Investors spent the past two years counting their profits. Now they’re counting their worries.
Start with the worst inflation in four decades. Then add a bloody war in Europe. As well as a lingering pandemic, slowing earnings growth and rising interest rates.
Oh, the uncertainty of it all. Long-term investors can take heart in the knowledge that patience has always been rewarded. Unfortunately, most of us aren’t quite so philosophical about the multi-year link between risk and reward. We would like to avoid the short-term pain, thank you very much.
So cue the search for havens. Gold? Oil? Bitcoin? All of them are widely touted as potential safe spaces from the current chaos. None of them quite live up to the hype, though.
Oil, for instance, is a bet on a certain scenario – one where energy prices remain high or climb even higher, because of the continued absence of Russian oil and gas. This may well turn out to be the case. But a bet on energy prices could also lose money if Saudi Arabia starts pumping more crude or U.S. fracking rebounds.
Bitcoin is even riskier. Over the past year, it has sunk below US$30,000 and roared above US$60,000 before settling in around US$41,000. Crypto might be an intriguing speculation in some eyes, but it is definitely not a safe harbour.
Gold is a sturdier proposition, but it is vulnerable because of its propensity to fall during times – like now – when real interest rates (that is, interest rates after inflation) are going up. This weakness occurs because gold doesn’t pay a dividend. When rising rates are boosting yields on competing investments such as bonds, gold’s appeal tends to dwindle.
If all of this suggests to you that there is no obvious haven in sight, you’re absolutely right. However, there are some interesting hedges against what could happen next. Here are three to ponder:
Tobacco stocks: Smoking is horrible for your health, but tobacco stocks might be able to provide at least a temporary pick-me-up for worried investors.
Begin with the dividends. At current share prices, Altria Group Inc. offers a 7-per-cent yield, while Philip Morris International Inc. delivers a 5.3-per- cent payout.
In addition, the cigarette business has substantial pricing power, which means it should be able to raise prices if inflation continues to roar. Best of all, it has a history of performing well no matter what the broader economy is doing.
Lawrence Hamtil, a strategist at Fortune Financial Advisors in Kansas City, notes that U.S.-based tobacco stocks have consistently churned out positive returns for investors since 1947, with the exception of one brief period in the late 1990s when the industry was under regulatory assault. Barring an unlikely repeat of that episode, tobacco stocks should be able to soldier through whatever comes over the next couple of years.
Canadian REITs do well even as
yield curve flattens
REIT performance vs. Gov't of Canada 10-year
minus two-year bond yields
S&P/TSX Capped
REIT Index
CAD 10Y minus
2Y yield spread
180
2.90
160
2.40
140
1.90
120
1.40
100
0.90
80
0.40
60
-0.10
-0.60
2005
2007
2009
2011
2013
2015
2017
2019
2021
the globe and mail, Source: CIBC World
Markets Inc.
Canadian REITs do well even as
yield curve flattens
REIT performance vs. Gov't of Canada 10-year
minus two-year bond yields
S&P/TSX Capped
REIT Index
CAD 10Y minus
2Y yield spread
180
2.90
160
2.40
140
1.90
120
1.40
100
0.90
80
0.40
60
-0.10
-0.60
2005
2007
2009
2011
2013
2015
2017
2019
2021
the globe and mail, Source: CIBC World
Markets Inc.
Canadian REITs do well even as yield curve flattens
REIT performance vs. Gov't of Canada 10-year minus two-year bond yields
S&P/TSX Capped REIT Index
CAD 10Y minus 2Y yield spread
180
2.90
160
2.40
140
1.90
120
1.40
100
0.90
80
0.40
60
-0.10
-0.60
2005
2007
2009
2011
2013
2015
2017
2019
2021
the globe and mail, Source: CIBC World Markets Inc.
Canadian REITs: When the world is in turmoil, staying close to home is an attractive notion. So is owning a physical asset that retains its fundamental value no matter how much inflation rips.
Canadian real estate investment trusts look attractive on both scores. They own apartment buildings, industrial warehouses, offices and retail malls that produce reliable streams of income.
Perhaps most intriguingly, they tend to do well when the yield curve is flattening, as it is now, according to a report from CIBC analyst Dean Wilkinson.
The yield curve measures the yields on short-term bonds compared with longer-term bonds. A flattening yield curve is often seen as a sign of a slowing economy. But according to Mr. Wilkinson’s calculations, REITs have historically done just fine as the spread between 10-year bond yields and two-year bond yields narrows.
Rather than a slowing economy, the bigger threat to the sector would be a rapid rise in interest rates that would boost mortgage costs and make REITs’ payouts look less attractive. Mr. Wilkinson acknowledges the risk, but argues REITs will be able to take moderate rate increases in their stride, thanks to rising rents, returning office workers and new development opportunities.
Bonds: Yep, bonds. Written off for dead in recent years, fixed-income investments are now beginning to look more attractive as yields climb higher. With the yield on 10-year Government of Canada now around 2.2 per cent, bond investors are finally getting some payoff from their holdings.
Granted, today’s yields still aren’t high enough to offset the bite of inflation. However, if inflation falls over the next couple of years, as the Bank of Canada expects, bonds’ appeal will grow. At the very least, they now provide a decent hedge against the possibility that central banks will tighten too much and push the economy – and stock market – into a downturn.
The risk here is that interest rates will have to rise by a lot to tame inflation. Remember that bond prices move in the opposite direction to interest rates, so a big move higher in longer-term interest rates would hurt bond prices.
But it is questionable how much higher bond yields can go. The yield on 10-year Government of Canada bonds is now above where it stood before the pandemic and not that far from its highs of the past decade. If you’ve shunned bonds in recent years, now may be the time to start tiptoeing back in.
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Ian McGugan