This week’s Weekly Insights is on inflation as we are starting to see some of the transitory components begin their descent back to earth. Used car prices and airline tickets can’t go up 10% a month for long. While not a surprise, attention should increasingly be focused on the non-transitory components of inflation that are showing some signs of stirring. We believe inflation comes back down as temporary supply bottlenecks/demand spikes normalize. Afterwards, the base rate will likely be higher than the past decade, putting some upward pressure on yields.
Category: Blog Post
Modern Portfolio Theory (MPT) sits at the core of just about every portfolio construction process. While developed some seventy years ago, the core beliefs of MPT remain as applicable today as they did before. Combining various asset classes that have different return and volatility characteristics, a portfolio can be constructed to target an expected return given an appropriate level of risk (volatility). More recently, say the last 25 years, this approach has been at the core of proportionately combining equities and bonds to achieve different portfolios to suit various investor needs and objectives. And to put it frankly, this has worked very well helping many investors reach their goals.
The equity markets did not disappoint as the summer months have now come and gone. Historically, a term that is used frequently throughout the season is ‘Summer Doldrums’. Safe to say the doldrums were nowhere to be found in the year 2021. Particularly in the U.S., markets continued their outperformance on the backs of dovish Fed policy. The S&P 500 climbed +2.9% in CAD terms duringthe month of August, while the Nasdaq jumped a whopping +4.0% (CAD) in the final month of summer. Investors must be getting more intelligent, as every time there is a dip down to prices seen one or two months ago, the market comes roaring back. Say it with me, “BUY THE DIP!”. There, now we can all call ourselves members of the self-proclaimed ‘Reddit Army’.
Uncertainty is the bane of the markets and we have experienced a higher than normal dose over the past few years. The greatest level of uncertainly was clearly during the early days of the pandemic when nobody knew anything about how things would unfold. As uncertainty declined, markets rose … quickly. The markets have clearly enjoyed 2021, with vaccine rollouts, re-opening trends and economic recovery driving earnings growth, plus continued monetary + fiscal stimulus. The S&P and TSX are up about 20% since January 1, with similar numbers out of Europe.
Investing is all about trying to figure out what is likely going to happen next. While a daunting task, sometimes what happens next is a bit easier to see. In this case, retail sales have exploded to unseen levels thanks to stimulus and changed behaviours during the pandemic. As stimulus begins to fade and the re-opening continues, this may reverse leaving, posing a threat to sectors that have been riding high on consumers spend behaviour.
Fluctuating oil prices is nothing new. We’re no longer surprised to see crude move +/- 4% in a day depending on the news, whether it be a production accident, an OPEC meeting or rising case counts. Most recently, oil has been under pressure on rising concerns over the demand impact of the next wave of infections. The contagious delta variant is already triggering renewed lockdowns in parts of China and other Asian countries where vaccination rates are low. This is a global concern, but we continue to believe that this remains a passing demand headwind, which can be offset by existing supply tailwinds.
Earnings season is nearing its conclusion for the U.S. and it has been a great season. With 442 S&P 500 companies having reported, 85% exceeded earnings forecasts and 83% beat on sales as well. Looking at data over two decades, these are historically elevated positive surprise rates. Even more impressive has been the magnitude of the surprises. On average, earnings beat by +17% and revenue by +5%. Wow.
A recent negotiation standoff between OPEC and the United Arab Emirates left investors wondering whether oil production would be ramped up enough to meet growing demand. Luckily, it appears the two sides have reached a tentative agreement and will meet once again in the coming months to hammer out the details. Still, this is a disconcerting piece of news that could have an effect on investors and the Canadian economy as a whole.
Portfolio diversification has always been a major key to investing success. This is exactly why the 60/40 portfolio theory has become so popular over the past 50+ years. But with interest rates remaining near zero, and a broader range of investable assets available than ever before, is it time to rethink this long-held portfolio management strategy?