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.
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).
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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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.
What’s up in the days ahead
Markets are underestimating the chances of post-election chaos. Ian McGugan will explain this weekend.
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Compiled by Globe Investor Staff