Chalten Investment Review – Q2 2021

Welcome to the Chalten Investment Review for Q2 2021.  Investors were again well rewarded for taking risk as global equities continued the strong performance observed in Q1.  Bonds also performed reasonably well over Q2, clawing back some of the negative returns suffered in Q1.  Publicly traded real estate securities also performed strongly. 

Investors often feel uncomfortable during times of market unrest, often fueled by incendiary market commentary!  However, investors also can develop anxiety during good market stretches.  “Where is the next risk coming from?”  “What if we see another wave of COVID in the fall?”  One common question we have fielded from investors is about the potential risk of inflation stemming from economic recovery, government stimulus and generally loose central bank monetary policy.   We think it is a fair concern.  The US Labour department just reported that the US consumer price index increased 5.4% in June from a year ago, the highest 12-month rate of change since 2008.    In May, Statistics Canada reported year on year inflation of 3.6%, the highest rate in nearly a decade.  Should we be concerned, especially as governments and central banks seem to continue to be willing to fund recovery as we emerge from the COVID-19 crisis?   On the other hand, shouldn’t we expect at least some price dislocation given what economies around the world went through over the last 18 months?  Is there evidence or indicators that might help us?

After the 2008/2009 financial crisis investors had similar concerns.  Would loose fiscal and monetary policy lead to inflation and what should investors do?   At the time, one could have looked to the market to provide some potential answers.   The US government bond market is quite helpful in this regard as there are liquid markets for both nominal and inflation-protected treasury bonds of various maturities.  The difference between the yields of a 10 year treasury bond and a 10 year “real” or inflation-protected treasury bond should in theory give us the market’s prediction for what inflation is expected to be over the following 10 years.  For example, that difference (or spread) at June 30 2009 was 1.75%.  And – actual inflation over the subsequent 10 years?  About exactly that!   When we look at the spread as at June 30, 2021, we observe 10-year implied inflation of about 2.3%.   This is lower than current inflation so perhaps the market is telling us that currently high rates are simply transitory as we emerge from COVID related economic dislocation. 

What if we don’t believe the market or want to prepare our portfolios for inflation anyway?   A recent interview between David Booth (founder of Dimensional Fund Advisors) and Eugene Fama (University of Chicago Depart of Economics Distinguished Professor and Nobel laureate) is helpful:


Booth: Conditions change, so is there anything about the current environment and the risk of inflation heating up that would cause you to change your portfolio?

Fama: I don’t think anybody predicts the market very well.  Market timing is risky in the sense that you’ve always emphasized: You may be out of the stock market at precisely the time when it generates its biggest returns. The nature of the stock market is you get a lot of the return in very short periods of time.  So, you basically don’t want to be out for short periods of time, where you may actually be missing a good part of the return.

I think you take a long-term perspective. You decide how much risk you’re willing to take, and then you choose a mix of bonds, stocks, Treasury Inflation-Protected Securities, and whatever else satisfies your long-term goals. And you forget about the short term. Maybe you rebalance occasionally because the weights can get out of whack, but you don’t try to time the market in any way, shape, or form.  It’s a losing proposition.

Booth: As you get to the point in life where you actually need to use your portfolio, does that change the kinds of allocations you’d want?

Fama:  The classic answer to that was, yes, you’d shift more toward short-term hedges, short-term bonds.  Once you had enough accumulated wealth that you thought you could make it through retirement, you’d want to hedge away any uncertainty that might disturb that.  That’s a matter of taste and your willingness to take risk and your plans for the people you will leave behind.  All of that will influence how you make that decision.  But the typical person who thinks they’ll spend all their money before they die probably wants to move into less risky stuff as they approach retirement.

Booth: The notion of risk is pretty fuzzy.  For example, if I decide that I want to hold Treasury bills or CDs when I retire, and you did that 40 years ago, when we started the firm, and you’ve got that 15% coupon, that’s pretty exciting.  With $1 million at 15%, you’re getting $150,000 a year.  Today you might get less than 1%.

Fama:  Right, but I remember when inflation was running at about 15%, so not much better off!

Booth: Those are different kinds of risks.

Fama: When you approach retirement, you’re basically concerned about what your real wealth will look like over the period of your retirement, and you have some incentives to hedge against that.  You face the possibility, for example, that if you invest in stocks, you have a higher expected return, but you may lose 30% in a year and that might be devastating for your long-term consumption.

Booth: I think part of planning is not only your investment portfolio, but what to do if you experience unexpected events of any kind.  We’re kind of back to where we start our usual conversation: “Control what you can control.”  You can’t control markets.  What you can do is prepare yourself for what you’ll do in case bad events happen.  Inflation is just one of many risk factors long-term investors need to be prepared for.

Q1 Market Review    

In the US, indicators for employment, economic growth, industrial production and confidence were all robust.  An infrastructure spending deal was agreed and the Federal Reserve made no policy changes but hinted that rates may need to rise by 2023.  In Canada, while lockdown measures have lingered, all provinces are starting to open up, vaccine progress has been steady, and economic growth is expected to be robust for 2021 as a whole and continue into 2022. 

In Europe, corporate earnings showed signs of strengthening and vaccine rollout plans have improved.  The EU also launched its Next Generation EU Fund to assist nations with their recovery efforts.  In Asia, the Japanese stock market was one of the only regional markets to post a loss for the quarter while non-Japan Asia performed better.  Emerging markets’ stronger outlook for economic growth was reflected positively in stock market performance.  

In most markets, smaller stocks and stocks with cheaper valuations (value stocks) underperformed in June which adversely impacted relative performance for the quarter but returns were still strong on an absolute basis and small cap value continues to outperform year-to-date.   

Within the bond markets, yields actually dropped in the US and Canada but were marginally higher in Europe.   The Canadian dollar gained again compared to the US dollar over the quarter.

  • The total return on the Canadian stock market was 8.5% for Q2 2021.
  • In the US, the total net return of the S&P500 in Canadian dollar terms was 4.9 % for Q2.
  • The total net return for the S&P Global ex-US BMI Index of stocks outside of the US (in Canadian dollar terms) was 4.1% for Q2.
  • The Canadian dollar gained 1.46% against the US dollar over the quarter.
  • Total return for Canadian bonds was 1.6% over the quarter, marginally worse than US bonds but better than international developed market bonds. Emerging Market bonds rebounded positively over the quarter.    

Financial Planning topics of interest

The federal budget was announced April 19.  As promised, the federal government looks to be doing “whatever it takes” to support economic growth through the pandemic recovery with a record $101 billion of stimulus. 

What the budget didn’t do was introduce any of the most feared potential tax measures such as increasing the capital gains inclusion rate, revisiting the primary residence exemption or imposing a wealth tax.  No such measures were even proposed and federal personal and corporate tax rates remained unchanged.  

Some measures worth noting:

  • Childcare does remain a high priority with $10 per day daycare targeted for 2026.
  • Pandemic relief measures seem mainly aimed at businesses, with incentives to hire and help to stay afloat, although workers can benefit from extension of the CRB relief program by 12 weeks for those facing the end of existing CRB benefits.
  • OAS – those who will be 75 as of June 2022 will receive a one-off payment of $500 in August 2021. OAS benefits for everyone 75 and older will increase by 10% starting in July of 2022.
  • Student loan interest will be waived for another year.
  • Luxury tax – if you are thinking of purchasing a car (or aircraft for that matter) for more than $100,000, best to do so before January 1, 2022 when a luxury tax of the lesser of 10% on the purchase value or 20% of the value over $100,000 will be imposed. There is a higher threshold for luxury tax on boats.


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