2024 Year End Update

 

Over the past few years you’ve heard us talk about the K economy. In short this means that the economy and specifically the consumer has been moved into two categories. The top half of the K have experienced growth and continued wealth accumulation, while the bottom half faces more and more challenges every day. Although the term was initially used for the consumer coming out of the COVID crises, it can now be used for a number of different areas of the economy. Small businesses have had two years of debilitating challenges due to among other things, inflation and interest rates, while the largest companies have been able to thrive. This has also translated to the stock market where the largest companies have done extremely well and in many cases have defied all traditional norms, while the remainder of the market has stagnated. According to Charles Schwab, the max drawdown for the S&P 500 was 8%. However, the average, max drawdown for the 500 companies that comprise the S&P 500 was 22%. For the NASDAQ, that drawdown it was 14% for the index yet 49% drawdown was the average for the members of the NASDAQ. What this tells us is that the market performance has been very concentrated in a handful of companies. Although I do not have this information for the Canadian market it would most likely be very similar. In a nutshell 2024 was a good year in the markets but it wasn’t as strong across the board as the headlines would make it seem. More importantly is what are we doing and where are we going.

We want to first start with the premise that our goal as advisors and as investors is to preserve, protect and compound capital in a manner that allows each one of our clients to live the lifestyle that they wish to achieve. To build off of last year’s letter, as investors, it’s important for us to look inward and ensure that we are reaching our own personal goals which is for most of us to compound at some reasonable rate of return over an extended period of time so that we can have the peace of mind to enjoy our lifestyle of choice. With that in mind, let’s look at the World we currently live in.

Inflation, gold, commodities and growth.

What do these four items have in common? We believe that they will all go higher in the coming months and quarters and it all starts with inflation. Let’s look at how the CPI is actually calculated. There are two aspects of CPI calculations which I find quite interesting. The first is called the chain link method, which quite simply is an assumption that the changes in price will cause consumers to adjust their behaviour. For a simple example, you are at the grocery store deciding to buy beef or chicken. For simplicity sake, assume you buy 2lbs of both chicken and beef and beef was $2/lb while chicken was $1/lb costing you a total of $6. Now let’s say the price of beef went up 50% to $3/lb so you decide to buy 1lb of beef and 3 lbs of chicken. You still have four pounds of meat for $6 and as such that basket of goods has a 0 inflation. The other method that is used is the hedonic adjustment. If there is an improvement in the good or service that is offered and the price goes up accordingly then the CPI calculation will state that you are getting more for your money and therefore there is no inflation. As an example, if you have a health insurance policy that now covers more medications or procedures the insurance company is most likely going to raise your premiums. Since you are getting more services for your dollars this isn’t inflationary however the reality is that you as a consumer have to find the money to cover that increase.

Over the past four years according to the bank of Canada inflation calculator https://www.bankofcanada.ca/rates/related/inflation-calculator/ we have had an official cumulative inflation of almost 18% in the past four years and I would surmise that if we were still using the same consumption patterns that we did four years ago that number would be significantly higher, I know for my family we are buying a lot less steak and cheese now then we used to. Although inflation is a confluence of factors if you ever took an economics 101 class you learned about supply and demand. I don’t think I needed my economics degree to understand that as it’s really more common sense. The more people want something the more you can charge for it. So one of the most important factors of inflation is demand. If we look at https://www.usdebtclock.org/world-debt-clock.html we can see an astronomical amount of debt. When you create money that money goes into the system and thereby creates demand. If you look at the US debt clock, you’ll see that they have just shy of $36 Trillion dollars in debt. However exactly 4 years ago in 2020 it was under 30 Trillion and in 2016 before any COVID bailouts it was $21Trillion. Meaning the US government has added roughly 75% to their debt level in just 8 years!! This is not a political statement as both parties have held power in different branches of the government during those 8 years. Canada at 2.3Trillion is even worse in relation to our GDP but you get the point.

As mentioned above, there is no single factor that causes inflation but for sake of time I’ll move on to hard assets.

Let’s start with gold which is trading at all-time highs but is one of the most under invested asset classes in the West. As I have previously mentioned, during my vacation in June I had read a great book called “How to Listen when markets speak”. We believe that the gold market is “speaking” to us. Gold is currently behaving in a manner like never before, and for an asset class that has existed forever, that is something that we believe everyone should pay attention to. If we dial back to July 1944, the Breton Woods agreement essentially what happened was that in exchange to becoming the global currency the U.S. would provide support and stability backed by the World’s largest military. The United States received currency strength affording their reserve currency great purchasing power. The rest of the World would have stability and ease of global commerce. This arrangement started to break after 2008 when the United States started issuing debt at levels they had never done before. According to the CBO from 1962-2008 US Debt-GDP ranged between 23% and 48%. That all changed in 2008. Since then Debt to GDP has grown to 39%-97% and the CBO anticipates that debt to GDP ratio will grow to 97%-172% over the next 30 years and that’s planning for no recessions, wars or pandemics. You can also make an argument that the quality of the GDP growth isn’t as strong as it was as so much of the GDP is now based on financial engineering and home building versus manufacturing but that’s a conversation for another time. What this means however is that interest charges have become the single largest line item on the US budget and this is not what the rest of the World signed up for. Since around 2014 many central banks reduced the amount of US Treasury Bonds that they were buying for their surplus dollars. They were concerned about the level of spending that they were seeing and thought it would be prudent to start reducing their reliance on the US dollar and instead started increasing their gold holdings. When the US and their allies started to freeze Russian assets held in US dollars after Russia invaded the Ukraine we saw a huge increase in volume of gold purchases at the expense of US treasuries. This is a trend that has continue to persist. I have heard, and even been known to say over the years, what’s the point of owning gold? What I have really learned over the past number of years is that gold is a store of value. It’s why the US central bank owns, at $2200/oz, $630B worth of the shiny metal and every major government around the world owns a significant amount. In fact, according to the World Gold Council, in 2022 46% of Central Banks said they were planning on holding moderately higher levels of gold in 5 years, in 2024 that number has spiked to 66% of the banks. Gold provides stability and is a store of value when the fiat currency is debased. With the quantity of money printing over the past two decades and the inflation over the past 4 years we have seen massive debasement in our currencies. To give some context to the amount of money that our country has printed, according to Bloomberg and Hedgeye estimates, since 1999 Canada has grown it’s money supply by 542% meaning we’ve had a debasement of 81.5%. So we have seen a lowering of the value of our Loonie by 81.5% since 1999. In light of this debasement gold has held up its value remarkably well.

 

Energy and other commodities.

 

We have historically seen a lot of inflation created by the increase in the price of commodities. We believe that over the coming months and quarters as inflation accelerates, energy and other commodities will continue to move higher. I would highlight however that it won’t be a straight line as commodities can be quite volatile. We wanted to highlight two. First is energy, both oil and gas. We’ve written a fair amount over the past two years about these two assets and I understand that they can be polarizing, when we look at the data, it is clear to us that there is a long term structural under investment in these assets which could create a medium term energy shock. As everyone clamours for the best new AI and the talk of AI data centers has driven the market, people have forgotten that all this creates massive demand for energy. Here I’ll share from a research piece I posted in Nov.

The world needs cheap reliable and efficient energy. According to the Energy Institute, since 2000 Global energy consumption has increased by 50% with no signs of abating and not one source of energy will be the only solution. In the current environment it takes roughly 10 years for a new nuclear development to come on line and once it has been commissioned the demand stays very stable. As such forecasting demand for uranium is fairly straight forward. When we look at existing supply/demand trends there is a significant under investment in uranium. The second bull case scenario to long term uranium/nuclear demand is as mentioned above the need for cheap reliable and efficient energy. Some of the trends that will continue the demand for energy are the electrification of the grid, the massive energy demand of AI and data centers, (A chatGP search takes 10x the energy of a normal google search), and the continued economic prosperity and urbanization of the developing World. As such it is no surprise to see the largest technology companies in the World strike up deals to have access to cheap energy. Microsoft is reopening Three Mile Island https://www.bbc.com/news/articles/cx25v2d7zexo, Google is planning on generating 500MW of nuclear energy https://www.weforum.org/stories/2024/10/google-joins-big-tech-move-into-nuclear-power-and-other-top-energy-stories/ and Amazon is developing SMRs https://www.cnbc.com/2024/10/16/amazon-goes-nuclear-investing-more-than-500-million-to-develop-small-module-reactors.html Those are just the three largest announcements made this October.

Although we are believers in long term nuclear as a clean and efficient source of energy, that won’t happen overnight. We expect natural gas to help power that transition. Both nat gas and WTI continue to reaccelerate their price going into the new year.

Growth – The big unknown for 2025 will be how does Trump deploy his tariffs and how fast can the Department of Government Efficiency cut costs. Both of these have the potential to have a large negative impact on GDP if they deploy them both quickly. Tariffs will boost inflation and cause issues for Canada and other trading partners to the US. If the DOGE is successful in reaching half their target and pull $1Trillion out of government spending then estimates suggest that this will be a drag of, depending on your source, around 2-4% on the US GDP dragging growth down to nothing. In the short term this would be negative for the economy and the markets, however long term we believe this would help the US economy tremendously. It could stimulate growth, decrease the US balance sheet issues, enhance productivity and innovation. In short it would have short term pain for long term gains.

To close, as we look out to 2025 we remain realistically optimistic. We believe that the World is fundamentally changing and that can feel worrisome, but we believe that we are living in one of the best times in the history of civilization. Yes there is geopolitical unease, yes there is inflation, yes parts of our society are feeling a heavy burden however the other side of this is opportunity. If we know the rules of the game we can continue to make money. We are not positioned in the areas of the market that currently are showing signs of a bubble. We are positioned for continued inflation and an energy transition. We believe that 2025 will be a stock pickers market where there will be alpha that can be generated by not holding the stock market. We will continue to focus on planning and ensuring that we are helping all our clients meet their goals and importantly do it with a focus on downside protection. As we have always stated, during a bull market like we’ve been in, we are willing to give up some upside as long as we can protect on the downside.

 

Here's to a happy, healthy and wealthy 2025.

As always, if you have anything you’d like to discuss, please don’t hesitate to reach out.

 

CIBC Wood Gundy Andrew Lacas, CFP®, CIM®, RIAC Wealth Advisor Portfolio Manager

Lacas Advisory Group

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