Good afternoon,

 

For those of you who don’t follow your portfolios online, you’ll notice on your April statements that it was a tough month for investors. While the conflict overseas is top of mind as well, the main cause of this recent volatility is inflation. I’ve attached our most recent performance data as usual, where you’ll notice we’ve significantly underperformed for growth lately. That underperformance can also be tied back to inflation, specifically in commodities, where we have traditionally had a very low weighting in portfolios. I would rather continue to focus on quality long-term growth companies, rather than ones that tend to be more cyclical in nature. For those of you uninterested in the reason your account might have declined in value this year, you can stop reading at this point… for those who might appreciate a bit more clarity on inflation and its effects, read on.

 

What is inflation?

 

Inflation can be most easily described as an increase in the cost of ‘stuff’. Depending on conditions, certain types of stuff (oil, fertilizer, food, real estate) might be more affected than other types. The main indicator of ‘stuff’ is called the consumer price index, normally expressed as its acronym; CPI. If CPI goes up in value, it is expressed as a % growth. These days, CPI is increasing around 6-8% over the previous year, depending on where you live. Most governments would like to see moderate increases in CPI of about 2% per year.

 

Supply & Demand…

 

There are two causes of inflation at its most basic level. The first is based on demand for stuff. In this case, the increased demand is because of the massive amounts of money that the governments and central banks around the world have provided, either through monetary stimulus (printing money to buy bonds to keep lending rates low) or fiscal stimulus (government programs to actually provide money in the form of loans, grants, tax credits directly to consumers or businesses). Both were employed in record breaking amounts to prevent an economic collapse because of COVID-19. This had the effect of making it far easier to buy stuff, as one had either new money, or access to loans at ultra low interest rates. This is the demand side of inflation.

The supply side of inflation is when there isn’t enough stuff to satisfy an existing level of demand. Right now there are two major areas where the normal supply of stuff is being interrupted – the Ukraine/Russia conflict (oil, gas, fertilizer sales are being restricted as punishment to Russia while grain supply from Ukraine is being limited simply because of the conflict itself), and China (factories that make stuff are being shut down because of China’s ‘zero COVID’ policy during these most recent outbreaks). The lack of supply causes us to have to pay more for the stuff that we are actually able to get our hands on, from alternative sources (like buying fertilizer from Canada instead of Russia).

 

How do we stop prices of stuff from continuing to climb higher?

 

We try to either increase supply (difficult to do quickly because of these various geopolitical scenarios outlined above) or reduce demand. The latter involves simply making it more difficult for people to buy stuff… and the best way to do that is by increasing interest rates. Using real estate as an example, if I wanted to buy a home for $1 million and needed a mortgage for that full amount, it might have cost me 2% in annual interest last year, or $20,000 per year. Now, that same mortgage might cost me 4%, which is $40,000 per year. That’s a difference of $1,667 in monthly payments, assuming it is going to take me the same amount of time to pay off the loan. That of course would leave a lot less money in my bank account for other… stuff! When an entire population is affected by rising interest rates, there is less overall demand for other goods and companies are forced to reduce the cost of the goods they sell to hopefully increase their appeal.

 

What can I expect in my investment portfolio?

 

The nerve-wracking part of inflation as it relates to investing is the adjustment period for our stocks. They have been the beneficiary of increased demand over the last couple of years. This happened either directly as a result of investors having more money to buy stocks and bonds with, or indirectly, as the businesses we invested in had better financial performance because more people wanted to use their service or buy their product. Either way, the tricky part is to make sure that the companies we invest in currently are able to maintain financial success in the face of both inflation (rising costs) and rising interest rates (higher cost to service their debt). We do this by looking at companies that have healthy balance sheets (not too much interest to pay) and also do things that people need, therefore being able to potentially pass through cost increases to customers, or at least maintain their current prices. In the short term, markets will generally react negatively to the onset of rising interest rates. As the story plays out and these good companies show their resilience, I believe that our path forward will continue to be a successful one and we will see our portfolios return to new highs in due course.

 

If you made it this far, I hope we gave you some insight as to what’s happening in the world and why there has been this recent bout of volatility. As always, if you have any questions, please do not hesitate to call. I thank you again for your continued support of our group.

 

Best regards,

 

George Wright, CIM, FMA | Senior Wealth Advisor, Portfolio Manager