May 2022 SWM Letter … SUN WILL SHINE!

//May 2022 SWM Letter … SUN WILL SHINE!

May 2022 SWM Letter … SUN WILL SHINE!

As I write this my window is open for a spring breeze.  A bird nestled nearby sings encouraging notes of springtime.  World events continue along themes we have addressed in recent letters.  Questions have certainly been rising about housing prices, inflation, interest rates, and fluctuating investment markets.  In particular, how do we view investment values today when news media melt at every shadow despite solid corporate earnings and increasing income yields?

Secret for next month:  my June letter will be titled How to Immunize your Portfolio?  In today’s letter you can already find some early threads and under-footings on this theme.  Keep this in mind as you’re reading here and call me anytime with your thoughts and questions.  Also scroll through the letter today – as it’s longer than usual you will likely want to focus where you have the greatest interest or questions.

The sentiment of investment markets isn’t panic but grumbling uncertainty because of war, prices of food and gas, questions of covid and travel, anxieties of school or career.  Interest rates that hit 0% two years ago are rising as we knew they should – sharply at first and then easing.  Covid restrictions have widely reduced (except China).  Employment numbers are strong, job openings are vast, wages are rising.  Ukraine’s valiant defense may not end the war but they stole Putin’s May 9th anniversary victory speech as his troops bog down in the Donbas.

2022 investments opened as the reverse of 2021, which grew more in the first half while we expect restored growth this year in the second half.  I am sure world markets will recover from their malaise and offer enthusiasm and rising rewards these months ahead.  Meanwhile we reap the rising yields of blue-chip dividends, and accelerating cash-flows in our real estate and infrastructure funds.  Remember to a large degree these are inflation-indexed by design and have never failed to reward patience.

While TV and websites harp about market volatility, it’s interesting to watch but it’s no cause for panic.  Panic is not an investment strategy, and has long proven dangerous to long term wealth.  Focus carefully.  I purposely “bold” these following lines:  All our holdings follow disciplined investment process, adjusted continually, following long term principles to manage today’s business cycle and achieve strong long term results.  If you recall the image of a duck in the water – steady on the surface but paddling energetically below – that fits our teams in these opportune times.  Because in fact, our portfolio teams benefit from the type of pessimism we see in today’s market.  Instead of indulging media-hyped fears, we take advantage of them in times like these.  This ongoing care and perennial stewardship creates stronger value for our clients over time.

I know these things to be true.  If you prefer a picture (and skip 1000 words) here it is as you’ve often seen in my office.  There are dark clouds, strong winds, and high waves, yet the sailboat (portfolio) and the crew (our team and our clients) will keep safe because we have always prepared for these times.  Only the jib sail out front and a sea anchor drawn behind, hatches battened down and everything tight, it matters not whether progress is made but that we keep the ship pointed forward into the storm and at an optimal angle to the waves.  Storms end, the sun will shine, and we are confident to reach our journey’s goal. 

NOW is time for discipline:  don’t focus on the storm or the winds.  Downturns are time to remain invested.  Growth is the time for withdrawals.   Ned Goodman said, “The time to invest is when you have money.”   Warren Buffett added, “Invest when others are fearful, be fearful when others are greedy.”  As you’ve found with us over the years, we have excellent navigation to steer between the cliffs of fear and greed, and safely bring the results outlined in your financial plan.

INFLATION.

I have experience and enough research to hurt a camel.  You want to know how to survive inflation – or how to hedge against the increased costs that arise with inflation?  In fact the answer is clear:  equity investments, especially investing in companies and assets that share with you their income.  Particularly strong companies with rising earnings and a history of paying higher dividends to us year over year, … along with global infrastructure and real estate whose income is uniquely and often contractually designed to increase more with inflation.  Owning these (Life Income Mandates)  are the most powerful secret to conserving and growing wealth.  To get rich, stay rich, never go poor, your launch-pad is a diversified portfolio of dividends, real estate, and infrastructure.  I’ve spoken before about what we add to enhance that base but when a storm hits, these principles are the best assurance of safe sailing and reaching your goals.

One could be curious and ask, as central banks aim to stabilize inflation in a range +/- 2% … are they battling 8% inflation or 4% inflation?  Recognizing this difference is vital.  8% today is entirely temporary in comparison to artificially depressed prices through covid (eg. gasoline was cheaper than bottled water).  As covid normalizes like the flu, services are opening wider, manufacturing and shipping will flow more freely, inflation will naturally ease nearer 4%, then 3%, as this year moves into next.  If media harp on headlines of 8% please remember half of that is entirely temporary – born of the stimulus that helped avoid deflation and global depression.  So our central banks honestly are acting to avoid persistent 4% and rein this back to +/- 2% within two years.

INTEREST RATES.

These are central banks’ main lever to rein inflation back to 2% range.  Canada’s 10-year government bond opened 2021 at 0.7%.  Second half of last year it doubled to 1.5%.  Now it doubled that again near 3%.  More will follow, but higher short-term rates will soften consumer spending until inflation eases and rates can fall back again.  Central banks are using interest rates to dampen inflation for a year or two:  careful adjustments will hopefully succeed while keeping our economy growing at a safe modest pace.

Pictures or metaphors for the Central Bank’s challenge:   “Pushing on a string” to make the far end of it move.  Some say bank rates must reach 8% because if you’re pushing on this end of the string, it can’t move the other end until you get all the way to 8%.  That thinking would launch a depression.  How about some other pictures, eg. moving water over a distance, or adjusting medication to get a balanced result.  A country gardener has a spring in one area and a garden at some distance:  guiding just enough water into a pipe at the spring, will assure the desired flow toward the garden so it can produce wonderful vegetables and fruit without drowningSimilarly a doctor may adjust medication over time to safely monitor change without hazard, so every action is stepped and timed to measure the result.  Thus too, central banks are taking first steps quickly for the health of our wider economy, ready to add or ease such medicine over months ahead.

VALUE OF HOUSING AND OTHER ASSETS.

What you’re willing to pay for an asset today (or value you’re prepared to keep in an asset today, whether it be a house, toll bridge, office building, other investments) relates to benefits you expect to receive over time and in future.  For example consider a Dividend fund:  buying today at $10 you could expect it will report earnings of $1 or more and give you half of that as dividends, increasing over time and likely doubling in 7-10 years, and you’ll sell some at $20 and hold the rest to repeat it again.  The same approach works for Infrastructure and Real Estate.  If you owned Highway 407, a toll bridge or airport terminal, you wouldn’t care if the world thought its value less today than a year ago; you’d cheerily continue receiving revenues, more and more as the years go on.  That’s what we have with our infrastructure and real estate funds.  Owning a diversified portfolio of such holdings (LIM) in Canada and globally helps reduce downswings, spread risk, safeguard income and accelerate growth to assure your desired future.

Sometimes there’s a fad, a gleaming new idea – it happens every decade – flashy names posing as high-growth but questionable business and no reportable earnings.  Once it was dot.com.  For a time it was cannabis.  Duds that fly and then fall, erasing all earlier gains.  We don’t own those.  It comes down to basic valuation:  starting price, zero earnings, zero dividends, maybe zero final value.  What should you pay?  Zero of course – we don’t buy those.  If there’s no return while owning it, and possibly no end-value, then we cannot use that as any part of a certified financial plan to achieve and secure your future.

Interest Rates feature here too because today’s themes entirely weave together.  When interest rates are low, blue-chip dividend assets are always vital but for a time they pale in comparison to fad-stocks (no earnings, no dividends, infinite valuations, seemingly priceless, but soon the sparkle is gone and they won’t be your best friend).  Today with interest rates rising, what a different result we see!   Dividend, Real Estate, Infrastructure assets have made a temporary slide 10-15% but actually they will do very well and even increase their earnings to match higher interest rates … while fad stocks have dropped 60% to 80%.  Caution: if someone watches “fear and greed” TV shows etc. pumping fads on the way up, and fears on the way down, it’s poison to your wealth.  Advertisers make millions on this but you can never sue them, and the show goes on while one fad leads to the next endlessly risking peoples’ life savings. 

Huge protection comes from focusing on earnings and income-yield.  Even today we can see this so clearly.  Great investment assets have slid in share-value despite record earnings and rising dividends.  That means the price is on sale, earnings are up, dividends are growing, and account values can double faster from today’s lower base.  What’s not to like!   Keep these assets because their value will definitely be growing, and absolutely be higher in years ahead.

  • Extra if you like:  other assets which may be 10-30% of client assets depending on your personal investment profile.  Aside from the asset-income focus, but definitely not the zero-earning fad.  I’m speaking of the “plus” in LIM+ with teams such as DeGeer/Arpin in Canadian/Global Growth, Phil Taller with U.S. Mid-Cap and Small-Mid Opportunities, also the Dynamic Small Business fund, also our Science and Technology funds.  Those positions face directly into the wind of market storms at times like this, adjusting holdings for lower-price and higher-growth because they focus on more aggressive results, low-debt, high earnings-growth, social and environmental responsibility, and capacity to be reach record profit within 12-36 months.  Our managers have been highly opportunistic on your behalf.  One holding is a pharmaceutical company whose products are widely consumed in Canada/US at a price point that fits every family.  Another specializes in treating employees, families, and work teams suffering deep pervasive anxiety and stress whether work-from-home or returning to offices.  What we own here are leaders in their field, increasing market depth and breadth, growing earnings year over year until share prices exceed true value or they get an especially lucrative buy-out.

HOUSING.  This is big whether you’re young or middle-age buyers, baby-boomer downsizers, or somewhat-senior aiming to lock-in peak value.  Consider a house that was worth $500,000 when interest rates were 4% and rose to $1,000,000 or more with interest rates at 0-2%.  With covid, people needed more space and were spending less on travel and entertainment.  So now, if interest rates regain 4% will housing values drop by half?   Not quite; that’s more like bond markets. But housing certainly is pausing and estimates range from 10% to 25% drop (see picture below), cushioned somewhat for such vibrant economic regions as GTA/west, and specifically with resuming immigration and a diverse, skilled work force and healthy economy.  Home valuation: it’s not just math but it remains worth pondering the risks or opportunities when people buy in an over-priced environment.

Canadian Housing Affordability Gap (sorry graph isn’t clearer) measures times when homes have been especially expensive or affordable.  Showing years 1986 to 2021, high points are when housing was most costly, while low points are when home costs were easier.  Many bought in the mid-1980s before prices dropped (-25% in Toronto).  Again around 1992 before prices dropped so by 1998 people finally saw some growth.  And it wasn’t easy:  while prices were down and mortgage payments were painful (remember 10% and higher?), owners had to pay city taxes, repair and upkeep (or condo fees).

Younger buyers and others can ask some illuminating questions:

  • What is my optimal price for a home today?
  • What costs, for mortgage, repairs, utilities, taxes?
  • Gains/loss or flat values in 5-year property values?
  • Tax benefit, subsidized costs if working from home?
  • Expensive drive to workplace after return-to-office?
  • Option, rent out a room to subsidize your costs?
  • How many years will you expect to live here?
  • What future value can you foresee when time to sell?
  • Would you wait a time as markets cool, lower prices?
  • What gives you comfort and peace of mind – that’s priceless.

RECESSION?

While the present business cycle has sped forward to match the stimulated recovery from covid, we are mainly still MID-CYCLE and not on the cusp of a recession.  Canada’s GDP rose 1.4% in the first quarter and we’re looking strong into the second half 2022.  The USA had 1.4% drop in first-quarter, due first to peak inventories from late 2021, also with the sharp spike of US covid infections, and persistent transportation disruptions in ports, terminals, railroads, shipping.  Those factors have been easing so recession is not on the table for now; any mention of it is noise.  Just a few of countless quotes:

  • U.S.:  Ian Shepherdson, Pantheon Macroeconomics. “This is noise; not signal. The economy is not falling into recession. … net trade will boost GDP growth in Q2 and/or Q3.”
  • Canada:  Noah Blackstein, Dynamic Funds. “We are heading into a period of lower economic growth which bodes well for companies with secular growth tailwinds. We don’t believe we are headed for a recession. Looking out over the next 5 years, we really love this …”
  • U.S.: Doug Sandler, RiverFront.  “US consumer is healthy.  The unemployment rate is low, wages are up, and the labor participation rate is rising as Americans return to work. … We believe that stocks have fallen to levels where valuations provide support …
  • Eric Lascelles,  RBC GAM.  Looking forward now to next year “we continue to flag a recession risk around 30%.”   Ie. up from 15% and caution for 2023 or 2024, but not this year.

Recessions are highly unlikely when:

  • Employment is strong and jobs are extremely plentiful,
  • Wages are moving higher for lower & middle-income workers,
  • Consumers have increased savings and reduced consumer debt,
  • Interest-rates remain mildly stimulative or reach ‘normal’,
  • Shipping / transportation flows are opening up.
  • Post-covid venues & workplaces are safely re-opening.

Thank you for being here.  More next time: How do we Immunize your Portfolio?

Call me with any questions.  Reach us when someone you know needs help.

Yours in Financial Security for LIFE!

Brian Weatherdon, MA, CFP, CLU, CPCA. 905-637-3500

627 Guelph Line, Burlington, Ont. L7R 3M7.  1-877-937-3500

Brian@SovereignWealth.ca.

Certified Financial Planner, Certified Retirement Coach

Author:  A Lifetime Of Wealth — And How Not To Lose It  (2013). Protecting Life, Loved Ones, and Future Dreams  (2013). Your Business, Your Retirement: Halton Retirement Study (2015).

** This monthly letter touches on key strategies in Canadian and global investing and financial planning. This letter is not an offer to sell any kind of security, insurance, or program. Historical returns and risk measures are not a valid guide to future performance. Returns are from publicly available sources and research from a variety of firms including but not limited to Canada Life, CIBC, Dynamic, Mackenzie Financial, RBC / PH&N, and more.   Opinions in this letter belong solely to the author and no other body is responsible for the content expressed here. We value opportunity to coordinate with your legal and accounting advisers to further your financial goals in home and business.  We are grateful always to receive your comments and questions.

2022-05-12T14:15:30-04:00May 12th, 2022|