The Schultz Group - ScotiaMcLeod Peterborough

 

 

There seems to be no doubt that we are headed for harder economic times here in North America.  Harder economic times can unfold differently; anticipating how they can be expected to unfold allows us to keep our eye on the ball as investors.

 

No one has a crystal ball, least of all me.  But I do have some views about where I think we are most likely headed, and what we can do to protect ourselves and potentially benefit from what is expected to unfold.

 

My view remains that North America is going through a period of “stagflation”.  Stagflation is characterized by both a weak economy (usually intermittent recessions and short periods of shallow growth) and increasing price pressures (rising inflation).

 

Stagflation is particularly difficult for the monetary officials to deal with.  Classically, central banks cut interest rates and increase the money supply when they expect weakening growth and weakening price pressures.  They raise interest rates and try to lower the money supply when they expect stronger growth and rising inflation.  But when they expect a weaker economy and rising inflation – that paralyzes them.  And that is where the Bank of Canada, the Federal Reserve Board of the USA, and the Bank of England find themselves now – “on hold” because price pressures are increasing even as the economy is weakening.

 

A stagflationary environment is a difficult one for investors as well, but not a hopeless one.  It tends to be a volatile period, so of course being balanced is ever so important.  There is a temptation, when “depression” fears are predominant, to go to all to cash, but with inflation, cash is actually falling in value.   

 

The high volatility means that “timing,” which is a disparaged art during periods of sustained growth and price stability like we experienced in the 80’s and 90’s, becomes important.  And picking the areas where investment and opportunity will be strongest is also important – there is no rising tide to lift all boats.

 

The last extended period of stagflation was in the 1970’s.  It was a period when America, the UK, and France were experiencing a decline in economic power relative to Japan and Germany, which were on the rise at the time, and the OPEC nations.  Similarly today, America, Western Europe, and Japan are experiencing a decline relative to the “emerging-market” nations like Brazil and India, the oil exporting nations, and resource-rich first world nations like Canada, Norway, and Australia.

 

I see many other similarities to the 70’s, as well as some key differences.  But the 70’s experience is a good starting point for some ideas as to what sectors are most likely to prosper over the next few years – and we will want to make sure we do not get shaken out of good investments in those sectors as the market inevitably swings from greed to panic to relief to greed to panic.  In addition, we can simply look for investments in businesses which will survive or even prosper if the economy goes into recession, but can also survive or even benefit from rising prices (think pricing power) and/or rising interest rates (think strong balance sheet).

 

The great thing about investing with a stagflationary compass is that if a more extreme outcome develops – extreme inflation or extreme economic slowdown, you will have chosen an investment that will be buffered from the negative effects.

 

In future “Musings” I will be writing more about why I think “Stagflation” is the most likely outlook, and some of the areas where that view leads me to look for opportunities.