One of the reasons the market has been so strong in the past few years is because of low inflation. Most economics are baffled by this: they don’t understand how inflation could be so low when employment is so high. They expect wage pressure to push up prices overall — but this is not happening.
We studied economics in university, but we don’t see the reason for the confusion. In fact, we can find dozens of reasons why inflation is so low, when we look at today versus prior decades. So, rather than worry about the why, let’s take a look at how one might get some portfolio benefit or ideas from the following low-inflation reasons:
This the most obvious example of why inflation is low. With changes to its production technology, the U.S. has gone from oil-dependent to oil-surplus in a very short period of time. With the “green” crowd shifting to alternatives, the combination has resulted in very weak oil prices. Now, with China growth concerns, oil is very unlikely to do much in the near future. Since energy impacts almost everything in the economy (think of your Amazon packages being delivered by truck), lower oil prices can have a dampening impact on prices across thousands of industries. How to get some portfolio benefit from this? Well, think of the earnings leverage that delivery companies such as CargoJet Inc. (CJT on TSX) get from lower gas prices. Or, just avoid the whole energy sector, as the rest of the world seems to be doing.
Sure, this is a bit of a circuitous argument. We have low inflation, so we have low interest rates, which can lower costs and keep inflation low. Think about it: your mortgage payment, car payments, margin interest — everything — is impacted by lower interest rates. At a government level, lower interest rates mean billions in savings on interest charges. Interest rate deductibility means interest charges on stock loans are practically free, after tax. Is it any wonder why the market is doing so well? How to benefit? Well, maybe keep your financial sector exposure in check — banks typically make more money with higher rates. Or — if you have the temperament — consider some margin. Be very careful here, of course, as borrowing money to invest can open up a whole can of worms and risks. A simpler method might be to invest in stocks such as Onex, Apollo or Blackrock: These private equity companies can do very well in times of low interest rates, by borrowing money to make deals.
Have you bought a TV recently? Not long ago, a 62-inch flat screen TV might set you back $10,000. Now, you can get one (65 inches, actually!) on Amazon for less than $800. Since every family has (at least one) TV, there is obviously an inflation-dampening impact from a price decline of more than 90 per cent. Now, price declines are not good for TV manufacturers’ stocks (though TCL Electronics shares in Hong Kong are up 25 per cent in the past year) maybe a better play here is Walmart (WMT on NYSE), where customers buying TVs these days just might have a few thousand dollars extra to spend in the store.
When one considers a smart phone these days, it is mind-boggling to see how much money it can save you, versus what you might have spent on technology a decade ago. Sure, the phone itself is expensive, and there are monthly fees. But the latter is usually offset by customers cancelling their home phone service, and the former is dwarfed by cost savings you get. Let’s take a look. Music: I used to spend thousands of dollars annually on CDs and (yes, I am old) record albums. CDs used to cost $15.99 each. Now, for the same amount monthly, I get access to 40 million songs via my Apple Music streaming service. Is it any doubt that CD-producer Cinram went bankrupt in 2012? Movies: I used to spend $15 going to the movies. Each one cost me. Now, I essentially get unlimited entertainment via Netflix, Disney and Apple for less than $20 per month. Cameras: Have you bought a camera recently? Didn’t think so. Cameras used to cost $300 or more. Now, you get a very high quality one free with your camera. Mail: When was the last time you wrote a letter? Bought a stamp? Wrote a cheque? The smart phone has resulted in thousands of dollars in cost savings by automating communication and payment options. We could go on and on here. Maps, games, even dating are far, far cheaper than they were 10 years ago, because of the capabilities of the phone today. Investment ideas here include Spotify, Alphabet, Netflix, Disney, Match and, of course, Apple.
When I first started in the investment business, it might cost you $275 to buy 500 shares of BCE. Today, you can make the same trade in Canada for less than $10. In the U.S., at most online brokers, it is completely free. There is nothing like a 100 per cent decline in prices to keep inflation low. Stock ideas here: Well, we were going to mention E-Trade, but as we were writing this article Morgan Stanley decided to take it over. Zero commissions do hurt revenue at trading companies, but every investor now gets far lower fees on buys and sells within their portfolio, and that of course can only help improve long-term investment returns.
Peter Hodson, CFA, is Founder and Head of Research of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (http://www.5iresearch.ca).