On Tuesday of this week, Statistics Canada announced that inflation had dropped in the month of May to 3.4% year over year which was the lowest rate in 2 years. A big contributor to the drop was lower gas prices. This was encouraging but, of course, not everything is going down. Food prices were over 9% higher from last year and this would explain why it just doesn’t feel like inflation is that much better. Interest rates have been raised to slow down the economy but, ironically, rising mortgage interest costs is now one of the biggest contributors to inflation! Add to this the rising income of savers who are happily seeing their returns on fixed income going up, you can see that fighting inflation is not as easy as it may seem. There is nothing more inflationary than putting money in someone’s pocket because the tendency will be to spend it!

My sense is that inflation is coming down but it will not be a straight line. Mortgage interest costs are going to continue to go up as homeowners renew in the next couple of years and savers will continue to enjoy higher income from their fixed income investments. I also strongly believe that gas prices will be significantly higher in the coming months as oil prices go up from where they are today. If inflation stays stubbornly high, which I think it will, this could cause continued volatility in the market. Even though the market is up year to date, there is fatigue around the volatility and uncertainty which is understandable.

I have an opinion about what is going to happen next but no one really knows exactly how this going to play out. I do think two things have changed. First, interest rates are not back to zero. While this will increase borrowing costs for everyone, it was completely unrealistic to have expected rates to stay as low as they were forever. I think this is positive and the economy will adjust to this new reality.

Second, my sense is inflation is not going to back down to the 2% target easily or anytime soon. Unemployment probably has to go up significantly before this happens which means a recession is likely. A recession would not be the end of the world but investors are very preoccupied today with what that will mean for their portfolios. The strong temptation is to conclude that if there is a recession, the stock market will go down. The truth is it might but not necessarily. We don’t know if this is already priced in and we won’t know until after the fact. Staying out of the market can be more costly long-term then staying in if you are wrong on your timing.

I’m attaching a link to a newsletter I sent to clients on April 7, 2020. You might recall there was a flu virus going around and the markets had dropped 35% in 6 weeks. I remember very distinctly clients feeling justifiably afraid of what might happen to their portfolios. I was nervous, too! Everyone at the time was watching Covid case counts and assuming that higher numbers of Covid cases and deaths meant markets would go lower. What I noticed, however, was that in Spain and Italy, while cases kept climbing, the markets started to come back up. My conclusion was that markets had already started looking ahead past Covid and that the worst case scenario for the economy and markets had been priced in.

Can I be completely honest? I was scared but that is almost always the best time to buy. Clients who agreed with this philosophy, were able to capitalize on the upswing. I’m not trying to draw any analogy to today’s environment because it is completely different. The only point I am trying to make is no one should assume that they know with certainty what the market will do in any short time period because it will often do the opposite of what you expect. Longer term, I am extremely optimistic and I think you should be, too.

 

As always, reach out if you have any questions.