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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.

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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

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

The Rundown

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Why low interest rates don’t justify sky-high stock valuations

The story du jour holds that low interest rates justify Wall Street’s sky-high stock prices. Sadly, this isn’t true. But it remains every money manager’s favourite reason for continuing to pile into one of the most expensive stock markets in decades. That supposedly simple relationship between interest rates and stock prices? It’s actually more complicated than you think. And it could hold some nasty surprises if you base your investing strategy on the conviction that today’s meagre bond yields offer unlimited fuel for more stock market gains ahead. Ian McGugan has this analysis. (for subscribers)

Also see: Money markets ramp up bets on U.S. interest rate hikes by 2023

The irrational market exuberance can’t go on forever. Here’s how to prepare your portfolio for the Biden presidency

If even a quarter of Joe Biden’s fiscal spending plan is enacted, it will represent a huge stimulus for the economy. An easing of the coronavirus epidemic would further enhance economic gains. With bonds offering low yields and little upside potential, you can see why stocks are booming. But more analysts are starting to use the word “bubble” to describe what’s going on in the stock market. So, what does this mean for your investments? Gordon Pape shares his thoughts after a historic week of turmoil in Washington. (for subscribers)

The simple stock-picking strategy that beats the TSX long term by playing good defence

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The Two-Minute Portfolio is a simple stock-picking strategy that has a proven record of winning over the long term by containing losses in down markets rather than by beating the index in bull markets. As Rob Carrick reports, the past year was a vintage performance. (for subscribers)

These TSX stocks have been consistently buying back shares - and could be set to outperform

Firms that buy back large fractions of their shares at low levels, say, during a pandemic-related market crash, can be particularly attractive. That’s why Norman Rothery searched for members of the S&P/TSX Composite Index that cut their share counts by more than 3 per cent over both the past year and the past five years. (for subscribers)

Canada’s retail REITs under pressure to slash monthly payouts as COVID-19 cases spike

Escalating economic shutdowns are increasing pressure on Canada’s retail-focused real estate investment trusts to slash their payouts, putting investors at risk of losing out on monthly income that used to be considered sacrosanct. Tim Kiladze reports. (for subscribers)

Investors look to upcoming U.S. earnings for a view into 2021

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Investors will be anxious to see whether upcoming quarterly reports and outlooks from U.S. companies validate expectations for a strong 2021 rebound in earnings and the economy, which were ravaged by the coronavirus pandemic last year. Caroline Valetkevitch of Reuters looks ahead to what the Street is expecting. (for everyone)

Cancel your weekends! Bitcoin doesn’t rest, and neither can you

Bitcoin doesn’t sleep. Trading volumes across six major cryptocurrency exchanges have been 10% higher at weekends than weekdays in recent weeks. The wild weekends are posing new challenges for market players large and small who face having to staff desks outside traditional office hours or risk missing potentially lucrative, or damaging, price moves. So what’s caused the change? Tom Wilson and Anna Irrera take a look. (for everyone)

Also see: Bitcoin falls 19% to face biggest one-day drop since March

Others (for subscribers)

Monday’s analyst upgrades and downgrades

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Monday’s Insider Report: Executive invests nearly $1-million in this dividend stock trading near a record high

Twitter shares dive after Trump account suspension

Globe Advisor

Why fund managers are betting on direct indexing

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Ask Globe Investor

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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

What’s up in the days ahead

Who were the most accurate equity analysts in Canada for 2020? We’ll have the answer.

Click here to see the Globe Investor earnings and economic news calendar.

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You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.

Compiled by Globe Investor Staff

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