The old adage ‘history repeats itself’ often rings true with financial markets. Considering we are now in the midst of the fourth strongest bull market in the last 85 years, another adage that says ‘those that don’t learn from history are doomed to repeat it’ also comes to mind. Now, while absolutely nobody has a working crystal ball, history is telling us that caution is the better part of valour when we see a bull market of this length.
The Five Strongest Bull Markets and Consequential Bear Events since 1928
To put the above chart into proper context, the figures are in reference to the S&P 500 and the bull market is measured from the market lows in 2009, a period in time when many prognosticators were forecasting an impending depression. To put these returns into perspective, the S&P 500 has only provided investors with an annualized growth rate of 4.7% since March 2000. The intent of the above chart is to illustrate the destructive power that bear markets can have on your household’s long-term portfolio returns.
The problem with bear markets is that they typically begin when most people ‘feel’ the market is safe and there is a great deal of complacency with respect to volatility and risk. We point this out because while we do not foresee a bear market or economic recession this year or next, we have seen market volatility reach near record lows and investor complacency towards risk approaching high levels. Thus we feel that some caution is warranted, so we are currently holding elevated levels of cash within portfolios.
The risk we see beginning to show up in the financial markets is the return of inflation. Inflation has continued to increase and according to Martin Murenbeeld at Dundee Capital Markets, it could reach 3% in Canada and 2.3% in the United States towards year-end. Currently we do not expect the Bank of Canada to change its interest rate policy until next year, but in the US core inflation is moving up faster than expected. Thus we think it is logical that we could see the first interest rate increases this time next year should we continue to see incrementally rising inflation supported by wage growth in the United States.
This is not meant to scare investors, but rather to illustrate that we see inflation as a growing risk that investors have not had to deal with over the past decade. We are now building your portfolio’s defensive strategy in anticipation of this risk.
So what does this defensive strategy to contend with inflation look like?
For the most part portfolios will retain many of their current characteristics of fundamentally strong companies that pay dividends. The difference will be a greater incorporation of Gold and other storable commodities, as they have strong positive correlations to inflation. Last week we wrote a little bit on gold and you can expect to us to place greater emphasis on that asset class over the remainder of the year.
Have a great weekend.
Thank you for your trust.
As always, we welcome any feedback.
The Dekker Hewett Group