To my clients:
It was an up week for North American stock markets with the Canadian TSX finishing up 1.8%; the U.S. Dow Jones index up 1.8%; and the U.S. S&P 500 up 0.8%.
It’s the first week of a new month, but before offering my regular comments on the “big 3” economic indicators I invariably cite, let me first address the significant pick up in market volatility seen recently…
Despite the fact that the three indices (above) that I regularly offer as market indicators were all up for the week, these gains mask weakness seen in the tech sector as well as a pickup in the aforementioned market volatility. What’s going on? Simply put, with economic recovery and societal normalization by the latter half of 2021 becoming a more widely accepted narrative, markets are becoming spooked by the spectre of accompanying inflation. Historically, when inflation rises, so do interest rates. More specifically, higher interest rates mean that the future profitability of a public company becomes worth less to investors in the present. At the end of the day, it is the sum of all future earnings of a company (any company – public or private) that determine what an investor is willing to pay for the stock of a company, and if that future stream is deemed to be worth less owing to higher interest rates, then stock prices are likely to fall. This is a very simplistic explanation of what is transpiring, but it is broadly accurate. Current investment conditions are somewhat reminiscent of the climate that existed in the last quarter of 2018 when equity (i.e. stock) markets ended on a very significant down note before rebounding strongly in 2019.
certainly can’t be ruled out as a possible headwind for markets. So much stimulus – both monetary and fiscal - has been pumped into the global economy that I’d be surprised if inflation didn’t pick up somewhat. It’s one of the reasons that clients own an approximate 5% weighting in gold bullion as a possible hedge to such conditions. But, I’d note comments from U.S. Federal Reserve Chairman Jerome Powell yesterday – paraphrasing, he said that a short-term uptick in inflation is anticipated, but that the Fed feels that such an uptick will be temporary. Further, prior guidance from the Fed has indicated that the Fed will allow inflation to “run hot” for some while such that average inflation over time achieves the Fed’s 2.0% long-term goal. This means that inflation must continue to rise AND be sustained for the Fed to consider raising interest rates. Again, just yesterday, Mr. Powell stated that the FED does not feel inflation will be sustained.
I’ll harken back to comments I’ve made several times over the past few months: that the back half of 2021 looks set for strong economic recovery, but that the path from our present to that point will inevitably be a bumpy one. The past two weeks of inflation inspired volatility are an example of the bumpiness I envisioned. I used the volatility this week to add a new ~ 3% position in QQQ for clients (QQQ is a U.S. listed ETF of the top 100 largest stocks found in the NASDAQ index… it might be simplistically viewed as an investment in a broad basket of large-cap U.S. technology stocks).
Finally, turning to the “Big 3” economic indicators, I’ll be far briefer than usual and simply state that the ISM Manufacturing Index and the monthly U.S. jobs report both showed strong month-over-month improvement and came in significantly better than expected. Offsetting this was a lesser than expected, but still solidly expansionary ISM Non-Manufacturing Index (aka: “Services”). Continued strength in these metrics is envisioned as the coronavirus case trends continue in an encouraging direction.
That’s it for this week. All the best, and stay safe,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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