Sunday, July 29, 2018

How would a portfolio in a rising interest setting look like?

The interest/inflation cycle has turned what does this mean for my investment strategies?   Inflation is picking up amidst reports of better worldwide economic growth. Wages are rising and in Europe many employers complain about the shortage of skilled staff.  Well, the baby boomers are at the end of their careers. Many are disenchanted with the callused ways industries have thrown out their expertise and years of experience.  They probably could still work, both in Europe and North America, but many are tired after the ups-and-downs of employment.

 Companies start hire young-cheaper labor and inexperienced middle managers don’t know what they don’t know.  The young upstarts think they ‘know it all’ and that the baby boomers are passé. In the meantime, many baby boomers don’t want to work with these young ‘dumb’ managers.  That is how generations switch roles in society. Not very efficient and with longer life-expectancies this will gradually change in favor of the older workers, but this is the current situation and it is inflationary because salaries of the younger people will increase faster than inflation while those of older workers will be steady or even decline.

The millennials will start buying houses and take on more debt for starting young families and with increased GDP governments feel pressure to spend more as well to meet the demands of an ever-growing population. This all contributes to new inflationary pressures. In the mean time, the world has now for years under-invested in commodities including the much-boohooed hydrocarbons. This will result in higher commodity prices if not explosively higher prices. No way that green energy will be able to keep up with demand, especially if we would be going more electric with our transportation.

I think there will be a revival of the nuclear industry and the development of different types of nuclear reactors that require less cooling. People will recognize that CO2 is not the evil poison as currently portraited. What is bad are the toxic elements in our emissions such as heavy metals and sulfur. With improved scrubbing technologies we may even revert to coal.  Coal for plain electric generation but also for the generation of hydrogen.  Maybe in 10 years we will be experiencing a repeat of the 1970’s oil price shocks and hyper inflation but now for all commodities. After all, we may hit 11 billion people, all wishing a comfy lifestyle on this planet of ours.

Inflation will likely creep higher and higher. The central banks will try to smooth out the cycle, but I don’t think they will be able to suppress the cycle and the laws of economics. So, what to do with high inflation and interest rates?  In the early years of rising rates, pundits are likely trying to convince you that rates will flatten and may even decline. But demographics are arguing against this. Energy and financials will always be in demand. However, energy and other commodity business seem always to be the most cyclical in our economy. They go boom and bust.  Financials also have their cycles but more sedate. Most manufacturing will be automated and less dependent on cheap labor and more on the locale of demand. I think there is a good chance that manufacturing returns to the West and to Africa for more labor-intensive industries. But the profit margins are likely to decline until the basic needs of life are affordable for all. 

Innovation and technical revolutions will continue until the time that we are ready for extra-planetary activities. That will be a new era of explosive expansion but it maybe decades if not a century away.  On the other hand, maybe Elon Musk is right, and we will be colonizing Mars within the next 50 years.  I can not foresee the future only extrapolate from today and that is likely way too timid.  And don’t believe the doom-sayers, although we must have some very vigorous discussions on ethics, morality and religion. For example, is cloning a realistic opportunity for extending our life or are we losing our soul in the process?  Are clones just soulless carbon copies of our former-selves or are they entirely new beings?

In this setting, interest rates will rise and probably to much higher levels than most foresee. Governments will never learn, and their debt cycle will repeat.  Thus, I suggest don’t invest in long-term debt. Only use short durations until the next interest peak which maybe 20 years or longer out. Yes, during stock market crashes, which will be due to over-speculation and similar market excesses, fixed income will protect you from severe market declines as it always has done. But restrict your bond and GIC horizon to less than 5 years. Keep an eye on taxes as a balanced portfolio may use capital losses on intermediate-term bonds and debt obligations to offset capital gains elsewhere. 

There will be new technologies that often rapidly appreciate but also crash very fast. The commodity cycles are a bit more predictable, although this last downturn seems to never end. But that me be more the effect of ‘recency’ than real. I remember that after 1982 we didn’t have a big oil and gas boom until 2000 or so. Calgary was bad between 1982 and 1987 or so and then only gradually got better and better until the culmination in 2004-2015. Its population over that time more than doubled. I didn’t realize this during those years but looking back it is obvious.

During periods of rising interest rates a laddered GIC approach may be good. I think for housing inflation is great and with the tough mortgage rules currently in place, rental properties may become very profitable. I would consider real estate as a form of fixed income as it provides steady rental cash flow while the properties appreciate. Although manufacturing of goods for basic living become somewhat deflationary, technology and new industries will remain sources of growth. Will computers and internet remain the forefront of these high growth industries or will they become the dividend-aristocrats of the future?  I think the latter but that would also mean falling P/E ratios and  their dividends may not be able to offset the loss of valuation. Don’t buy them unless their P/Es are in the 10 to 15 range – preferably closer to 10.  With rising interest rates the overall market P/E is likely to fall except for new innovations and developments.  

Canada will dramatically change in population and population composition. With a nearly doubling of the world population, we are a natural place for immigration. I wouldn’t be surprised if in 20 or 30 years we have over a 50 million citizens and we would have many more industries than just resources and auto manufacturing. Also, the white Caucasians will likely become a minority. I expect many more North and Central Africans will call Canada their home and thus we will get significant changes in cuisine – yummy!  Alberta’s population is likely to more than double. That would make real estate one of the most promising investments in Canada with lots of new infra-structure. 

I do suspect  that agriculture maybe in for major change as well. What if production of food would undergo major technology breakthroughs.  Direct conversion of energy into food for example. Or more food production concentration through robotic hydroponic facilities. Underground food production and protein production in tanks rather than cattle.  With so much demand on quality living space, farms and cattle may be considered highly uneconomic only afforded by the very rich on this planet.  I suspect though that these trends will become a lot clearer over the coming years; long before one has to worry about their investment potential. I would though consider the fertilizer industries and companies like Monsanto as main stays for many futuristic portfolios. 

Stock markets and maybe blockchain based investment technologies will likely stay relevant but focus on investments whose earnings keep up with or out-perform inflation. Energy, finance, infrastructure as well as food technology and of course healthcare would be core in each portfolio. Short to intermediate (max 5 years) debt and, above all, don’t ignore real estate and gold.  Crypto-currencies and blockchain are promising but far from a sure thing – I wouldn’t be surprised if this area will become the domain of angel and small cap investors, e.g.  ICOs for junior oil companies or a start-up tech company. Technology remains unpredictable and risky. If you consider investing in high-tech, diversify through ETFs.

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