Central Banks

Inflation has fallen from over 9% last year to just over 3% today. Some are calling it the immaculate disinflation and giving credit to the central banks for masterfully reducing inflation by raising interest rates from close to zero to more than 5%. I'm not so generous with my compliments to the central banks. Let me explain. 

Inflation is the rate of change of the cost of the same basket of goods year over year. A big driver behind the rise of inflation from 2022 to 2023 had to do with restricted supply chains and closed off economies that drove up the prices of goods. As supply chains normalized and economies started opening, prices didn't rise at the same rate as the previous year, however inflation remained elevated. Last week, the consumer price index in the US was released and although the expectation was that inflation would be less than three percent, it was 3.1%. It's like trying to lose that last 10 pounds of weight…almost impossible. But why is this?

When we look at the details behind the 3.1%, we find that the inflation in goods declined as expected, but the increase in service costs was higher than expected with hourly earnings rising 4.5% year over year. In my opinion, it will be very difficult to bring inflation down to the central bank target of 2% if wages are rising above this level. Any expectation of a cut in interest rates will have to be delayed until later this year.

The longer the rates stay higher, the greater the impact on the economy and consumers. Sadly, I think the central bankers put themselves in this position by acting too late. I think we have to prepare for an environment where the economy slows due to high interest rates with inflation still stuck at 3%.

Canadian Economy
According to TD Economics, the Canadian economy is more susceptible to decline than our neighbors to the south.  They cite three main reasons:

1. The Canadian Consumer is carrying a lot more debt.  Canadian debt levels are higher than what the US had in 2007. The higher interest rates have a greater impact in the country where consumers are more indebted.

2. The US have 30 -year mortgages. Over 30% of borrowers in the US have locked in rates that are under 3% for 30 years. In Canada, borrowers will have hefty increases in payments as their mortgages come due which will limit their ability to spend on other items. We have already started to see a marketable difference in spending patterns of those individuals who don't have a mortgage versus those that do. In addition, spending also changes based on when your mortgage is up for renewal. If it's due in the next year, you are already spending less.

3. Higher Wages. Canada is more unionized than the US which means wages are higher in Canada. Higher wages impact profitability and if the economy starts to slow, employers will cut back and we may see layoffs sooner in Canada than the US. 

We have been, and continue to be, cautious regarding any company that focuses on the Canadian consumer. Individuals will simply have less money to spend on other goods when they are paying significantly more on shelter costs.

Artificial Intelligence
AI is a topic that virtually every company is thinking about. Organizations are trying to understand how they can utilize AI to know more about their customers, offer elevated service, and be more productive. An intelligent, automated process can not only provide data, but also integrated process solutions on how to alter and use the data. 

You can imagine how it could impact industries from one side of the economy to another. For example, in manufacturing, AI could detect a failing part in a machine and create a process to replace that part before it stops working – a gamechanger for companies in this sector. In the healthcare industry, reams of data could be analyzed in seconds to speed up the process to create life-saving drugs, consolidate test results, or diagnose a patient. This all sounds incredible, but there will be some drawbacks. Concerns have been raised about the impact to workers, threats to cybersecurity and privacy, the influence of bias or errors in data, and the loss of human influence. This is all moving faster than companies or governments can understand or regulate. 

One thing that might not immediately come to mind when you think about AI is energy. AI involves vast computing calculations that require tremendous energy usage. According to an article in Scientific America, the majority of data is stored and processed at a collection of data centres that together consume about 1% to 1.5% of global energy supply. If AI expands to what people expect, the AI energy consumption will explode. By 2027, AI could require more energy than what some small countries use in a year.

At a time when the demand for energy is rising due to AI, supply is also being constrained due to the crisis in the Middle East and the Red Sea. Energy transition is not happening fast enough, and our grid system is already unreliable in many parts of North America.

This is a serious challenge and one that we believe creates an opportunity for investment not only in traditional energy, but also with alternative sources of energy such as uranium, wind, and solar, and more importantly with new technologies that allow those sources to integrate into a grid system.

Last month, I had the opportunity to visit my kids in Montreal. I was delighted to meet my daughter’s new friends, and particularly the two she will be sharing an apartment with next year. Such a bright and motivated group of young people who are clearly enjoying their first year of university, and not just the academics! I also had the pleasure of spending an evening with my son’s roommates who are keenly aware of their last term together before they graduate and head off on new adventures. Watching football and spending time with them made me feel like one of the guys. I was quickly snapped out of that when my son sent me directions on how to get back to my hotel, just so I wouldn’t get lost. Clearly, my perspective of how I fit in was different from his.

Ashit