Fall 2023 Market Update
We head into fall with no shortage of financial & economic headlines. In the past few weeks, both the Bank of Canada and the U.S. Central Bank maintained their overnight interest rates at 5% and 5.5%, respectively. More importantly, both agencies have indicated their intentions to leave rates higher for longer. Unfortunately, this has brought volatility back into the financial markets with both bond and equity markets showing negative performance in the past few months.
Adding to the investor anxiety was the risk of a partial U.S. government shutdown this past weekend, which Moody’s (Rating Agency) warned could harm the country’s credit rating. The trading week ended before a deal was reached in the House of Representatives on Saturday evening. Despite the stop-gap measure at the 11th hour, the 10-year U.S. Treasury yields went to 16-year highs. This is also in the wake of the U.S. central bank’s hawkish long-term outlook, from last week.
On a forward-looking basis, a number of indicators point to greater fragility over the six-month horizon, with, among other things, the dwindling of excess household savings. The decisive factor for the markets, however, is likely to be the evolution of the monetary policy stance of major central banks. For the time being, a rapid fall in inflation would be the best scenario for stocks and would allow for possible rate cuts going into 2024.
As we head into the fourth quarter, our mandate is to stick to the game plan and overweight high-quality fixed income within the portfolios. There will be a point in the near future where we can extend our duration of fixed-income assets as we continue to see the economy slow down…..it’s just taking a little bit longer to get there.
Inflation Indignation
As the 2024 U.S. Federal election approaches, the current state of the economy will undoubtedly be a central issue because it profoundly impacts peoples lives and is closely tied to many other critical issues. Many voters assess the state of the economy based on their personal financial well-being. If they are experiencing job security, rising incomes, and a stable cost of living, they may be more inclined to support the incumbent party. Conversely, if they are struggling with unemployment, stagnant wages or increasing living costs, they may be more likely to seek a change in leadership.
In the 12 months through August, the U.S. Consumer Price Index (CPI) accelerated to 3.7%. This was a sharp drop from its peak of 9.1% in June of 2022, but a bit of surprise increase in August given the magnitude of interest rate hikes over the past year and a half.
But do voters care that CPI is less than half of what it was a year ago? Even as the pace of price hikes recedes, the sticker shock from previous increases remains. Just because inflation falls doesn’t mean prices fall back to where they were – only that they are growing less quickly. Put simply, anyone in a grocery store is less likely to appreciate that meat, poultry, fish, and eggs are slightly less expensive now than they were at the start of the year. Inflation among those goods was negative for several months – yet most sources of protein still cost considerably more than they did prior to the pandemic.
How does paying more at the grocery store or the gas station compare with a mass catastrophe like the pandemic? In the latter case, a multi-trillion-dollar government safety net gave people a bridge through the initial spike in unemployment and provided a buffer for them to stay away from jobs until they regarded the workplace as safe. There is no similar buffer from higher grocery prices or a stretched family budget. Inflation is universal and efforts to combat it with things like price controls or subsidies typically don’t work.
As the increase in interest rates take hold on the economy, the question will be how long the inflation scar will last from here?
The Great Debate – When should you apply for CPP?
In addition to self-generated savings accounts and annuities, government pensions serve as an important piece of retirement income. Old Age Security (OAS) and the Canada Pension Plan (CPP) are the two bedrock stipends available to Canadians. OAS begins just after your 65th birthday and depends on the number of adult years you have lived in Canada. CPP is based on contributions made during your working career, and can be taken as early as age 60, and, effectively, as late as age 70.
With CPP, there has always been the great debate – when should you take your CPP? Should I take it early? Or defer to sometime after age 65? An objective conversation will certainly help you make the best CPP decision based on your unique situation.
For most people, delaying CPP payments will maximize their lifetime benefit, but many factors like health, taxes, inflation should be considered. If CPP income is not needed for immediate living expenses and you are not experiencing or expecting life shortening health issues, waiting will generate larger payments each month. It will also reduce the amount of tax you currently pay, if you still have other sources of income (corporate dividends, salary, etc.).
If a pensioner applies for CPP prior to their 65th Birthday, their payment will be lowered by 0.6% for each month (up to a maximum of 60 months) that they applied early. In other words, if you applied on your 60th birthday, this would be a 36% discount from your payment than if you had applied at age 65. However, delaying beyond age 65 (up to a maximum of 60 months or age 70) earns the pensioner a premium of 0.7% per month, or a maximum bonus of 42%.
Let’s illustrate this using actual dollars. The current maximum payment at age 60 is $836.20, $1,306.57 at age 65, and $1,855.53 at age 70. A 60-year-old receiving a lower payment and a 65-year-old receiving their full allotment will ‘break even” after 9 years. That is, in 14 years the 60-year-old will receive $139,646 and after 9 years, and a 65-year-old will have received $139,803. Every month afterward the 65-year-old will receive $549 more than the CPP pensioner who began payments at age 60. At average life expectancies[1], a 60-year-old who applied for CPP, will generate a lifetime loss of $66,000 compared to a 65-year-old.
Furthermore, a 60-year-old will generate $110,000 less compared to someone applying at age 70.
If age 74 is not expected to be reached, then waiting to take CPP is likely not the best strategy. However, more than half of 60-year-old Canadians will live past their 83rd birthday. Accessing CPP early could deprive you of guaranteed income later in life.
[1] Life expectancy at birth – https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1310040901