Chalten Investment Review – Q3 2021

Welcome to the Chalten Investment Review for Q3 2021.  

Inflation perspiration?

In the Chalten Review for Q2, we focused on inflation and how investors might think about inflation with respect to their investments.  As usual, we like to look to see if the market is telling us anything about inflation and noted specifically that US Treasury market yields were implying that investors should expect inflation to average about 2.3% per year over the next 10 years.   Specifically the spread between the 10-year nominal yield and the 10-year real yield was 2.3%.  That yield spread (as at the time of writing) has widened to 2.5%, an increase but nothing too alarming.  In Canada, the Consumer Price Index has increased at an average compound rate of 3.6% over the last 40 years.   On average most major asset classes performed better than inflation over that same time frame including Canadian 30 Day Treasury bills (5.3%), Canadian Aggregate Bond Index (8.5%), Canadian stocks (8.7%), International developed market stocks (9.3%) and US stocks (12.0%).  But what about over shorter time periods or when inflation is unexpectedly high?  Inflation is difficult to predict in the short run and there is no clear rule about how stocks will behave under such conditions.   For example, during the years 1973-1975 Canadian inflation shot up (average 10.5% over those three years) and average Canadian stock performance was -4.2% over the same time period.   From 1979-1981 inflation also shot up (average 11.1% over those three years) and average Canadian stock performance was +19.1%.  In the US, inflation in 1974 was 12.3% while the S&P500 returned -26.5%.  In 1980 inflation was 12.5% yet the S&P500 returned 32.4%.  Gold and commodities are also quite volatile and it is difficult to say they provide an adequate inflation hedge over the short or long run.  2021 year to date provides a good example.  So far this year, while inflation concerns have been rising, the S&P500 is up 16% (in USD terms through September 30) while the S&PGSCI commodity index is up 37% and gold is down -7%. 

Over the short-term, inflation is difficult to predict and so is the response of the stock market.  Over the long-run you should feel comfortable that a balanced portfolio of stocks and bonds, whether weighted towards stocks or bonds, will protect you against inflation.   Control what you can control!

Haunted by all-time high?

“Even if I’m not worried by inflation, there are lots of bad things happening and the market is at an all-time high!”  The reality is that the market very frequently hits an all-time high.  There have been thousands of all-time highs over the course of the stock market’s history.  In fact, the S&P500 hit 19 all-time highs just during Q3 2021 alone!  While “All time high” makes for great headlines and the financial press and financial sales people try their best to get you to trade in order to “get the good and avoid the bad”  The reality is nicely captured in a quote from investor Tom Lewis:

“The American stock market is similar to watching a person walk up the stairs with a yo-yo. People focus on the yo-yo going up and down, while the real story is the consistent movement of the person up the stairs.”

The evidence seems to support this.  Over its history since 1927, 80% of the time the S&P500 has hit an all-time high, the index has been higher one, three and five years later.  One year after hitting an all-time high, on average the index’s return is 13.9%, three years later average annual returns have been 10.5% and five years after average annual returns have been 9.9%, all fairly close to the long-term average of about 10% per year. 

What about after a crash from an all-time high?  The results are not that much different.  After a 25% retreat from an all-time high investors experienced on average 11.5% after one year, average of 9.9% after three years and 9.6% after five years.  

Therefore, whether we are at an all-time high, or have just experienced a severe downturn from an all-time high, our expectations for future returns should not be that much different, even if it does not feel that way at the time!   Market timing is too difficult – ignore the yo-yo!   

Q3 Market Review    

In the US, corporate earnings were robust, however inflation and growth concerns resurfaced in September and the Federal Reserve indicated that details of quantitative easing tapering would be announced in November.  The market now seems to expect more frequent rate hikes going forward than previously expected.  In Canada, the election on September 20 resulted in another minority government.  Summer re-openings seemed to spur economic growth, however fears of further COVID-19 waves have resulted in most restrictions being held in place. 

In Europe, corporate earnings again showed signs of strengthening and in Asia, similar trends emerged in Japan while China’s economic outlook and financial markets were marred by concerns that the massive Evergrande property group was failing.  These concerns impacted investor sentiment across the region.  Emerging markets’ weaker performance may have reflected concerns over growing global supply chain issues.  

The performance of smaller stocks and stocks with cheaper valuations (value stocks) were mixed by region relative to market capitalization weighted benchmarks.   

Within the bond markets, yields and bond returns were relatively flat in developed markets while emerging market bond yields rose and prices fell.   The Canadian dollar weakened compared to the US dollar over the quarter.

  • The total return on the Canadian stock market was 0.2% for Q3 2021. 
  • In the US, the total net return of the S&P500 in Canadian dollar terms was 3.3% for Q3.
  • The total net return for the S&P Global ex-US BMI Index of stocks outside of the US (in Canadian dollar terms) was 0.3% for Q3. 
  • The Canadian dollar retreated -2.7% against the US dollar over the quarter.
  • Total return for Canadian bonds was -0.5% over the quarter, underperforming both US and international developed market bonds.  Emerging Market bond performance was negative over the quarter.   

Financial Planning topics of interest

As we approach the end of the year there are few things worth noting:  

  • RRSP contributions:  RRSP contributions to be deducted against 2021 income can be made up until March 1 2022.  However, if you are contemplating a contribution to a spousal RRSP you might consider doing it before the end of the calendar year, especially if you think you might begin withdrawals sometime in the next few years.  Recall that spousal RRSP contributions are subject to a three-year attribution rule.  A December 2021 contribution would avoid attribution if withdrawn at the beginning of 2024 (just over two years) while a January 2022 contribution would have to wait until January 2025 for withdrawal to avoid attribution.  
  • RESP contributions are subject to calendar year restrictions, unlike RRSP contributions which can be made until March 1.
  • TFSA withdrawals made between now and the end of the year can be re-contributed in January 2022 whereas you will have to wait until January 2023 to re-contribute withdrawals made in January 2021.
  • While markets have generally gone up so far in 2021 remember that investments in a loss position sold before the end of the year can be used to offset realized gains from this year, any of the three preceding tax years, or carried forward indefinitely.  


In closing, we remind investors again of the importance of a long-term plan that considers many potential risks and that will ultimately help them to both reach their financial goals and sleep at night!