Inflation Is Worse than Expected

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    Inflation increase concept in vector format

    By: John De Goey

    The first thing people should ask when they read a headline like this one is: ‘Well, what the heck did you expect?’ A year or so ago, I wrote an article for this publication entitled ‘The 5% Solution’ where I suggested that if inflation were to persist at over five per cent by the summer of 2022, the Bank of Canada would have to take more aggressive action than had been anticipated to curb it. Not only did this come to pass, but inflation climbed to well over five per cent by the spring of this year. As of this week, the inflation rate has climbed even further – to an astonishing 7.7 per cent ‒ and seems poised to continue even higher.

    We are now into the summer months and the emerging consensus is that inflation is not only dangerously persistent, but getting to the point where major consequences could come into play. If drastic action is not taken, inflation could soon spiral out of control. In other words, the concern is that we are in for inflation that not only lingers, but inflation that increases.

    This means the people who set monetary policy must get serious. There is no doubt that central bankers throughout much of the Western world will be raising rates in the coming months to try to rein it in. Multiple and substantial rate hikes loom on the horizon and that has the potential to pose significant challenges to stocks, bonds, and real estate.

    Get Ready

    Most commentators would not be surprised if three months from now, rates were one per cent to 1.5 per cent higher still. That is a challenge for people who hold long-dated bonds, for stocks, and for anyone with a mortgage. Not only do rate hikes seem inevitable, they will almost certainly inflict more pain on virtually all investment and financial assets. Get ready.

    When I counsel people to prepare for a multi-asset bear market caused by draconian, inflation- induced rate hikes, the usual reaction I get involves some form of denial. But looking the other way will not make the problem disappear. We need to address the situation head-on.

    There are plenty of people who believe markets can head lower throughout the remainder of 2022 and into 2023. I’m one of them. Even if we hit a bottom in 2022, it could easily take many years for a meaningful recovery to take hold. At a minimum, there is typically a lag of at least six months for the stimulus of rate cuts before an economy will rebound. Given that hikes will be the order of the day for the foreseeable future, a reasonable expectation might be for rate increases until the autumn, followed by stable rates for the remainder of the year and then followed by rate cuts some time in 2023. That, in turn, might be followed by a recovery of six months or more after the cuts start. I wouldn’t expect a meaningful rebound until this time next year and that’s at the very earliest.

    The course of action one might take in this environment is highly personal. In most instances, independent financial advice is in order. For those who waited until the early New Year to take profits, I offer my congratulations. Whether this was done by design or not, you likely sold near the top of the market, deferred your taxes until April 2023, and allowed yourself to re-position your assets on favourable terms. You may have decided to raise cash as markets started dropping.

    The thing to remember is that it’s not too late to do something even as we approach the mid-year pole. Gains will likely be lower if you sell later in the year, but at least they will still be gains if you do so soon. Many pundits fear that if people sell much later, the gains will be smaller. Depending on what it is you’re selling – and when – there may even be losses.

    The standard industry line is that investors should ‘stay the course,’ ‘take a long-term view,’ and ‘remain patient.’ I’m not necessarily saying that is bad advice, but that you need to reflect on just how much pain you are prepared to tolerate, assuming you subscribe to that perspective. No one knows what the future holds, but I cannot recall any point in the recent past where people were more worried about a serious drawdown than they are right now.

    Without explicitly telling you what to do, there is one bit of general advice that I believe is fair – prepare for a prolonged and choppy market. Put another way, hope for the best, but prepare for the worst. If that preparation involves building the resolve to stick with what you have, so be it.

    Selling Assets

    On the other hand, if it involves selling some assets to take profits while there are still profits to take, my sense is that you ought to do so sooner rather than later.

    The financial advice industry can suffer from ‘optimism bias.’ That means the industry almost always says times are or will soon be good, so don’t sell. My forthcoming book ‘Bullshift’ will get into this in detail. In my opinion, it now seems that stock, bond, and real estate markets are simultaneously heading for a major crash caused by the recent run-up in asset prices, combined with the now-urgent need to tame inflation. It’s already begun. Here are two more observations to ponder:

    • The unique combination of unprecedented consumer and government debt, soft earnings, high valuations, and a strong push to much higher rates have put a major strain on the economy that will only become more severe in the coming months.
    • For context, note that less than two weeks before the stock-market crash of 1929, one of America’s top economists said valuations would remain permanently high. It looks as though history is repeating. Even experts are chronically poor at calibrating risks.

    It very much looks like we’re in for a huge correction that many don’t see coming and haven’t prepared for.

    John J. De Goey (CIM, CFP, FP Canada FELLOW)
    is a registrant with Wellington-Altus Private Wealth Inc.
    www.standupadvisors.ca