSX) is able to pay a 7.6% distribution from royalties it earns from contracts with companies like Mr. Lube, Air Miles, Oxford Learning and Sutton Group Realty.  DIV has very little operating expense, but will earn rising royalties in an environment of rising sales or prices by its royalty partners.  On the U.S. side, Mesabi Trust was formed in 1961 to collect royalties from iron ore mines on the Mesabi iron range in Minnesota. Rising inflation will mean higher iron ore prices and higher distributions.  Each of these royalty trusts can provide good returns in a variety of economic scenarios.  But they are especially likely to shine if inflation continues to surprise to the upside.

 

Mark Lloyd, Ph.D.

Senior Portfolio Manager