Summary: Short-Term Pain for Long-Term Gain
Sacrifice is a requirement for making progress in life. In order to save for the future, you must sacrifice your consumption now. In order to learn to speak a new language or to play a musical instrument, you must sacrifice time relaxing. In order to be healthy, you must sacrifice the temporary pleasure of eating whatever you want all the time. Essentially, there must be short-term pain for long-term gain.
2022 has similarly been a year of sacrifice. Here are a few events that, while painful in the moment, I believe will be viewed as positive developments in the future.
Rising yields are causing bonds to have their worst year on record.
It’s rare that the word “unprecedented” can earnestly be used when it comes to the financial markets, but it’s fitting for bond prices in 2022. After failing to properly characterize the risk of inflation last year and overstimulating the economy, central banks have been aggressive in hiking interest rates to quell the problem of rising prices as quickly as possible. In response to the rate hikes, the yield for the Canadian bond universe rose from 2.4% in the spring of 2022 to 4.3% as of mid-October. Bond prices and yields move inversely, and this spike in rates has the Canadian bond universe index down about 14% year-to-date. With yields starting from such a low point and facing an inflationary economic slowdown, bonds have offered nothing in the way of security in 2022.
Despite the pain felt this year, higher yields going forward are good for fixed income investors. When yields are extremely low, as they have been for years, bonds provide little in the way of income. Longer-dated bonds, which are more impacted by rising and falling interest rates, display equity-like volatility with rates near the zero bound (this combination of low yields and high volatility is why long-term bonds have been given the label of “return-free risk” this year). Now, the script has been flipped. Debt isn’t being issued for free anymore. Bondholders are again being compensated in the form of higher yields.
Once inflation falls to long-run historic averages, fixed income should deliver a positive real return (a return higher than the rate of inflation). Fixed income is traditionally included in portfolios to provide current income as well as diversification from equities. It delivered neither so far in 2022; it should deliver both moving forward.
Supply chain disruptions caused widespread damage to the global economy.
Remember when the Ever Given got stuck in the Suez Canal? This image encapsulated what a mess global supply chains had become:
Granted, a massive container ship could have gotten stuck in a major throughfare at any time, but of course it had to happen when supply chains were strained to the point of breaking.
We’re still feeling the effects of Covid-linked supply chain disruptions. New vehicles are being delivered on a 6- to 8-month lag, and many cars that were purchased over the past couple of years are missing some of the features that we’ve grown accustomed to (garage door openers, automatic tailgates) because of semiconductor shortages. Canadian auto factories have inventories of finished vehicles that can’t be sold because they’re missing requisite semiconductors.
Inefficiencies in port cities were also exposed. Many began to question why the United States didn’t adhere to standards present in most countries and unload ships 24 hours a day. Ships sat in ports for days at a time waiting to offload their cargo. Delays led to scarcity, which contributed to higher shipping costs. These costs were passed onto consumers and pushed inflation higher.
These supply chain problems highlighted just how delicate our system was. Now, measures are being made to address the problems. The logistics of overcrowded, inefficient ports are being revised, and countries are investing in excess capacity. A delicate supply chain may have hurt the global economy, but efforts to avoid these problems occurring again in the future have motivated long overdue actions to find solutions.
Russia’s invasion of Ukraine sparked an energy cost crisis.
I don’t need to quote statistics about rising costs for fossil fuels. It’s clear enough when you fill up your vehicle or pay your natural gas bill. The problem is even more acute in Western Europe; prior to the start of the war, the EU received 40% of its gas from Russia. Through the EU’s own sanctions and Russia’s retaliatory supply cuts to the EU, the amount of natural gas flowing to countries like Italy and Germany has dropped off precipitously. This happened at a time when demand for natural gas was rebounding as Covid-19 restrictions were being lifted. In late August, natural gas futures were trading at levels about twelve times higher than those seen at the same time a year prior.
The humanitarian crisis in Ukraine is nothing but a tragedy. But Russia was empowered to invade by the dependence of the Western World on their fossil fuels.
This problem will not be resolved quickly, but it is likely the sort of painful event that will spur the world toward necessary action. Many world leaders now see the danger of powering their economies with energy provided by volatile, despotic regimes. The appeal of green energy also grows: not only will it save our planet, it will also protect national sovereignty. Investment in wind, solar, and long-shunned nuclear energy has been increasing since the invasion. A green energy agenda may prevent future wars.
The Blue Jays blew an 8-1 lead to get eliminated from the playoffs.
Just kidding. There’s no silver lining for this one. It’s going to be a long winter for Jays fans.
It’s human nature to reflect fondly on the past while feeling anxiety for the future. The world has given us some scary headlines this year, but sometimes we need the benefit of hindsight to recognize good from bad. In this case, I believe that the argument for short-term pain for long-term gain is more relevant than ever.
For more articles similar to this one (Short-Term Pain for Long-Term Gain) by Max Kirouac, click here.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.
