Making sense of the markets this week: December 19

Jerome Powell, the stage is yours

This week, all eyes and ears were on the U.S. Federal Reserve and the Fed chairman, Jerome Powell. The Federal Reserve, the U.S. central bank, conducted a two-day meeting on Wednesday and Thursday. On Thursday, it was announced the pace of the tapering of bond buying will double and that rate hikes are likely to begin in 2022. Power suggested we could see three rate hikes in 2022, with more to follow in 2023. 

The Fed was forced to respond to ongoing and troubling inflation in the U.S. On Monday, inflation readings showed a 6.8% increase for November, year over year. That was the greatest rate of increase in more than 40 years. It was time for Powell to get to work. One of the main tools a central bank has is to raise rates—to ultimately increase borrowing costs, and in turn cool the economy. 

The most notable line from the Powell press conference: 

“This is not the inflation we wanted.” 

It’a certainly time to act. But will the U.S. Federal Reserve take away the punch bowl? Is the stock and real estate party over, thanks to the removal of stimulus?

The markets said “party on.” Markets in the U.S., Canada and around the globe spiked on the Powell comments and the path laid out in the commentary. 

Here’s the S&P 500 (IVV) chart courtesy of Seeking Alpha. Stocks added more than 1% on December 15, as Powell gave his remarks. 

Stocks did soften at the close of the week. Traders are absorbing the rate hike agenda and the surging Omicron variant. 

The market likes certainty. And the Powell comments, and the Fed moves, came in as expected. Powell also balanced his rates outlook with a strong dose of optimism. He appears to fear inflation, but not the new Omicron variant. 

Stock market history suggests the initial period of rate hikes is not harmful to markets. That makes sense, as rates are usually increased to cool a red-hot economy. The rate hikes normally begin when things are “all-good.”

Also from this Seeking Alpha post:

That said, trouble (ahem, recessions) can often begin years after the rate hike cycle begins. As reported from Seeking Alpha:

“ ‘Since 1955, there’ve been 13 hiking cycles, and the median time from the start of the hiking cycle to the next recession is just over three years, with the earliest gap at 11 months,’ Deutsche Bank’s Jim Reid writes.”

Market history suggests there may be no immediate threat. My column from May 2021 features a table showing the returns for U.S. stocks through the rising rate environments over the last several decades. 

And, there is certainly no guarantee that the Fed will follow through with rate increases. 

“Bloomberg Surveillance” host Lisa Abramowicz was not buying the rate increase suggestion.  

On Thursday morning, Abramowicz suggested the markets are thinking “transitory” on the possibility of those rate increases. (Ha! Transitory humour.) 

Canadian economist David Rosenberg is also suspicious. Check out his tweet:

Quite possibly, the markets don’t believe Powell. When push comes to shove, the Fed will be there to reverse course and pull the plug on rate hikes. 

(For some background, read: What is a taper tantrum?)

I checked in with Greg Foss, a former credit-focused hedge fund manager. I asked how he interpreted the tepid response from the bond markets. The bond markets reacted as if it was status quo and they barely noticed. 

Foss responded via email:  

“The bond market does not believe that hikes are possible …. nor do I.” 

And he responded on a stronger U.S. dollar: 

“The strengthening of the U.S. dollar will cause all emerging markets to crater, then it will leak into the S&P, then the Fed will turn their back on those rate hikes.”

As we’ve all discovered during this pandemic, times are unpredictable, and so much could happen over the next several months. Inflation could moderate, and economic growth could slow. 

There might be no need to fight inflation or slow economic growth by way of rate increases. 

And, as has been the case for the last 21 months, the pandemic and now Omicron are the wild cards. Anything can happen. Be prepared, as always. 

The green transition will be inflationary

It will take an incredible amount of materials (commodities) to build the electric vehicles and batteries, and to create the amount of clean energy and infrastructure required to meet our net zero climate targets. I see that as a very obvious and investable trend. Global greenficiation might be the greatest political event driving the planet right now and that greenficiation will likely become the greatest economic force. 

In late November, I wrote about the greenification commodities supercycle. 

I found a few reports suggesting the greenification process will also be inflationary. On Yahoo! Finance (watch the video), Principal Global Investors’ chief strategist Seema Shah said that, as companies and countries deal with the massive infrastructure build, this could lead to an energy shortage and higher prices. She adds that we will start to see energy inflation. That’s “en-flation,” a term we’ll be seeing a lot more of in the future. And en-flation could lead to structurally higher inflation over the coming years. 

As companies strive to get to net-zero targets, many will purchase carbon credits. Those costs are expected to rise. Companies struggling to meet CO2 reductions targets will also face government levies, as more countries put a price on carbon. 

It will be expensive for those companies that do make the required investments. From that same Yahoo! Finance:

“Companies making strides to transform their business models may also face constraints on labor and Capex, which could, in turn, lead to downstream inflation for investors and consumers.”

Additional costs for companies are often passed along to consumers by way of higher prices. 

Bloomberg offered more background and sources of green inflation, reporting:  

“Hitting net-zero targets requires investment of $5 trillion a year in energy  systems by the end of the decade, more than double the average in the past five years, according to the International Energy Agency. 

“ ‘If I had to put my money on a single factor that was going to push up costs in the years to come, I would say it was the environmental emphasis and in particular the drive towards net zero,’ said Roger Bootle, founder of Capital Economics Ltd. and author of the 1996 book The Death of Inflation.”

The post offers examples of the cost of greenification. Making glass without poisoning the planet costs 20% more, and cleaner steel can be 30% more expensive. 

BlackRock CEO Larry Fink warned in the Yahoo! Finance article: 

“If our solution is entirely just to get a green world, we’re going to have much higher inflation, because we do not have the technology to do all this, yet.”

And “old oil” could also factor in. From that same post:

“How to shift the balance between sources of energy—new versus old, clean versus dirty—will play a huge role in how the transition affects growth and inflation. Major oil and gas producers are coming under increasing pressure from shareholders to cut back on drilling to make credible net zero plans, and lower supplies could push up prices for customers.”

Higher energy prices can seep into prices for anything and everything, as most companies require energy to produce products and to keep the lights on. Oil is also required for the production of many items we use every day. Boston Consulting Group and the World Economic Forum found that greenificion would add 1% to 4% to end-consumer costs in the medium term, according to the article. 

There is the expectation that a virtuous cycle of innovation and adoption of greener ways will eventually bring down costs. Technological advancements are known to be deflationary. 

Bloomberg reports: 

“In the case of electric cars, BloombergNEF estimates they’ll reach price parity with internal combustion vehicles starting in 2025. Falling prices are already being seen in some areas, such as solar power, which is down more than 90% in the past decade.” 

Of course, no one knows how long it might take for technology and innovation to tame any inflation that might be a byproduct of the greenification cycle. We’ve seen how the transitory inflation call has turned out in 2021. We’re in “transitory for longer,” and now the phrase “transitory inflation” has been scrubbed from the central banks’ song sheets. 

Economics is a tricky business. 

I feel the greenification commodities super cycle hedge might do the trick with respect to the greater trend of green inflation. And simply owning stocks passing along those higher prices can help. In the advanced couch potato models you’ll also find a commodities/real asset ETF. 

For the greenification commodities super cycle you can look to the VanEck green metals ETF (GMET). That is a U.S. dollar ETF. I still like my BATT ETF, and will keep adding to that investment. Keep in mind that BATT is also a U.S.-listed ETF. I’ve also started a position in Horizons HLIT that holds global lithium producers. 

The world runs on chips (semiconductors). Given that, I also started a position in Horizons CHPS. You might hold energy producer stocks and ETFs as well. I will keep adding to those ETFs. 

This future-themed basket might offer very good long-term growth prospects and an inflation hedge. I will keep you posted on this portfolio effort, holdings and returns. 

Things are looking up for the REITs  

The challenges for the real estate investment trust (REIT) sector has been a common theme in this column throughout the pandemic. This modern day pandemic changed the way we work and live. We stopped going into the office, we stopped going to malls, retirement residences were strained, and it all affected landlords across the board. 

REITs had a trying year in 2020, the first year of the pandemic. The iShares REIT index ETF (XRE) was down by 13.60% in 2020. 

REITs more than bounced back in 2021. And 2022 might be setting up for a repeat according to this 2022 Global Real Estate outlook from Hazelton. The report suggests global REITs are positioned to serve as an inflation hedging asset class that will benefit from next year’s ongoing economic recovery and sustained inflation. 

The target total return for global REITs in 2022 is 12% to 15%. They see opportunity in industrial facilities in North America, data centres in Asia, the U.S. residential sector, European office REITs, and cell towers. The Hazelton report is very good with interesting charts and tables. It makes a good case for REITs in 2022. And, I am always a proponent of REIT exposure for a balanced portfolio. 

I had the pleasure of a video chat with Lee Goldman at CI Global Asset Management. Goldman (along with Kate MacDonald and Chris Couprie) runs CI’s actively-managed REIT ETF (RIT). It is Canada’s best-performing REIT ETF and can be more nimble and diversified, compared to the Canadian passive benchmark ETFs that have the bulk of assets concentrated in just a few holdings. RIT holds 35 names.  

Goldman shares the optimism seen in the Hazelton report. He’s expecting strong earnings growth in 2022. And he is seeking value and has recently added to Chartwell (a seniors retirement residence REIT) and America Hotels Income Properties. Goldman is also not shying away from retail REITs and says, even in the hybrid work-from-home and work-from-the-office hybrid future, there is a place for the right office and mixed space REITs. 

Goldman adds that REITs can be a very good inflation hedge, due to the fact that as the greater real estate sector inflates, the existing REIT properties become more valuable. REITs can also adjust their rent levels, and many REITs will write in step-up provisions, with rent adjusted to the rate of inflation. 

Many consider REITs a portfolio staple for the added diversification, yield and that inflation hedge. 

Apple, the $3 trillion question  

Apple is looking to become the first US$3-trillion company by market cap. The company continues to reinvent itself and grow several business lines. 

Apple’s market value first crossed the US$1-trillion threshold in August 2018 and it passed US$2 trillion in August 2020. The stock needs to hit $182.85 for Apple to surpass the US$3-trillion mark. 

In August of 2021, I looked at Apple’s 10 years under CEO Tim Cook. It’s an incredible story and an incredible company. 

From CNN’s Paul R. La Monica:  

“Sales surged nearly 30% to more than US$83 billion in Apple’s most recent quarter, which ended in September. The company has a whopping US$191 billion in cash as well.”

Also in the race to The US$3-trillion Club, according to the same CNN article:

“Microsoft (MSFT) is now worth about US$2.6 trillion and Google owner Alphabet’s (GOOG) market value is right around US$2 trillion. Still giant but further behind are Amazon (AMZN), which has a market cap of US$1.7 trillion, and Elon Musk’s Tesla (TSLA), worth US$1 trillion.”

On Monday shares of Apple (AAPL) were up about 1% in premarket at $181.75. The stock fell short on Monday. In live trading, the price hit a high of $181.65, falling short of $182.85. 

The stock price dipped into Tuesday and Wednesday. Apple gave it a go on Wednesday, after the Powell remarks moved the markets. But again, Apple couldn’t keep up for the US$3-trillion fight. 

On Friday, the decline continued for Apple as well as the tech sector. Maybe we’ll see the first US$3-trillion company next week. Or, perhaps Apple will reach the milestone in 2022. 

Dale Roberts is a proponent of low-fee investing and he blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodg for market updates and commentary, every morning.

About Dale Roberts

Dale Roberts is a former investment advisor and proponent of low-fee investing. He created the Cut The Crap Investing blog in 2018. Find him on Twitter for market updates and commentary, every day.

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