Investment Environment - Summer 2019
High summer in Toronto has coincided with high-water mark values for our investment portfolios. The pivot earlier this year toward a lower interest rate outlook has produced a rally in stock prices, even though the justification for the lower rates is a slower than forecasted economy. This sort of counter-intuitive market behavior is typical of financial markets. Sustained wealth creation happens for people who ignore the noise in favor of a more far-sighted view. Meanwhile, today’s record market prices are powerful testimony that steadfast investors who weather all storms get rewarded handsomely for their trouble.
We live in the age of the modern central banker. Around the world, central banks are active and aggressive at trying to manage growth, inflation and employment levels by manipulating interest rates. One paradox of this situation is that we have record low global interest rates at the same time as record high corporate profits and record low unemployment. Fully half of the developed countries in the western hemisphere have government bonds trading at negative interest rates. In fact, Barron’s reports that Nestle (a Swiss corporation) has corporate bonds that are now trading at negative yields! I believe that this bizarre and unprecedented situation is allowed to continue because there is no consumer price inflation to deter governments from keeping interest rates low. The historical wisdom has been that a flood of cheap money causes inflation. In the twenty-first century (so far) that wisdom has not proven true. Governments have been able to service their heavy debt levels at attractively low interest rates while accommodating business people and consumers. What’s not to like? But if the day comes when inflation reignites, these same central bankers may find it difficult to contain.
What this all means for us is that inflation risk needs to be accounted for in shaping our go-forward portfolio strategy. Holding some commodity stocks (gold, oil) and an overweight share of hard-asset based enterprises (real estate and infrastructure) helps to immunize our portfolios from inflation risk. We also hold some inflation-protected “real-return” bonds.
Maximizing capital appreciation and dividend income from our holdings is always priority one. A close secondary priority is reducing risk and volatility wherever possible without sacrificing total return. Recession is the greatest threat to our confidence and our comfort (even though we know from experience that we can ride recessions out until sunnier days come). The forgotten risk of inflation also demands consideration. I build and manage your portfolios to balance these diverse risks and opportunities as they unfold in real time.
Mark Lloyd, Ph.D.
Vice President & Portfolio Manager