With the Canadian government spending hundreds of billions of dollars to fight the pandemic, are you concerned about possible hyperinflation in Canada and what it could do to the value of your dividend stocks?
Hyperinflation usually conjures up images of people pushing wheelbarrows of cash down the street and shopkeepers frantically raising prices several times a day. So, no, I don’t see Canada heading down the same path as Venezuela or Zimbabwe.
But inflation is certainly heating up. This hit home for me recently when my contractor quoted a price of more than $1,000 to replace a three-metre section of fence in my backyard. He wasn’t trying to gouge me: Lumber prices have more than tripled in the past year, driven by surging demand and tight supply as the pandemic spurred a renovations boom.
Higher lumber prices, in turn, have added tens of thousands of dollars to the cost of a new home, pouring accelerant on a real estate market already on fire. Prices for commodities such as copper, wheat and corn are also on the rise. With automakers curtailing production because of a global shortage of microchips, many car dealerships have ditched incentives and are selling vehicles at full sticker price.
Clearly, government stimulus isn’t the only reason inflation is percolating. When the pandemic hit, many industries cut production because they expected demand to plunge and remain depressed. But the rebound was faster and stronger than expected, catching companies flat-footed and leading to shortages and higher prices.
“While core measures of inflation are far from boiling over, pressures are starting to stir beneath the surface in areas such as furniture, appliances, and personal care services,” Sal Guatieri, senior economist with Bank of Montreal, said in a note. BMO expects inflation to average 3 per cent in 2022, which would be the highest annual rate in a decade, he said.
So what should investors do?
The first thing is: don’t panic. While it’s true that the stock market went sideways during the 1970s and early 1980s – when U.S. inflation hit a high of nearly 15 per cent and unemployment reached nearly 10 per cent – few economists or policy makers are expecting a repeat of such an extreme scenario.
“We have been living in a world of strong disinflationary pressures … for a quarter of a century. We don’t think a one-time surge in spending leading to temporary price increases would disrupt that,” U.S. Federal Reserve chair Jerome Powell told Congress in March.
Also keep in mind that, unlike cash – whose purchasing power erodes with inflation – stocks can provide a partial hedge against rising prices. That’s because companies can pass on cost increases to customers.
Consider Restaurant Brands International Inc. (QSR), a stock I own personally and in my model Yield Hog Dividend Growth Portfolio. If prices rise for coffee and beef, for example, the company could charge customers a little more for a double-double at Tims or a Whopper at Burger King. It’s not an ideal situation, but modest increases in inflation are usually manageable.
Similarly, power producers and utilities have mechanisms in place to protect against inflation. Power companies often sell electricity under long-term contracts that include annual escalators linked to inflation, while utilities can apply to charge higher rates, although it usually takes a while for the regulator to approve such requests.
“There is no question regulated utilities and contracted independent power producers have less inflation risk than uncontracted, or merchant, enterprises,” Darryl McCoubrey, utilities analyst and head of research at Veritas Investment Research, told me.
Another plus: Many utilities and power companies raise their dividends annually. This week, Algonquin Power & Utilities Corp. (AQN) hiked its dividend by 10 per cent. Other stocks with growing dividends include banks, pipelines and telecoms. On Friday, Telus Corp. (T) lifted its payout by 1.6 per cent. (Disclosure: I own Algonquin and Telus personally and in my model portfolio.)
If you are worried about inflation, owning stocks that churn out a growing stream of cash is a great way to preserve your spending power. Contrast that with bonds, whose fixed interest payments and principal are eroded by inflation. (An exception are real return bonds, which are indexed to inflation.)
I’m not saying inflation will have no impact on my dividend stocks. But as long as my dividends keep rolling in, I’ll be happy.
After all, I have to pay for that new backyard fence.
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