The spike

If you’ve bought anything lately, you know. We’re in a price storm.

Pandemic-fueled demand has crashed into Covid-caused supply chain messes and the result’s been inflation. Lumber is insane. Houses are unattainable now save for move-up buyers and the wealthy. There’s a chip crisis. Try buying a Peloton. Or a purebred GSD. A boat or RV.

The official inflation rate in Canada is 2.2%, which says a lot about officialdom. But even that represents a big surge  (last year we had mild deflation, thanks to the bug). In the US financial markets had a mini heart attack recently when inflation raced ahead to 4.2% from 2.6%. That came as the vaccines flowed, immunity spread and the economy began to reopen. Markets are now getting used to the fact a lot more is coming.

In a few days we get the new number here. RBC economists said Monday it will be 3.3% – which is (of course) a 50% hike over the previous month. Gas is up 60% in a year. Some building materials have doubled. The bank says more is coming, now that more than 48% of Canadians have been vaxxed and supplies are ramping up.

“A concern is how quickly household demand could bounce back once the economy begins to re-open. Some services have been largely unavailable over the past year, and the price at which those services re-open could have a significant near-term impact on inflation measures. In Canada, COVID containment measures were still widely in place in April, but prices in the US spiked sharply as the economy began to reopen. We expect underlying inflation pressures in Canada to firm further as the year progresses, underpinned by a rapid recovery in consumer demand.”

Okay, so what does this mean? Here in the real world we already know what’s going on with plywood, bungalows and exercise equipment. How does this coming tsunami of additional inflation impact society?

Well, incomes might rise, but WFH will help put a damper on that (work-from-home can easily become work-from-Manila). And big hunks of the economy (travel, hospitality, tourism, entertainment, commercial real estate) have been seriously distressed and stripped of cash flow. So no fat increases there for workers. Not for a while.

Nah, the big thing will be monetary policy. As reopening happens, demand ramps up, savings are spent and the economy runs hot, CBs will throttle back on stimulus – which means interest rate increases. As RBC says: “If slack has been fully absorbed and inflation is sustainably at the 2% target, then the BoC is likely to feel quite comfortable moving off the effective lower bound around the middle of next year.” Translation: mortgages swell.

This chart gives you an inkling of what’s ahead (the source is Ratesdotca). Mr. Bond Market is pricing in three rate hikes in the next 24 months, and five of them by 2024. So if you take out a five-year home loan in 2021, for example, you’d better have the income in 2025 to finance a big monthly increase, or the capital to pay the sucker down upon renewal.

Five rate hikes (or more) by next mortgage renewal?

Click to enlarge. Chart source: Bloomberg

And what happens if – after the pandemic – those rising rates, repopulation of cities, return-to-workplace protocols and parabolic prices bring a flatlining or declining housing market? Then that 2021 purchase, when FOMO raged and recency bias had infected society, would look like a rash move.

In any case, rates are going up. Deal with it. Prepare for it. Borrow now long and low. You can use a weekly-pay mortgage (the right kind, 13 equivalent monthly payments instead of 12) to reduce the principal, or invest in a growth portfolio to build capital for a pay-down at renewal. Or plan on selling and moving to Tillsonburg in five years when everybody but the resident hicks has left again.

Have you noticed how many mainstream and social media stories there have been lately about the pandemic ‘forever changing everything’ including the way people buy real estate, where and how they want to live? It’s bunk. The current practice of buying houses for massive amounts of money through FaceTime viewings, without financing conditions or home inspections is not sustainable. History is littered with the financial detritus of those who thought prices would always go up, booms last forever, or human nature would bend.

When the masks come down, the six-feet between us melt away, places of work restore, crowds gather and normality is within grasp society will focus again on what matters. It won’t be house porn.

About the picture: “My partner got me onto your blog just before the pandemic started. Haven’t missed a post,” writes Amanda. “Thank you for sharing your insights and experience. You’ve taught me a lot! Not sure if you’ve had one of these on the blog before. This is Aengus – a 200lbs, 3-year-old Irish Wolfhound. Majestic, until you get to know him! He’s a giant suck. All cuddles and snuggles. Practically a lap dog. BTW, that photo is at my family home in Ontario and about a month into the pandemic (back when it was going to end in a couple weeks) we bought a place in Lunenburg. Why? Buying in the GTA was impractical (even a year ago) and people on NS are generally nicer. We want to spend our summers there so the kids grow up knowing the rat race isn’t everything.”

The yield

Where, oh where, to invest?

As my fancy colleague Doug mentioned yesterday, when crazy genius rocket-Tesla dude Elon Musk called crypto Dogecoin a “a hustle’ on SNL last week, the coin plunged in value. Then Musk ratted on Bitcoin just months after inflating it. Tesla won’t be taking that fake-money as payment anymore he said, blaming the climate crisis. (To make one Bitcoin sucks off as much energy as Brockville burns in a week. Or is it a year?)

These are days when investing risk is large. Crypto, for example, is backed by nothing. “There’s no inherent value in it,” Jack Brennan said on the weekend. The guy’s no slouch, having run Vanguard’s $7 trillion in funds.

Real estate’s a landmine, too. The pandemic’s taken prices parabolic, wildly inflated household debt, critically damaged small town social and financial equilibrium while infecting a whole generation with debilitating FOMO. Soon the pandemic will end. Big changes ahead.

Meanwhile $20 trillion in government Covid stimulus money around the globe has swollen financial markets. Stocks in New York, for example, have hit two dozen record highs in 2021 – and it’s only May. Commodity prices, inflation and corporate profits have erupted, while CBs keep rates artificially low and snorfle up bonds.

Some people call it the ‘everything bubble’ which has merit. Nonetheless, this is the world in which we live. We all need money, incomes, savings, investments and a plan forward. Cash is a poor option with prices romping. Most people don’t have enough liquid assets to happily enjoy the rest of their lives. Not investing is not an option.

In my day job, when not posting dog pictures to a pathetic blog, it’s what I do. Here are the two goals I assume people have: (a) don’t lose money, and (b) give me a reasonable rate of return. Anyone sharing those goals should not buy crypto, mortgage their butt off buying a house at historic high level, or throw their money into four or five stocks. Instead, be balanced. Be diversified. Use the tax shelters you’ve been given. Stop paying ridiculous mutual fund fees. And don’t assume the last 14 months will change the entire future. They won’t. It’s fiction.

This brings us to the famous GreaterFool B&D Portfolio. No, we did not invent 60/40 investing, but in a stupid, virus-addled, overly-emotional world where governments make stuff up weekly and everybody’s now a vaccinologist, it’s needed more than ever. The idea is simple: invest not like a cowboy but instead for predictable, boring long-term returns. To do that you need safe assets as well as growth ones (balance) and a broad range of assets and locations (diversification). Not everything advances at the same time. Like one of those old pre-Elon eight-banger engines, some cylinders rise while others fall, and you keep moving ahead.

Where are we today? Simple. Rates are low and will rise. Economies are reopening. Governments are steeped in debt and will raise taxes. Houses and puppies are inflated and will moderate. Income disparity is soaring. Lefty politicians are challenging the right. Inflation and speculation are ramping up. Volatility lies ahead.

If there was ever a time for B&D, this be it. Here’s a summary of a portfolio strategy for the post-Covid world.

First, the safe stuff. This 40% of the portfolio is made up of cash (1%), bonds (26%) and preferreds (13%). Because rates will be rising and bonds lose value when that happens, hold bond ETFs containing short-duration debt or floating-rate assets, as well as a bit of government exposure. Remember bonds are not primarily held for income (they pay diddly) but for insurance, to protect you during times of flux – and there’s probably a lot ahead. When Covid hit, investors with balance were happy campers.

Preferreds, on the other hand, rise in capital value (if they’re the rate-reset variety) as the cost of money starts jacking up. Already happening. Plus they pay you to own them with a dividend in the 4-5% range, along with the dividend tax credit. So the 40% fixed-income portion of the portfolio overall yields about 3.25% – liquid, not locked up and therefore vastly superior to a GIC. Plus it protects you.

The growth side of the plan (60%) is equity-based, which means exposure to stock markets, plus commercial real estate. Use ETFs, of course, instead of trying to pick a few stocks – this greatly reduces the potential risk, especially if you listened to what your BIL told you to buy. Also don’t just load up on Canadian stuff, since home country bias is a fault. Having said that, Canada will likely benefit from the end of Covid, the reopening global economy and rising commodity prices. These days 20% (of the 60%) might be in maple – including a 5% weighting in REITs – with 22% in US and 18% in international equities. In larger portfolios, some of that will be in small-cap companies as well as the big stuff, along with a biotech exposure. Also remember it makes sense for Canadians to have 20-25% of a portfolio invested in US-denominated assets. Always.

How many positions to hold? Maybe 20. Fewer for smaller portfolios. And be conscious of putting assets in the right places (RRSPs, tax-free and non-reg accounts) for maximum tax efficiency.

Don’t trade every day. Or month. Rebalance once or twice a year when weightings get out of line. Don’t be seduced by headlines or social media nonsense. Ignore corrections. And don’t be consumed with fast growth. It’s not a race. Life is long, so setting up a proper portfolio then letting it run for decades is key. Risks include your own impatience, or fear of starting. If you need help, reach out for it. There’s more to life than money. But life without it is less.

About the picture: “Long time fan of the blog,” writes Derek. “This is Riley the Chocolate Lab. He lives in the Lower Mainland with friends who take him for daily walks. He’s an inflation predictor. If you toss a small stick in the woods….he comes out with a bigger stick!”