Morgan Stanley chief economist Chetan Ahya is reiterating his strong arguments for higher inflationary pressure in what could be bad news for retirees and dividend investors.
Mr. Ahya has outlined Five Reasons Why We Are Inflation Bulls in a new research report. They are: government support has protected consumers from the recession, which means risk appetite remains and they are ready to spend; employment should recover quickly; central banks and policy makers are pushing economies to run ‘red-hot’; more government fiscal spending initiatives are likely and the Federal Reserve is committed to its 2-per-cent inflation target and is willing to accept upside risk (an overshoot) to achieve it.
Reason three - the multi-institution attempt to run economies hot or above historic averages in order to regain full employment levels - is perhaps the most under-recognized inflation driver. “Accelerated restructuring in the economy will mean that displaced workers will need time for retraining,” Mr. Ahya writes. “As this process unfolds, the labor market may tighten even earlier than the headline unemployment rate implies.” Tighter labour markets imply rising wages and goods prices.
A return to the rampant inflation of the 1970s is still a long way off, but there are signs that markets are beginning to price in higher inflation. The U.S. 10-year Treasury yield has climbed from 0.91 to 1.13 per cent since Jan. 4 and the domestic equivalent yield has increased from 0.68 to 0.82 per cent. The most recent ISM survey of U.S. manufacturing saw the prices paid component – which measures the cost of manufacturing inputs – rise to levels just below five-year highs.
Retirees, with a declining pool of assets to support their standards of living, are most at risk from inflation. Blair DuQuesnay, a financial adviser at New York-based Ritholtz Wealth Management, advises clients that higher inflation rates translate into rising costs of living. An inflation rate of 4 per cent for instance, means that living expenses double in 17 years.
For dividend investors, inflation hurts income-paying stocks that are unable to increase their dividends. The rising risk-free bond yields that accompany inflation pressure attracts investor assets away from equities that are unable to raise annual payouts. If rents rise along with inflation, for instance, REITs can maintain investor interest by hiking their yields. Utilities and consumer staples with slower revenue growth, however, tend to underperform in inflationary environments because they can’t increase dividends.
Commodities and other hard assets are the most common ways to protect portfolios from inflation. Scotiabank analyst Orest Wowkodaw, in a Monday research report, touted the particularly bright outlook for copper miners and predicted an imminent “new commodities supercycle” that investors will be able to ride and avoid the most negative effects of inflation.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: In Sept. 2019, I purchased 500 shares of Global X SuperDividend REIT ETF (NDQ: SRET) for my RRSP. The holding is only a small percentage of the total portfolio, and I am happy to continue holding it indefinitely for income purposes, unless you would advise otherwise. I expect that by a year from now, the share price will have bounced back to near my original cost per unit. Would your current advice be to continue to hold, add to my position, or sell it and use the proceeds to acquire a position in a different security? – Don C.
Answer: The entire REIT sector was hammered by the pandemic. This global ETF dropped as low as US$4.41 in March. It now trades at about double that amount but is still a long way below my original recommended price and is down 42 per cent year to date.
The distribution has been cut four times since the start of the year and is currently at US$0.055 per month (US$0.66 a year). That works out to a yield of 7.4 per cent, using the price at the time of writing, which was $8.90. That yield is on the high side, suggesting the market is still ascribing a significant risk level to this security.
At this point, I would hold and collect the high yield. However, I would not add more units. If you’re going to invest more money in REITs, I would zero in on individual securities that have shown they can survive and thrive in these difficult times.
– Gordon Pape
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Compiled by Globe Investor Staff