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I gave up on forecasting a number of years ago in the sense of trying to predict levels for asset class benchmarks. I did not, however, stop focusing intently on which asset prices outperformed in different market conditions, and this is now very relevant in light of the ongoing debate about future inflation pressure and higher bond yields.

I covered the inflation debate in Monday’s newsletter, and, while higher future inflation pressures are not yet the consensus view, the discussion has intensified since then.

Here’s how important inflation is – if you tell me where the inflation-adjusted U.S. 10-year bond will be in 18 months, I can tell you which asset classes are about to outperform with a high degree of confidence. (Investors can follow the trends here).

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Credit Suisse global strategist Andrew Garthwaite uses the real 10-year bond yield as a proxy for the equity risk premium (ERP). In basic terms, the ERP measures the attractiveness of equities relative to bond yields and economic growth. When real rates go lower, equities go higher because of the low available risk-free yields on government bonds.

Real yields are currently extremely low, thanks to central bank rate cuts and the inflation-crushing effects of the pandemic. In market terms, the primary beneficiaries of these low yields during the post-March 23 rally have been the large cap technology stocks – Shopify Inc., Apple Inc., Microsoft Corp. and Facebook Inc., for example – that were already expensive in terms of valuation.

The reasoning here is that because low yields and inflation signal a slow growth environment in which most companies will struggle for earnings growth, investor assets will shift towards companies less sensitive to economic growth, where profits are more dependable because of secular trends. Low yields also make the dividend income from defensive sectors like consumer staples and utilities more attractive.

As long as inflation-adjusted yields stay at depressed levels, equity investors can expect similar trends in sector performance, more or less. The nascent rallies in industrial metals and energy prices will likely be limited or fade.

A much different environment would confront investors in an inflationary environment where real yields are significantly higher in 18 months. In that case, economic and profit growth would have broadened out beyond technology to other sectors sensitive to the economy. Investor assets would move from expensive technology stocks and defensive sectors into much more attractively valued commodities, industrials, banks, and consumer discretionary stocks.

These sound like binary options, but there’s a middle ground where yields rise to non-inflationary levels and level off. I have no guidance for that eventuality except to note that passive index investors will likely have an even larger advantage than usual. They’ll own what’s working no matter what.

-- Scott Barlow, Globe and Mail market strategist

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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

Warren Buffett likes pipelines. Maybe you should too

After Warren Buffett snapped up U.S. pipeline operator Dominion Energy Inc.‘s natural gas transmission and storage network in a US$9.7-billion deal (including debt) announced on Sunday, Canadian pipeline stocks barely moved. But that’s good news if you are considering a foray of your own into the energy midstream sector: Share prices are down from recent peaks and dividend yields are high, even after the stunning stock market rebound of the past three months. David Berman looks at the investment case for Canadian pipelines. (for subscribers)

Bargain-hunting investors must turn sights (and dollars) away from U.S. stocks

Over the past decade, the path to market riches ran straight and narrow. It consisted of buying U.S. stocks and shunning everything else. Anyone who followed an all-American strategy did splendidly. The gap in performance was remarkable – but don’t count on it continuing. Ian McGugan explains why the time may be right to go further abroad in your portfolio. (for subscribers)

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How long can markets and the economy move in opposite directions? These indicators hold valuable clues

The second quarter saw an equity market rally among the strongest in history exist simultaneously with global economic data resembling the worst periods of the Great Depression. Investors are clearly looking through the current collapse in profit growth in expectation for a sharp economic recovery. But these two trends are incompatible over any significant time period. Scott Barlow looks at some key data to follow in coming months, as investors seek clues on how and when this disconnect between markets and economic growth will be resolved. (for subscribers)

Others (for subscribers)

Wednesday’s analyst upgrades and downgrades

Tuesday’s analyst upgrades and downgrades

Wednesday’s Insider Report: CEOs are trading these three securities

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Tuesday’s Insider Report: Multiple executives sell this stock as it approaches a multi-year high

Number Cruncher: Ten U.S. large-cap stocks with a history of steady growth and profitability

Others (for everyone)

Longer, greener, broader: strategies for a world awash in new bonds

The quarter after the half: Why the next 3 months are key for stocks

Globe Advisor

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Six small- and mid-cap stocks that offer dividends and growth potential

Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.

Ask Globe Investor

Question: Can I transfer an exchange-traded fund in-kind out of my tax-free savings account and into my non-registered investment account? Or must I sell it first, transfer the cash and repurchase the ETF in the investment account to be considered as a withdrawal from a TFSA?

Answer: Yes, you can transfer assets in-kind from your TFSA to your non-registered account. You do not need to sell and repurchase the ETF. The withdrawal amount is equal to the fair market value of the investment at the time of transfer. Keep in mind that, when you make a TFSA withdrawal, whether in-kind or in cash, the amount is added to your TFSA contribution room, but not until on Jan. 1 of the year after the withdrawal. This is in addition to the annual dollar limit ($6,000 for 2020) that is also effective on Jan. 1 each year. I strongly suggest that you closely track your TFSA contributions and withdrawals so that you know your available contribution room, as the numbers provided by the CRA’s “My Account” service are often out of date. If you are planning to make an in-kind withdrawal from your TFSA, also remember that the cost base of the investment – which you’ll need to calculate your capital gain or loss when you eventually sell the ETF – is the market value at the time of the transfer, not the price you originally paid when you bought the ETF in your TFSA.

--John Heinzl

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What’s up in the days ahead

Markets are underestimating the chances of post-election chaos. Ian McGugan will explain this weekend.

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

More Globe Investor coverage

For more Globe Investor stories, follow us on Twitter @globeinvestor

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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