Entries from September 2020 ↓

Inflation’s coming – in time!

RYAN   By Guest Blogger Ryan Lewenza

The economic toll, among other things, of the global pandemic has been devastating. From what I read, the conversations I have, and what I see around me, it’s heart breaking to see so many people hurting during this scary and uncertain time.

Due to the economic damage caused by this pandemic, governments around the world have responded by providing unprecedented benefits and support to those impacted by this virus. And with all this increased government spending and deficits, central banks are ramping up the printing presses again, leading some to fear that much higher inflation (some are even calling for hyperinflation) will come and blow everything up.

For example, we’ve seen the Federal Reserve’s balance sheet increase from US$4 trillion to start the year to US$7 trillion currently. As a result of this monetary and fiscal stimulus, we’ve seen US money supply skyrocket. M2 money, which includes all notes in circulation and bank deposits and money market funds, has surged 23% year/year! My data goes back to the 1960s and the next highest annual change was back in the 1970s when it hit 13.5%. So just looking at this, many assume inflation is set to skyrocket.

US Money Supply is Rising at a Record Clip

Source: Bloomberg, Turner Investments

But money supply only captures one aspect of inflation. When looking at inflation we have to examine all the key areas including wages, commodities, and the things we buy like food, energy, electricity, etc. Focusing on the US, I reviewed all the key components of inflation and while food inflation is on the rise – the main thing people tend to focus on – many other key areas like energy and apparel are experiencing major price declines.

While I see oil prices recovering next year as demand rebounds, oil prices are likely to remain contained (i.e., $60/bl), keeping gasoline prices low. With unemployment still quite high, I see minimal wage growth pressure over the next few years. And I see pressure on residential and commercial rents until Covid passes. Basically, I see a number of shorter term deflationary trends over the next few years, which should help to offset the dramatic rise in money supply.

US CPI 12-Month Percent Change, Select Categories

Source: US BLS, Turner Investments

Looking longer term there are also a number of major deflationary trends to consider. Some include:

  • Globalization: The most significant deflationary force in recent decades has been the offshoring of jobs and manufacturing to China and other low-wage countries. Look at the tags on your clothing or the stickers on your new TV and odds are it was manufactured in China, Vietnam or Mexico, where through their low wages they can manufacture consumer products on the cheap and ship it back to us. There’s a reason why Walmart, Costco and Amazon are some of the largest companies in the world.
  • Technology: After globalization, technology has and will continue to be a major deflationary force. Technology helps to improve productivity (a good thing) but comes at a cost as technology has helped replace millions of jobs in the US and globally. Technology has led to “disintermediation”, which removes the middlemen or intermediary in areas like finance and technology. Think free trading from Robinhood and online purchases using Shopify’s online platform. And it will only get worse with automation and AI, which will have huge ramifications on the labour market and wages.
  • Demographics: The world’s population is aging and this has implications for inflation as older people tend to spend less and be less productive, generally speaking. According to the UN, by 2050, one in six people in the world will be over age 65 (16%), up from one in 11 in 2019 (9%).
  • Debt: Lastly, high debt loads can be deflationary as more and more capital goes to servicing the debt rather than being directed to more productive areas like investment.

So, while the large increase in deficits and money supply are inflationary, there are a number of deflationary trends, helping to offset the impact of the rising money supply. Basically, the simple thesis of higher money supply, leading to much higher inflation is not so cut and dry.

Given the deflationary forces that I’ve highlighted above, in the medium term (i.e., 3-5 years) I see inflation remaining fairly low and contained, but longer term I do see the potential for inflation to rise and potentially sharply, which could cause dislocations to the economy and client portfolios. One day we’re going to have to pay for this debt binge, but as a society we’re pretty good at kicking the can down the road and delay taking the hard medicine, hence why I see inflation as a longer term concern.

US Inflation Has Been Low for Years

Source: Bloomberg, Turner Investments

At Turner Investments we always try to take a longer term view and to help combat against the prospect of higher inflation longer term, we have included positions in the portfolio, which could benefit from rising inflation. These include our long held position of preferred shares (if inflation picks up central banks will have to begin hiking interest rates, which given that the Canadian preferred share market is dominated by fixed resets, they would benefit from this) and more recently we’ve started to introduce floating rate bonds and bank loans, which would also benefit from rising inflation and in turn, higher interest rates.

It never hurts to have some hedges in the portfolio!

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.


Suck & blow

One problem with running a free blog is that anyone can come in, use the washroom, make a mess, rifle through the fridge, write on the wall and leave, smirking. So far there have been 686,200 comments published here. A whack more were deleted – too combative, disgusting, shanky, horny or dodgy to post.

Free speech is important. Abuse is too frequent. But these days, more than ever, we need debate. The world’s highly abnormal. More disruption and change on the way. There’s no black-and-white solution to anything.

Here’s a recent controversial topic: if massive government and CB stimulus are causing danger by inflating real estate, why isn’t a puffed-up stock market just as bad?

Answer: people buy houses with 10x and 20x leverage, usually for emotional reasons, often when they can’t really afford it, and despite the fact renting is almost universally cheaper. Today we owe over a trillion in mortgage debt which is guaranteed to cost more to carry in the years ahead. People willfully ignore the inverse relationship between rates and real estate prices. So when the cost of money starts to restore, mortgage debt grows more expensive, houses lose some value and personal finances wither.

That’s the risk. The naysayers counter by stating rates will never rise again in their lifetimes. But they will. No question of that, unless the economy remains in recession for decades – in which case, real estate will be a death trap. This is the mistake Mr. Socks made on TV Wednesday night, saying Canada can add excessively to its deficit/debt because of low rates. But when they double – from 2% to 4% (it’s coming with economic recovery) – it will add $20 billion a year to the cost of carrying $1,000,000,000,000 in existing debt. That’s twenty billion less for health care transfers, child care, seniors or renovating 24 Sussex.

Finally, lots of residential real estate transactions are non-productive. Aside from realtors, lender dudes, lawyers and movers, nobody gains. No new jobs are created. No products produced for export or domestic sale. No factories built, stores opened or offices launched. It’s hard to understand how a nation of people continuously selling each other houses and condos at ever-rising prices with larger whacks of debt expect a higher standard of living.

All that debt, by the way, is expensive to maintain – even at these rates. It sucks off disposable income that might otherwise buy cars, iPhones, clothes, vacations and stuff which actually creates products and jobs. Plus, look what Covid did. Almost a million families stopped making mortgage payments – a quarter of all the indebted households in the nation – because they couldn’t carry that $180 billion in borrowings. Now they are madly adding to them.

Is this not a warning we have taken the real estate, the one-asset strategy, too far?

What about financial assets?

Yup, also benefitting from government fiscal stimulus and central bank monetary diddling. Low rates have shoved down bond yields (along with bank savings and GICs) so more money flows into growth assets like equities. Cheap rates help corporations by lowering their borrowing costs. Govy handouts such as CERB keep people buying food, kibble and Internet connectivity, which helps Loblaws, Shaw, Purina, Sobeys, Rogers and Bell. There have been small business loans (partially forgivable) and payroll subsidies, as well as sectoral bailouts (more coming for the airlines).

As a result, people with financial portfolios have flown through the dogawful 2020 largely intact. Those 15% gains in 2019 have been retained. Now investors look forward to a recovery and post-election euphoria in 2021.

Meanwhile real estate buyers in 2020 have paid more for a house than ever before in history, taking on greater debt when the jobless rate is above 10% – the highest in the OECD – and the country is in recession with four million people worried about CERB cheques ending next Thursday (they won’t, of course).

In short, pretty much all of the assets in a financial portfolio end up in the economy, productively feeding corporations, employers and jobs or financing government debt. Most critically, people with RRSPs, TFSAs, RESPs, non-registered accounts and RRIFs do not have government insurance backing their portfolios and did not use leverage to buy them. They have assets which are not layered on debt. So when Covid hit, there were no deferrals. Besides, people always require income, especially in retirement. They don’t need houses. You can rent nice accommodation when you’re seventy. You cannot rent cash flow.

Apples, oranges. Bananas and Buicks. Simple comparisons are meaningless. Stop trying to make them. There’s no competition between real estate and financials. You should probably have both.

Despite the above, nothing will change.

A survey out today from BMO found 40% of first-time homebuyers think this is a swell time to make a house purchase – with record-high prices, greedy sellers, low inventory, steep unemployment, a deep recession and a global pandemic. Thanks to the sick economy, the bank says, many of the kids have had to dig into their savings and will require larger mortgages. “Even with a global pandemic as our backdrop, we’re encouraged to see Canadians maintaining their optimism on our housing market,” says the head of personal lending. Smiling.

But it’s not just optimism. It’s delusion.

Now get out of my bathroom.