Hello and welcome to The Download. I'm your host, Dave Richardson. And I'm joined by one of your favorites, Vice President and Head of Investment Solutions, Sarah Riopelle, at RBC Global Asset Management, I should mention. Sarah, great to see you.
Thanks for having me again.
So, Sarah, we've been talking a lot over the last couple of weeks on this podcast about inflation. It's in the news. People are seeing it in terms of their own pockets with price of things like lumber, gasoline, housing prices, certainly across Canada and the United States. The most recent inflation numbers coming out of the US suggest that we are seeing a pretty significant uptick in numbers around that measure inflation. So, what's your view on inflation? And is this something that the average investor should be concerned about?
That's a great question, because inflation is certainly top of mind for many. The combination of significant easing and monetary policy, central banks willingness to accept faster inflation and historically high sovereign debt loads has investors concerned that inflation could run too hot. So certainly, readings have trended higher over the past few quarters. Some prices are rising off of a low base. Things like gasoline, hotels, airfares, as those prices plunged during the pandemic. But for some other goods like housing, as you mentioned, and lumber, used cars, prices are hitting new highs due to unprecedented demand and supply constraints. So, what's caught the attention of many investors is the fact that some market-based measures of inflation expectations have been rising. It's normal for inflation to be low coming out of a recession. Just out of a recession, unemployment is high, pricing power is limited, and then, as the economic recovery takes hold, inflation tends to rise on the back of monetary and/or fiscal stimulus and pent-up demand. So, in the cycle that we are in, we've had to consider that central banks have printed a great deal of money. The Fed has communicated a new goal of inflation averaging 2%, meaning that it may allow inflation to temporarily run above that level to make up for that time that we spent below that target over the last several quarters. So, there's a possibility that some countries are going to try to erode that staggering public debt level that they have by allowing for some additional inflation. So, it's not going to be unusual to see inflation numbers running a little bit higher over the near term. The risk is there, but I think it's important to think about things in the longer-term context. Inflation expectations have risen, but they remain in line with the norm of the past decade. And although aggressive monetary and fiscal policy could trigger price increases in the near term, our view continues to be that any inflation spike likely settles back to reasonable levels over the long term. So, I guess the bottom line is, yes, prices are indeed rising. Some of this is due to low base effects. We think that the spike is likely transitory and longer-term inflation expectations are in line with levels of the past decade.
Yes, and I think it's really important to point out at this stage— because there's so many headlines and you see the word «inflation» and it's always viewed in a negative way (inflation is going up, there's inflation!)— but some inflation is actually a good thing. To have prices going up a little bit over time and to have the expectations that prices are going to go up a little bit over time, makes people go out and spend money. It makes people make decisions around spending, businesses make decisions around spending, because if you thought prices were going to go down, you'd delay that decision. So ultimately, you need a little bit of inflation. Where we get into trouble is when inflation gets too high and prices are going up in huge amounts, which makes it hard to forecast what the price is going to be in the short and long term. I just wanted to get that down, because we've been talking about inflation a lot on this podcast and I always hear from investors and they always come at inflation from a purely negative perspective, when, again, a little bit of inflation is actually something we need to continue to grow the economy. Having said that and with your view on inflation, how does that connect to investor portfolios and different risk levels?
Well, if you know me at all, you know that I'm going to make a reference to being diversified, because that's always my go-to response. Higher inflation is not always bad for your portfolio as long as you are well diversified. Near-term rising inflation will have an impact on asset prices and valuations. In particular, rising inflation will push bond yields higher and bond prices lower and put pressure on equity market valuations. Looking at the fixed income side of the portfolio, inflation threatens fixed-income assets because rising prices erode the future purchasing power of those fixed cash flows. So, in an environment of sustainably high inflation, investors would likely demand higher yields on bonds to compensate for that expected loss in purchasing power that they're seeing. Investors can dampen the impact of inflation and rising rates by diversifying their exposure into bonds with a variety of characteristics, including shorter maturities, higher risk, higher credit to allocations, and then global and alternative strategies as well. This is going to be particularly important for more conservative investors who have a higher allocation to bonds within their portfolios. So, diversified exposure within fixed income can help to mitigate some of those concerns around higher inflation over the near term. For equities, higher inflation may weigh on valuations, but better growth and more pricing power could boost corporate revenues and ultimately profits over the long term. So that goes back to the point that you just made about inflation not necessarily being a bad thing. Equities have historically generated returns that exceed inflation, which helps with capital preservation, so that's a reason for holding equities within a multi-asset portfolio. Inflation will not be the same in all countries and regions, so diversifying your exposure will help to mitigate the impact of that on your portfolio. So diversifying equities amongst regions is going to be beneficial as well. In addition to region, you can diversify your exposure to include equities with ties to commodity prices which are rising, to real estate which we talked about, housing prices or those with the ability to pass on price increases to their customers can help. So, consumer sectors that maybe have more pricing power. At the end of the day, investing success is about preparing your portfolio for a wide range of outcomes, both good and bad, inflation being a good example of that. And then also focusing on the long term and being well diversified is a great way for investors to protect their portfolios from potential risks such as rising inflation.
Well, I think after that, Sarah, we should rename this podcast the Diversifier, as opposed to the Download. All the guests that we've had on are such huge proponents of diversification, whether you're a very small investor just starting out or a large investor. And at any age, that diversification is such an important part of effectively managing through different economic environments, different inflation environments, and having a portfolio that can withstand and hold up to the test of time and reach your long-term financial goals. And that's why we love to have you on, because you're never off message on diversification.
Well, I'm definitely consistent.
Absolutely. And the one thing I lied about is, there is bad inflation. That's why this is an audio podcast. So people can't see my pandemic inflation both on the top of my head and in my big squirrely cheeks here. That’s the bad inflation. So fortunately, people don't have to look at that.
Well, thank you for that.
Sarah, thank you so much.
Thank you for your time today. And we'll talk to you soon.
Great. Thank you.