We often hear the phrase, market is topping out. Performance last quarter is a good example of this event that inevitably occurs after a torrid run since the spring of 2020. Last quarter, Canadian markets as measured by S&P TSX composite were up by a mere 0.7% while the US S&P 500 was up by 1.7%. These pale in comparison to year to date returns of 18.1% in Canada and 17.1% in the U.S.
The bigger question is what happens next. The rapid rise in stocks this year is no accident, corporate profits rebounded sharply boosting the value of a company especially when interest rates are flat to down. Higher profits mean higher valuation while higher interest rates lead to lower value. Markets top when these forces act against each other as it is happening now. Only if one or both of them change their direction, will there be a directional change in the market. If profits slow down but rates keep rising albeit slowly, stocks will have a difficult time rising further and bonds will continue to suffer. This is called stagflation, stagnant growth yet higher inflation. Left unchecked as in the seventies you start hearing price control and higher rates. The driving force of stagflation is high demand as consumers are unable to buy goods and services driving up prices. We are certainly in a high demand period but there is a difference. This time high demand is induced by the pandemic which will subside one day, hopefully soon.
Let me repeat like a broken record that companies which pay a regular sustainable dividend such as the banks, telephone and electric utilities, even pipelines which react to rising and falling energy prices, are the best way to earn a good return on investment. Technology continues to be important as it is the way to productivity and continued growth, some even pay a dividend.
The pandemic is making us used to a new norm in which masks will be around for a while and we have to stay apart from each other. Not the best of times but we have had to change our ways when a black swan occurs. 9/11 changed the norms of how we travel. It is hard to remember that 20 years ago we could carry a bottle of water when boarding a flight.