By Julie Cazzin with Amar Pandya
Q: I think the economic tide has changed and this period of higher-than-average interest rates is here to stay. What types of investments, and which investment strategies, historically do well during these economic times? — Domenic M.
FP Answers: Domenic, you may be right about anticipating a period of higher-than-average interest rates though it helps to put the term “high” in historical context. Back in the 1970s, due to exogenous shocks such as the Organization of the Petroleum Exporting Countries’ oil embargo and global food shortages, inflation shot up, doubling to 10 per cent within a decade and hitting a peak of 12.9 per cent in 1981. To try to tamp down inflation, the Bank of Canada lifted interest rates to a high of 21 per cent at one point.
The world’s central banks are in a tricky spot: Do they allow inflation to run hot (above the two-per-cent target) with the risk of entrenching higher inflation in the economy, or do they keep raising interest rates to crush inflation and potentially trigger a recession?
For investors, the past 35 years of benign inflation have been a tailwind for most types of assets, including equities, bonds and real estate. Portfolios constructed during this disinflationary period may not be inflation-proofed for the new reality. For example, during 2022, bonds, which are usually considered as being lower risk and less volatile than stocks, became highly volatile and generated significant losses as interest rates rose. Rising inflation is also a headwind for equities.Historically, there have been investment strategies that outperform in a higher rate environment. These have included international stocks, commodities and certain kinds of real estate. Some may even consider cash in this bucket since rising interest rates are reflected in higher nominal returns for guaranteed investment certificates (GICs) and other term deposits.
Two investment strategies to consider with the aim of generating positive real returns are merger arbitrage and small-cap funds.
Merger arbitrage (sometimes called risk arbitrage) involves purchasing shares of a company targeted in a merger or acquisition. There is usually a price gap between the price offered by the suitor and the current price due to the risk of the deal not closing. A merger arbitrage strategy involves collecting the difference, or spread, between the offer/closing price and the current market price.
An allocation to this strategy would fit into the fixed-income portion of a balanced portfolio. Because merger arbitrage has a low correlation to bonds (and equities), it is a good diversifier in any portfolio. Another advantage is its tax efficiency because returns are taxed as capital gains, not interest income.
Small-cap stocks are another potential beneficiary of higher rates for several reasons. Smaller companies do not use as much leverage as larger ones, so they are less likely to be holding costly debt that becomes more expensive to manage as interest rates rise. They also tend to have higher growth rates and, while they can have larger drawdowns during a correction, they also tend to outperform in the aftermath.
Currently, the valuation gap between large-cap and small-cap companies is at a historical peak, which also bodes well for future returns for small caps. Small caps, comprising anywhere from five per cent to 30 per cent of the equity portion of a portfolio, could provide inflation-adjusted real returns over the long term.
As inflation remains sticky, investors should re-evaluate whether a traditional allocation to stocks and bonds (60/40) is still the best strategy for generating positive real returns and maintaining purchasing power over the long term.
Amar Pandya, CFA, is a portfolio manager of the Pender Alternative Arbitrage Fund, Pender Alternative Arbitrage Plus Fund, and Pender Alternative Special Situations Fund.
NEW YORK (AP) — Shares of Tesla soared Wednesday as investors bet that the electric vehicle maker and its CEO Elon Musk will benefit from Donald Trump’s return to the White House.
Tesla stands to make significant gains under a Trump administration with the threat of diminished subsidies for alternative energy and electric vehicles doing the most harm to smaller competitors. Trump’s plans for extensive tariffs on Chinese imports make it less likely that Chinese EVs will be sold in bulk in the U.S. anytime soon.
“Tesla has the scale and scope that is unmatched,” said Wedbush analyst Dan Ives, in a note to investors. “This dynamic could give Musk and Tesla a clear competitive advantage in a non-EV subsidy environment, coupled by likely higher China tariffs that would continue to push away cheaper Chinese EV players.”
Tesla shares jumped 14.8% Wednesday while shares of rival electric vehicle makers tumbled. Nio, based in Shanghai, fell 5.3%. Shares of electric truck maker Rivian dropped 8.3% and Lucid Group fell 5.3%.
Tesla dominates sales of electric vehicles in the U.S, with 48.9% in market share through the middle of 2024, according to the U.S. Energy Information Administration.
Subsidies for clean energy are part of the Inflation Reduction Act, signed into law by President Joe Biden in 2022. It included tax credits for manufacturing, along with tax credits for consumers of electric vehicles.
Musk was one of Trump’s biggest donors, spending at least $119 million mobilizing Trump’s supporters to back the Republican nominee. He also pledged to give away $1 million a day to voters signing a petition for his political action committee.
In some ways, it has been a rocky year for Tesla, with sales and profit declining through the first half of the year. Profit did rise 17.3% in the third quarter.
The U.S. opened an investigation into the company’s “Full Self-Driving” system after reports of crashes in low-visibility conditions, including one that killed a pedestrian. The investigation covers roughly 2.4 million Teslas from the 2016 through 2024 model years.
And investors sent company shares tumbling last month after Tesla unveiled its long-awaited robotaxi at a Hollywood studio Thursday night, seeing not much progress at Tesla on autonomous vehicles while other companies have been making notable progress.
Tesla began selling the software, which is called “Full Self-Driving,” nine years ago. But there are doubts about its reliability.
The stock is now showing a 16.1% gain for the year after rising the past two days.
The Canadian Press. All rights reserved.
TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.
The S&P/TSX composite index was up 103.40 points at 24,542.48.
In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.
The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.
The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.
The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.
This report by The Canadian Press was first published Oct. 16, 2024.
Companies in this story: (TSX:GSPTSE, TSX:CADUSD)
The Canadian Press. All rights reserved.
TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.
The S&P/TSX composite index was up 205.86 points at 24,508.12.
In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.
The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.
The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.
The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.
This report by The Canadian Press was first published Oct. 11, 2024.
Companies in this story: (TSX:GSPTSE, TSX:CADUSD)
The Canadian Press. All rights reserved.
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