Bond yields are lower on both sides of the border in recent days, but, if BofA Securities chief investment strategist Michael Hartnett is correct, this is merely a pause before a new era of inflation and higher rates takes hold.
In a research report released earlier this month, Mr. Hartnett bravely declared that 2020 marked the generational low for borrowing costs and that “the 40-year bull market in bonds is over.” This would signal a wholesale change in market leadership, not least because capital gains will become extremely scarce for bond investors and reliable sources of equity dividend income, like utilities, will underperform.
In Trading the Inflation Theme, Mr. Hartnett presents a six-part argument to defend his claims. These involve loose central bank monetary policy, bigger government that will favour Main Street over financial markets, de-globalization, organized labour, demographics and high levels of government debt.
Central banks are clearly inflationary, keeping bond yields well below the rate of inflation. This has been enough to cause a significant spike in Canadian home prices thanks in part to rock-bottom mortgage rates. Federal Reserve chairman Jay Powell recently signaled no intention to raise interest rates until 2024, and that the Fed is willing to tolerate inflation pressures until that point.
Bigger governments, which gained popular support because of the necessary interventions of the pandemic, are another reason the strategist expects higher inflation. He expects that major federal governments will continue to be more active in their economies, supporting “workers over capitalists, nationalism over globalization, health over wealth.” This would result in higher wages and lower corporate profit margins leading to product price increases, both inflationary forces.
A BofA survey cited by the strategist found that 67 per cent of companies were planning to re-shore some operations to home countries, another potential driver of higher wages. An increase in organized labour, highlighted recently by unionizing efforts at U.S. Amazon facilities, would provide bargaining power towards higher pay.
The equity market winners in an inflationary environment would be much different than the technology and growth stock-dominated backdrop of the past decade. As such, Mr. Hartnett suggests investors focus on value investing strategies, economically sensitive sectors like industrials and consumer discretionary, inflation-protected dividend yields (companies that are able to raise prices to growth dividend payouts), and energy and materials stocks.
-- Scott Barlow, Globe and Mail market strategist
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