Prepare for riskier, more volatile future, Poloz says

Helping clients plan for risk is an important part of a financial advisor’s job. While the risk currently capturing headlines is inflation, the larger story about risk is that clients, as well as the companies in which they invest, will face a “rising tide” of it in the coming years.

That outlook comes from Stephen Poloz, special advisor with Osler, Hoskin & Harcourt LLP and former Bank of Canada governor. He laid out the case for a riskier and more volatile future in a keynote address on Wednesday at Franklin Templeton’s 2022 retirement symposium in Toronto, for pension plan sponsors and consultants.

Unexpected events, like pandemics, are catalysts that set underlying events in motion, Poloz said. Referring to a calmer environment ahead, “I don’t expect that at all,” because forces “beneath the surface are going to interact to give us volatility,” he said.

Examples of these forces — detailed in his book The Next Age of Uncertainty, published earlier this year — are the aging population, technological progress, growing income inequality, rising debt and the forced energy transition by 2050. “These five tectonic forces are all growing in power all at the same time,” Poloz said.

They give rise to a dynamic system, which isn’t easily modelled. As Poloz warned, “I’m predicting that these five forces will grow and interact in the future and create these bouts of unmeasurable, completely unpredictable volatility.”

Governments will be ineffective at addressing that volatility, he suggested, given, for example, that the aging population means fewer workers and a subsequent baseline fiscal drop, and that growing political polarization arising from income inequality tends to constrain policy-makers.

As a result, “A higher level of risk is going to wash up on the doorsteps of households and companies,” Poloz said.

That includes risk from potentially higher inflation longer term, he said, particularly given government debt levels and political polarization (debtors benefit from more inflation). “Those two things are … a poisonous combination,” he said.

Households and businesses will also face the risk of a higher unemployment rate, given tech disruption and rising inequality. With more people continually searching for work, households will require a conservative approach to finances.

“People will build bigger financial buffers, their decisions around … housing finance will be even riskier than they are today, so they probably won’t buy the biggest house that the bank will let them buy,” Poloz said.

Most risk management will likely be performed by companies, as they convert risk into value for shareholders. “They’ll keep capital in reserve not just to defend against negative risk but to pounce on positive opportunities,” Poloz said.

Further, investors and financial intermediaries will force more ESG accountability on companies — especially related to the S, he said. For example, as workers are burdened with risks such as tech disruption and job churn, a resurgence in unionization and defined-benefit pensions may emerge.

Poloz suggested companies should maintain a “solid narrative” through volatility, focusing on long-term, as opposed to quarterly, objectives. Investors and advisors will look for companies that best manage risk, he said.

“My sense is we’ll see a return to an era where stock pickers can actually make a big difference by understanding the risk environment and what companies are doing, either for themselves or taking advantage of weak competitors in a much riskier environment.”

Concerning the current rise in inflation, Poloz contextualized it and said he expects it will be managed, though no one can predict the outcome.

Most of the inflation we’re experiencing is unavoidable international inflation, he said, from supply disruptions, for example. This transitory inflation will resolve over time. On the other hand, when it comes to taming domestic inflation, one concerning factor is how sensitive the economy will be to rising rates, given debt levels.

Ideally, monetary policy will slow the domestic economy just enough to remove excess demand, and observed inflation will remain high for, perhaps, another year or so, he said.

“Stagflation is the optimal path from here,” Poloz said. “You shouldn’t fear it. You just need to understand it and invest around it.”