“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.” — Charles Dickens, A Tale of Two Cities
The past year harks back to Dickens’s encapsulation of the coexisting contrasts of French Revolutionary times. Markets probe new heights at the same time as government, corporate and consumer debt liabilities soar; amid growing geopolitical tension and polarization, we’ve been able to avert the worst impacts of a pandemic like never before in history; decarbonization of the global economy is gathering steam even as democratic governance is hobbled by gridlock and populism.
Understanding the current moment requires wrapping our heads around the paradox of seemingly contradictory trends.
What’s ahead
One thing we can be certain of is that interest rates are likely headed higher, which may have troubling implications for investors. Inflation has jumped to levels not seen in decades. What we’re watching now is the halting progress of 10-year bond rates. Should central banks carry through on their plans to raise overnight interest rates this year, we could end up with an inverted yield curve, often a precursor to recession.
If, conversely, bond rates rise, that would negatively affect stock and bond prices as well as real estate cap rates.
The threat of asset price declines is heightened by their current valuations, which are at the high end of their historical range by most measures. As a result, most asset managers and market researchers have very low expectations for returns in most asset classes over the next ten years. Bond returns are generally not expected to keep pace with inflation at all.
Relatively speaking, private assets such as private companies and real estate are more affordable. Nonetheless, all asset classes are more expensive than they were a few years ago. This has primarily been driven by ultra-low interest rates and quantitative easing – a form of money-printing – by central banks. So, should you sell everything, go to cash – or better yet, gold – and consider digging a moat around your home? Our brain trust at Nicola Wealth says no.
How to approach 2022
Notwithstanding the very formidable challenges facing investors, we feel there will be ways to create value in 2022. We believe that this is a time when active management will prove its worth outperforming a passive approach. Value investing will come back into style; dividends and dividend growth will matter.
Likewise in real estate, it won’t be enough to simply buy and hold (let alone flip) property. Think value-added instead – renovating buildings to increase occupancy, slow tenant turnover and sustain or increase rents. Industrial and multi-family residential will be a major focus for us. With respect to development projects, we take the approach of building to own.
The same goes for companies. Not only can we buy $1 of profits in the private markets more cheaply than in the stock market, but with the right general partners, we can help improve the growth strategies of the companies we hold and brighten their long-term profitability. And in contrast to the bond market, with its mostly negative real returns, with private debt we can obtain positive inflation-adjusted outcomes.
So yes, it’s possible to continue earning strong risk- and inflation-adjusted returns even as prices for assets soar. As Dickens had the wisdom to recognize, the world is not simply made up of either/ors, but also paradoxical ands.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. All investments contain risk and may gain or lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities commissions.