As we approach the end of Q1, I wanted to share some of my thoughts with you in plain English. I will do my best to pack in as much as I can in a simplified summary. Here we go…

We are in economic recovery and the recovery itself exceeded expectations so far. The economy has shown resilience during the second wave of COVID. Central banks and the Federal Reserve lowered interest rates to all-time lows in an effort to offset some of the devastating economic effects of lockdowns. The world is now focused on vaccination campaigns so that hopefully we can get back to “normal”.

Big picture summarized

I believe we are set for very strong economic recovery in the second half of 2021 and beyond with excess demand in some parts of the economy that have been halted over the last year. In the stock market, we saw technology and healthcare gain incredible momentum last year while other sectors lagged behind. In early 2021, tech and healthcare have been correcting as investors might be reconsidering some of those “stretched” valuations. Think Tesla for example trading at around 1,000x earnings! This year so far we have been seeing a “flight” to value stocks in anticipation of excess demand going forward as economies open up. We are always reminded of the importance of diversification and this is why I always position portfolios with a healthy mix of growth and value stocks and adequate exposure to all sectors at all times. My conviction in US equities has led to strong results in 2020 and I remain with the same stance as of now.

Strong economic recovery, all-time low interest rates, excess demand, rising value of financial assets and real estate… Sounds like a party, right? Sure, but what could excess demand lead to? Rising prices of goods and assets. What does rising prices of goods and assets mean? Inflation. This means your cash can buy you less than before since prices have gone up. We want an economic recovery but Central Banks do not want an overheating of the economy. This is when prices rise much too quickly and much faster than the wages. Healthy levels of inflation are normal so the Central Bank and the Fed have their eyes very close to this and they want to keep inflation in the healthy range of 1-3% per year. How do they do this? By raising interest rates. They do this slowly and carefully. Raising interest rates is a very sensitive lever and the idea is always to keep the economic machine running while preventing it from overheating. Here is a simplified look at how this works:

1. Low economic activity = Central Banks lower rates to keep stimulate growth
2. High economic activity = Central Banks raise rates to prevent hyperinflation

When rates are extremely low, an investor can expect lower returns from GICs and bonds as of now.

Specifically if the investor has fixed income as part of his asset mix, then the investor has two choices:

1. Keep the same level of risk and expect lower returns going forward
2. Increase equity exposure (risk) to adjust for lower rates to achieve same expected return as pre-lowering of rates

Furthermore, raising rates typically puts downward pressure on bond values. The FTSE Canadian Bond Universe Index had an incredible run in 2020 (+8.68%). YTD 2021, it has corrected (-5.37%) due to rising bond yields.

Quick word on CAD USD

For the purpose of keeping this a lighter read, I won’t go into all the variables that affect currencies. We could write a very long analysis on this topic alone. I will simply point out that a year ago around March 23 the CAD to USD exchange was at $0.69 while it is at $0.80 (+15.76%). Since we own many investments in USD, this can make your returns look lower when looking at the value of your portfolio in CAD. The same is true the other way around – when the CAD dollar goes down, this “boosts” up your returns when looking at the portfolio in CAD. While we do re-balance the portfolios systematically as values fluctuate, over the long-run it has always been beneficial to focus on the quality of the businesses we own rather than on which currency is up or down. The effects of currency will swing both ways and will average out through time.

Winners and losers

There are winners and losers in this equation. Inflation is a very real threat to cash hoarders and bond holders long-term. In my view, being too conservative is risky. Owners of solid, profitable businesses (stocks) will win as they always have, but even more so in this environment. I believe we are entering a new long-term growth cycle which will accelerate innovation and productivity and this may be an incredible time to be an investor. Opportunities are plentiful if we own the right businesses in a diversified manner.

Petrov’s bottom-line

1. Cash on the sidelines will lead to regret. It is not a viable strategy and the cash may devalue faster than previously.
2. Cash is only useful when used… To purchase goods and services or assets.
3. Especially in this environment, there are only two reasons I can think of where an investor should own bonds:
4. • Potential need for cash in the short-term
   • Investor simply does not have the stomach for being all-equity
4. To be successful with investing, one has to embrace volatility as it comes and participate in the winning side of the equation with well-selected businesses. It is more important than ever to stay focused on your goals.
5. Inflation is the threat, not market volatility.
6. Timing the market? Forget it… Your thoughts and concerns have been priced in long before they entered your mind.

Our team’s motto is “Conviction, Discipline, Patience” because those are the timeless keys to success in the world of investing.

-Alex & The Petrov Wealth Management Group