"Everyone may be worried about inflation, but it doesn't mean your stocks are going to decline."

The S&P/TSX composite index rose for 14 days in a row until the streak ended Tuesday, so perhaps it’s time to update a column we wrote eight years ago on assumptions and how dangerous they can be for investors. One of the biggest mistakes an investor can make is to assume something is going to happen. When you assume, you make an … well, you know the saying.

The trouble with assumptions in the market is that if everyone makes them, they might already be completely discounted. Thus, what you are concerned about may indeed be a real worry, but, ultimately, it might not have any actual impact on the stock market if the market has already correctly adjusted for it. For example, hundreds of experts in 2008 were predicting the end of the financial world. They just assumed a complete financial collapse. But at one point in the crisis, more than 1,000 companies were trading below their net cash position. Even in a meltdown, these companies’ stocks might have still gone up. As it happened, without a collapse, these companies soared.

So it goes with assumptions. Let’s look at five common assumptions in the market right now. Maybe you will pause to reflect on whether you should do anything in your portfolio about them.

Interest rates

Everyone now, more or less, assumes interest rates are going to increase. How could they not? Central bank stimulus has kept rates artificially low for a long time. But, remember, there is no rule stating that rates must rise. If economic conditions weaken (it happens), rates might not do much at all. Remember Japan? It had low (or negative) rates for more than 20 years.

All those investors who panicked this summer and sold their fixed-income securities need to stop and think, “Has the market priced in more rate increases than will actually happen?” If so, fixed-income stocks might still go up, even on small rate hikes. Investors have already had multiple panic attacks this year about rates, so stocks could actually rise when rates do if the impact has already been fully discounted.

Labour costs

One current fear investors have is escalating labour costs. Workers are very hard to find these days, and companies need to pay more to attract staff. There are 11 million available jobs right now in the United States that are unfilled.

But let’s think about this for a second. Is that so bad for companies? Business is booming, and they have to pay employees more. But they also might have 15 per cent fewer employees than they need. Now, of course, this isn’t fun for the employees who have to work harder due to staffing shortages. But for the companies, it might just mean higher profit margins as worker productivity is forced to increase.

Earnings

Most investors assume earnings growth is going to slow down after a stellar post-lockdown recovery year. How can companies, they ask, continue to reduce costs and drive up profit margins year after year? Well, maybe they can because of technology.

Companies continue to invest to speed up production and make workers more effective. Profits can nicely rise with improved efficiency. Technology has also been responsible for limiting inflation for the past decade. We certainly don’t think anyone should assume technology improvements — nor company greed for more profit — are going to stop anytime soon.

Inflation

The big debate this year, of course, is inflation. Is it transitory? Is it about to go parabolic? Everyone, it seems, has a story of paying more for something. Asset prices across the board have risen; money is sloshing around the system. Surely, inflation is going to be a big problem down the road. This is a very common assumption. But will it be a problem? Maybe, maybe not.

The transitory inflation crowd believes that supply chain issues will be solved next year, relieving a ton of inflationary pressures. But maybe inflation is becoming such a widespread assumption that markets won’t care so much.

There is no reason why stocks need to decline in an inflationary environment. Indeed, owning shares in companies can at times be a very good inflation hedge. Everyone may be worried about it, but inflation does not mean your stocks are going to decline.

Bitcoin and gold

A common assumption is that investors are no longer interested in gold because they are too busy buying bitcoin and other cryptocurrencies. Looking at current prices, it is easy to see how this assumption is so prevalent today. Bitcoin has soared to records, while gold has been a dog for the past little while.

But just because one is up and one is down does not mean there is an automatic correlation. Gold might be weak for entirely different reasons (inflation disbelief, for example — see above). The fact that gold is down does not mean bitcoin is the cause of the decline.

Bitcoin, while getting more popular, has not been tested in multiple different economic environments. Gold has thousands of years of history behind its use as a store of value. In a different world, bitcoin investors might sell bitcoin for gold. Who knows? But we would certainly not assume it cannot happen.

Take Care,