The first shoe

If you hold preferred shares in your portfolio (as a certain pathetic blog told you to, ages ago), it’s all good. You’re up 20% this year. Plus you’re collecting a healthy little 4% income stream, paid in cash every 90 days. And come April you’ll be claiming the dividend tax credit.

Sweet. This is the good side of inflation, post-virus financial euphoria and rising rates. The other side involves painful gas prices, rising mortgage costs and a busted supply chain. Investors with a traditional 60/40 (growth/fixed income) portfolio have seen a bigger return this year than homeowners anywhere. And no realtors, property taxes, condo fees, insurance or squirrels chewing through the garage insulation.

So what’s next?

On Wednesday the Bank of Canada will drop a statement and monetary report, then offer up boss Tiff Macklem for a presser in Ottawa. It will be the first live CB event since the BeforeTimes, and that’s significant. The bank will not raise its key rate this week, but will continue to turn off the stimulus tap and reduce bond-buying yet again. It’s a prelude to what the bond market is already telling us. Up she goes.

“That rate hikes are coming,” says a report from Scotiabank, “seems inevitable.” In fact the market is pricing up a whole host of increases, starting in about five months.

   Why is this happening? How can authorities permit the cost of money to rise just after everyone pickled themselves in debt? How high will they go? And, are we doomed?

Given official inflation at 4.4%, far above the CB’s target rate for six months now, along with $85 oil and runaway corporate earnings, it’s a slamdunk emergency Covid-induced, crazy-low rates will end. The longer money stays cheap the more that debt-loving beavers will feast on it, the more inflated asset values (especially houses) will become and the larger the risk this poses when everything reverts to the mean. Also the main tool central banks have to combat downturns is the ability to quickly cut rates and stimulate spending. So it’s simply impossible to leave the benchmark at a quarter of one per cent, leaving no room for cuts in, say, 2025 when the SHTF next.

In short, this is why mortgage rates will double:

• We’ve recovered all the jobs vaporized by the pandemic.
• There’s still a huge shortage of workers, thus wages will pop.
• Canada has one of the best vax rates in the world…
•  …and we haven’t even started on the kids yet.
• Corporations, and our banks, are rolling in profitability.
• GDP is expanding. By the end of 2021, the virus impact will be a memory.
• T2, newly re-elected, is about to spend even more. Fiscal stimulus to the moon.
• Lockdowns are out. Vaxports are in. Society can reopen.
• Commodity prices are nuts. Canada is rich in them.
• The TSX is in the longest rally ever. Stocks have added $200 billion. Look at your RRSP.
• Christmas will be a retail orgy.

So the rate increases may begin in March (as the market is forecasting) or in July (as most economists believe). Current thinking is there will be at least 8, adding 2% or more to the bank rate. That will increase the chartered bank prime to almost 4.5%, double five-year mortgages and make people with VRMs and LOCs unhappy. We showed you last week, in stark dollar terms, what this means for the amount of interest paid on home loans.

“Like potato chips, one or two rate hikes would leave any inflation-targeting central bank’s hunger unsatiated,” adds Scotia. “To be meaningful, the first stage of the hike cycle is likely to involve a rapid move off the lower bound through a meaningful number of initial hikes.”

So, doomed?

Nah, only if you borrowed your brains out, grabbed an inflated house with 20x leverage, believed WFH would let you live in Bunnypatch forever and grow equity, bought a Ram 1500 TRX (12 mpg) or put everything into a ‘safe’ government bond fund, like TNL@TB suggested.

?      ?      ?

So this is a good segue into Andrew’s contribution to the Investment Question of the Day.

You’re a stout believer in a B&D 60/40 portfolio, and the main argument for such seems to be because when equities fall, bonds rise and provide some stability in turbulent times. This reduces the shock to investors and thus reduces the likelihood they panic and jump ship at the worst possible time. I’m curious, if you took human emotion out of it, would you stick with this strategy? The S&P500 has returned around a 10% average in its lifetime, which is quite a lot better than a B&D portfolio. Assuming the investor is not going to panic during a downturn, nor do they ever need to fully liquidate their portfolio at once, would you not suggest going 100% stocks, or something more aggressive than 60/40? It just seems the B&D portfolio is essentially costing an investor potential returns, with the only reason really being to control their emotions. That’s arguably an unnecessary cost if the investor is steadfast in the event of a market collapse.

First, the long-term average for a balanced portfolio is just north of 7% while, yes, the US equity market has delivered over 10%. A major difference is that swings in an all-stock portfolio are far more extreme. By missing a few good days, performance can be shattered, whereas a B&D approach is more forgiving.

So, if you were emotionless, never worried about market gyrations nor required income or lump sums from your portfolio for a number of decades, then an all-S&P-all-the-time portfolio would work well. Sadly I’ve never met a person who fit that bill. Maybe it’s Andrew!

Moreover, putting all your eggs in one asset class means an extra level of risk. For example, rising rates might whack the tech stocks, but they feed preferreds (see above). Also being in US$ exclusively adds currency risk. Just wait until Mr. Trump returns…

About the picture: “I have been a reader of your blog for ages  – (and my Dad, bless him, was a huge fan as well.  He read all of your earlier books.) Anyway – some great advice given over the years and in these days of information overload, the blog is well worth the read,” writes Viola. “I am sending a photo of our much loved, now gone, Kelsey. He loved to pose for the camera! Hated being groomed (which was a regular thing) but endured it because we told him over and over how Handsome he was! He then pranced about, strutting his stuff! This is him at the beach on a winter day. One of these days, we will get another dog – put it off for a variety of reasons – not wanting to have my heart broken again being one of them.”