The Financial Advocate: Spring 2021
The “Dash to Trash”
In our last newsletter we mentioned that “Times were A-Changing.” Well, yes they have! We have been experiencing a much higher degree of volatility since mid-February. There have been lots of changes in Covid news, interest rates, inflation numbers, corporate profits, and economic predictions. Add to that poli-tics, Fed policy, and geopolitical events and we have a significant brew to sort out. We will make an attempt to do just that in this newsletter. Let’s get started!
Covid-19 and the Pandemic
Covid news is obviously very encouraging. Vaccines from Moderna and BioNtech are game changers. The US is largely on its way to vaccinated, as is China. Europe is not far behind. Now it’s time to help the rest of this planet. While variants of the virus will pose lasting threats, our medical responses should be up to the challenge. We are getting back to a “new normal.” While it remains to be seen exactly what that looks like, we clearly see signs of a return to travel, cruise ships, going to the gym, or head-ing into the office. Have you all noticed how much more traffic is on the roads? (Some people have forgotten how to drive!) With all this activity resuming at the same time, there are, and will be, lots of disruptions.
First, it is important to note the market disruptions that are tied to the name of this news-letter. During the worst of the pandemic, investments in Cloud computing, “stay at home” stocks, streaming services, artificial intelligence and robotics, e-commerce, and the like soared. The future was dragged into the present. From an investment standpoint it was exciting to watch (and profit from!). Now, we have almost the opposite. Inves-tors are reaping profits from all the “wave of the future” stocks so they can buy the stocks left behind last year, presumably because they are downtrodden and cheap.
So… out go the “expensive” growth stocks of the future and in come the “cheap” stocks of the past. While we are participating in this rotation to a degree, we are not “all in” on either concept. Many growth stocks are simply too good to sell, period. On the other side, many of the ‘cheap’ stocks were never good companies to begin with. Airlines? Does anyone ever make money consistently on airlines? How about hotels? Honestly some of this “smart” rotation is literally painful to watch. We agree with some of the rotation trade and have made investments in transportation, raw materials, and agriculture for example. But… a large portion of this rotation is a “Dash to Trash” that we would rather not participate in. It would be irresponsible to turnover positions, while in many cases creating tax events, all for what we believe is a short-term phenomenon. We believe it is more prudent to “wait it out ” in long-term winners even if they are not performing as well dur-ing this period.
Interest Rates and Inflation
Inflation is real, but we think the current trend is largely unsustainable.
For example: last year, no one was driving. Now, many are back on the roads. Is it surprising that gasoline prices are up? Don’t forget that Texas refineries were shutdown for a month during horrible winter storms (not to mention the East Coast ransomware attack that shut down the primary pipeline facility to many states). Food prices are way up because farming got disrupted during the pandemic and weather patterns were unfavorable last year in the southern hemi-sphere. Add to that, ships are sitting offshore waiting to be unloaded (the food is rotting) at ports that are in disarray due to the shutdown. Is it surprising that food prices are rising? Let’s not forget the Suez canal being closed in a freak accident.
Most entrenched inflation is a result of wage pressures. Recent jobs reports were meager in terms of hiring. We informally estimate the unemployment rate at approximately 10% (Formally reported around 6%). You cannot get wage inflation if 10% of the population is unemployed, right? At VWM we strive to remain apo-litical and not let politics influence objective advise. This is challenging at times. We want to share with you a statistic that deeply concerns us. The enhanced unemployment benefits currently being offered nation-wide amount to a salary of approximately $33,000 a year. Many of the jobs lost during the pandemic never paid $33,000 a year! So, if I am unemployed and making more money than when I was working, why would I go back to work? The additional unemployment benefits being paid are acting as a form of government sponsored competition to employers. We see signs on our commutes of companies paying signing bonuses just so people will apply for vacant jobs. Until the emergency unemployment benefits end, it will be difficult to reach lower unemployment levels. This may be helping to contribute to short-term inflationary trends.
Once on the topic of inflation, a discussion of interest rates is never far behind. Interest rates exist to keep pace with inflation and provide a return to investors making loans. If inflation is rising, theory goes, interest rates will have to rise to keep earnings ahead of rising costs. This is a LARGE market risk. Growth compa-nies (previously mentioned) have been under pressure due to the “Dash to Trash.” But, there is another rea-son for the pressure on the “stocks of the future.” If interest rates are higher, future profitability carries a higher discount. The reason for the outperformance of stocks in transportation, steel production, energy, heavy machinery, and the like is that their earnings are in the present. Any inflation gets passed along imme-diately to the buyer in the form of higher prices. This adds another element to the idea of the “Dash to Trash.”
At VWM we think that the Covid disruptions will pass. We think ports, highways, and transportation will get back to normal, farming productivity will rise, and commodity prices will reflect actual supply and de-mand. Wages? Ask your local Congressperson!
Profits and Predictions
Corporate profits have been outstanding! Companies morphed through the pandemic, remained largely func-tional, and “stay-at-home” created higher productivity among workers. Automation helped, robotics helped, e-commerce helped, and so forth. We have no complaints about recent corporate earnings. We acknowledge that the previously mentioned affected industries had significant losses but should be returning to their “new normal” shortly. Enter politics. There is talk of increasing corporate taxes. If moderate, we will also have no issue so long as funds raised are directed to real infrastructure. Better ports, highways, airports, and high-ways are good for everyone, including corporations. If egregious increases in taxes occur, the US will once again become uncompetitive, and jobs will disappear.
Economic predictions are largely favorable and if man-aged properly, the US economy is poised at the begin-ning of what could be a solid economic cycle. We lost track of the recession that occurred last year while we all sought shelter. There was a real recession and a real re-covery. That puts us at the beginning of an economic recovery in many industries. We see gains in industries ranging from electronic vehicles, solar, alternative ener-gy, precision farming, possibly hydrogen powered vehi-cles, and a potential rebirth of the travel and leisure in-dustries. Add to that, true infrastructure projects and the corresponding spending on machinery, high paying labor jobs, and material production and you have one booming outlook for the US economy. Perhaps another “Roaring Twenties?” Do not rule that out.
The Fed and Geopolitics
The Federal Reserve continues to pursue an extremely accommodative stance. There is enormous liquidity being provided to the marketplace. Some say this is facilitating “bubbles” in areas such as housing. Excep-tionally low interest rates, together with liquidity, have certainly made home ownership available to a wide (and growing) number of new home buyers. Millennials are in prime household formation mode. This de-mographic is larger than the Baby Boomers! Remember what happened when the Baby Boomers started their 30-year spending spree? At some point the Fed will have to start removing the proverbial “punch bowl,” but we don’t see that anytime soon.
This Fed is a collaborator. We are seeing coordinated activity among central bankers globally. We believe this is helpful for more normalized affairs with our allies. Our hope is that this coordination will become the standard for collaborating on issues of trade and commerce. We obviously need collaboration on actual de-fense and cyber threats as well. Perhaps, we can gain a bit of camaraderie that has been lost in recent years. It is not as if threats from China or Russia have gone away!
Let us end with hopes for the new “Roaring Twenties” and more importantly, the end of Covid for all of us!
Below are strategy updates on the firm’s three main portfolio strategies. If you have questions regarding which strategy stye (or styles) you own, please contact us and we are happy to discuss.
The Moderate Allocation portfolio continues to be overweight equities, underweight fixed income, and slightly overweight cash. We intend to deploy the cash opportunistically as the market likely consolidates. Over the past few months we have trimmed some of our core holdings as their prices far outran their funda-mentals. Examples of positions that were trimmed include: Waste Management, Intel, Home Depot, and Ap-plied Materials. To be noted, we are still overweight these holdings versus our benchmark. We also added to our cyclical exposure by opening positions in companies such as Whirlpool, Dupont, and WestRock. If infla-tion continues to accelerate we will add to assets that have historically performed well in inflationary envi-ronments. The model’s performance closely matches its benchmark on a year-to-date basis.
Global Balanced remains opportunistically positioned. Over the past quarter, we have added to select re-opening investments. This included additional emerging market exposure, new industrial positions (with an emphasis on infrastructure), and a de-emphasis on the healthcare sector. The fixed income portion of the portfolio was reposi-tioned to better insulate the style from rising interest rates. Core holdings in high-quality technology, healthcare, and consumer discretionary sectors have been maintained despite a short period of underperformance. The diver-sified nature of the portfolio makes it well-positioned for a potential period of higher-than-average volatility.
After a stellar 2020, Global Alpha is in a state of transition. The industries that made 2020 so profitable are under distribution (selling pressure) as investors seek returns from “reflation” trades in the beaten down stocks of last year. We have made investments in some material stocks such as steel and copper. We have made some investments in travel and leisure such as Disney and Delta. Further, energy, financials, industri-als, and real estate have crept into the portfolio. Our focus in Global Alpha has been on solid growth compa-nies in technology, consumer discretionary, and health care. We have not completely dropped that focus; rather, we have cut back on these investments in order to accommodate current investment trends.
Our Milestone 360 topic this quarter is education planning. The pandemic has had a measurable impact on the way some families have approached or altered education goals. Both short-term and long-term funding strategies have shifted as a result. This, coupled with potential changes to existing loans in the form of forgiveness or outright cancellation, create a good opportunity for planning conversations.
We are happy to confidently say that our new offices will be open for in-person reviews starting in the third quarter—less than two months away! The staff are well on their way to becoming fully vaccinated. For those of you that are comfortable with in-person meetings, we are looking forward to welcoming you to the new space. For those that are not yet at that comfort level, we are happy to continue meeting with you via Zoom and conference calls.
Looking forward to more “normal” times ahead!
Nick Ventura, CFP® CPWA® President / CEO