Is it still 2022? Have this year’s market moves aged you? Don’t worry, you are not alone in these feelings, but rest assured that we are considering all of the relevant information and working hard to position portfolios with a longer-term view in mind. The S&P 500 has had its worst start to the year since 1962, with yesterday’s darlings bearing the brunt of this pain. If anything, the recent market losses serve as a reminder that investors should be focused on their long-term goals that rely upon diligent planning, implementation and actionable items in order to reduce the negative impact of making an emotional decision that is based more upon short-term biases instead of actual facts.

Market corrections have always tested even the most experienced investor. They also happen to be a very normal part of fully functioning investment marketplace.   The real challenge is that corrections test an investors’ fortitude, conviction, goals and overall approach which quickly leads to even more fear, pessimism, and outright despair.  Despite the list of growing negatives that investors are currently facing, there are still a number of positive items that support taking a longer-term view:



How are we positioned and what does it mean to you?

Our investment process revolves around our risk controls. As a reminder, client portfolios remain fully invested, are positioned sector-neutral to respective benchmarks, and currently maintain valuation discounts. These tenets have been accretive year to date, as value stocks (lower price to earnings) have generally held up better than pricey growth stocks (higher price to earnings). Given the severity in divergence of returns across sectors, the fact that we also remain diversified across all eleven market sectors has proven beneficial as well. This fully invested positioning should continue to ensure that when, not if, the market moves higher fully invested client portfolios will stand to benefit from the market’s shift upward.

We have seen a common theme emerge amongst investment managers that believe current market conditions have provided investors with an attractive buying opportunity.  This is a sentiment that we also happen to agree with.  As a result, Dana has been focusing its efforts to identify those companies that are less economically sensitive and those that can protect their profit margins.  Therefore, we are seeking to own companies that exhibit both a resilient business model as well as strong pricing power, both of which are key elements of our investment process.  This type of approach supports a longer-term view regardless of short-term noise.

Overall, we remain committed to our relative valuation discipline which provides the potential for downside protection along with the benefits of more positive price movement when the market regains its footing.

Our counsel has always been to stay invested, within the risk tolerance guidelines that you have set with your clients. Your guidance, as an advisor, is always beneficial in times of stress and uncertainty. This is a time to be proactive with your clients – let us know how we can help.


Disclosure: Dana Investment Advisors welcomes any comments to their blog and is more than willing to discuss or explain any aspect of it. This blog is provided for general information only and is not intended to provide specific advice or recommendations for any individual or entity. This is not an offer, solicitation, or recommendation to purchase any security or the services of any organization or individual. The foregoing reflects the opinions of Dana Investment Advisors.


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The Reckoning

April 25, 2022
Dow: 34,049

The coming actions of the Federal Reserve have now become the key focus and driver of the equity and bond markets. Even though they faced issues during their tenures as Chair of the Federal Reserve, Ben Bernanke and Janet Yellen did not face the issue that Jerome Powell faces now. In March, the S&P 500 dropped almost 13% from its early January high and annualized CPI increased from 7% in December to 8.5% in March.

Over the last quarter century, whenever the markets or the economy encountered a period of stress, the Federal Reserve was able to ride to the rescue by providing liquidity and encouraging investment by cutting rates. During the 2008 recession, the Fed not only cut rates to .125%, but doubled the size of its asset holdings from less than $1 trillion to over $2 trillion. Their asset holdings doubled again to over $4 trillion in 2014, and doubled once more to over $8 trillion by the middle of last year. Annual U.S. GDP is about $23 trillion, and total U.S. debt is over $30 trillion, including intergovernmental holdings. In the last three hiking cycles, Fed Funds peaked at 6.5% in 2000, 5.25% in 2007, and 2.375% in 2019. Whenever the markets have indicated that they cannot tolerate higher rates, the Fed has heeded that warning.

Has there been a downside to an easy Fed? Not in decades. The Fed has been able to cut rates and add additional stimulus to the economy by buying assets. They began by increasing purchases of Treasury securities, then added mortgages, and even supported the corporate bond market through purchases during the COVID-19 crisis. None of these liquidity measures triggered inflationary spikes, providing a seemingly free lunch.

Now the Fed says that it is serious about controlling inflation, and realizes that its actions may cause asset prices to decline and will likely slow economic growth. The market believes the Fed is serious. As of September of 2021, the Fed Funds futures market expected one rate increase by the end of 2022. That increased to three expected increases three months later. By the end of March, the futures markets expected eight quarter-point increases over the next nine months, and now that expectation is closer to ten.

Can the Fed maneuver through 2.5% of rate increases over the next eight months? We doubt it. Real GDP growth is trending back to the 1-3% per year range. Inflation should pull back as the spike in energy due to the war in Ukraine recedes. There are other constituents in the CPI, such as shelter costs, that will prevent inflation from falling back to the levels of the last decade. Treasury yields are in the 2.5-3% range across the middle of the curve, and long-term market indicators of inflation have not moved above 3%. We believe that the market sees sub 3% Treasury yields as a sign that the Fed will not be able to raise rates to 2.5% this year and may not get beyond 1.0-1.5%.

What will the Fed do if the market or economy falters, or before inflation shows signs of receding? This is the reckoning. No Fed has faced this dilemma since Paul Volker vanquished inflation in the early 1980s. We expect a weakening market or economy to slow or stop Fed rate increases before the Fed Funds rate hits 2%. A better outcome would be indications that inflation was retreating prior to the implementation of all of the currently expected rate increases. Nevertheless, it is a dangerous time, and we will be watching closely and taking necessary action in our managed portfolios as the markets react to Fed actions over the next three months.

Counterintuitively, rates at the longer end of the Treasury curve usually peak at or near the beginning of a Fed-rate-hiking cycle, so most of the pain may have already been experienced by bond investors. Going forward, there is more yield to offset further price declines, and this should comfort bond investors. In the equity markets, the correction has lowered valuations. Economic tailwinds exist from a strong housing market, consumers with low leverage, corporations with strong balance sheets and a tight labor market that should maintain a low unemployment rate and strong wage growth. Consumers are also anxious to resume normal life after COVID-19 and this should keep consumer demand and spending robust.



Random thought: “Fasten your seatbelts, it’s going to be a bumpy night” – Bette Davis in All About Eve


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April 5, 2022


Dana Investment Advisors is pleased to direct our inaugural donation from the Dana Donor Advised Fund, to ShelterBox USA, Inc., a US-based 501(c)(3) nonprofit and affiliate of ShelterBox Trust, an independently governed charity in the UK. ShelterBox USA is 4-star rated by Charity Navigator and Platinum rated by Guidestar – the highest ratings for non-profit organizations. ShelterBox was nominated for the Nobel Peace Prize in 2018 and 2019.

ShelterBox helps people when disaster strikes by providing them with emergency shelter and essential equipment, which includes helping refugees fleeing Ukraine right now. Our colleague and Fixed Income Portfolio Manager, Noaman Sharief, became a Board member last fall, and brought this organization to our attention.  “What impresses me most about ShelterBox,” says Sharief, “is that the individuals associated with the organization are truly committed to serving humanity without delay.”

ShelterBox has three Ukraine-focused projects.

Project 1/Ukraine: Assisting Internally Displaced People (IDPs) who are sheltering in Collective Centers

ShelterBox is sending thousands of mattresses to evacuation collective centers, including schools, churches, and centers in western Ukraine, providing people who have fled their homes with somewhere to sleep and keep warm at night.

Project 2/Ukraine: Repairing Damaged Homes

ShelterBox is preparing to send thousands of ShelterKits, including heavy-duty tarpaulins, tools, and rope. The kits help repair homes that have been damaged so that families can shelter in place. The aid package includes high thermal blankets, hygiene kits, solar lights, buckets, and water carriers to help people survive in conflict-damaged buildings.

Project 3/Refugee Support:

ShelterBox will support refugees in neighboring countries with high priority portable items. As the conflict continues, the needs of people reaching the borders will increase. Resources of some countries are becoming overstretched as more and more people seek safety and refuge. Moldova, for example, has seen more than 380,000 people flee into the country – equivalent to more than 10% of its population.

Mark Mirsberger, Dana’s CEO notes, “Dana employees have always supported charitable efforts with their time, talent, and financial gifts. This new Dana Donor Advised Fund, established in Q4 2021, expands our collective efforts to help others. We plan on growing this Fund so we can provide financial resources to worthy causes like ShelterBox for years to come.”

If you would like to learn more about ShelterBox, please see:

A New Kind of World Disorder

March 15, 2022
Dow: 33,544

A brave new world began on February 24, 2022. It is always easy to spot the mistakes that were made in hindsight, but the Western world clearly did not do enough to deter Putin over the last 20 years. He took advantage of U.S. miscues in Syria, and he was clearly testing the West with his incursion into the Crimean and the Donbas regions in 2014. He believed that he could invade and conquer most of the Ukraine, even though Russian puppet leaders have been driven from Ukraine twice in the last 20 years. The failure of the West was a failure to take the threat of invasion seriously and to provide serious deterrents prior to the invasion.

If the Russian invasion is stopped or turned back within the next few weeks, the consequences for the U.S. economy will be minimized. Russian population is less than half that of the United States and declining, and their GDP is 1/12 that of the U.S. The companies in the S&P 500 Index with the greatest sales exposure to Russia still derive less than 10% of their total sales from that country. Historically, bear markets in the U.S. have been driven by economic slowdowns causing recessions – not geopolitical events.

The U.S. economy was in the process of emerging from the COVID-19 pandemic when this equity correction began. While inflation and imminent Federal Reserve rate increases have also been clouds hanging over the market, the economy added 678,000 jobs in February as the impact from the omicron variant wound down. Personal balance sheets are healthy, the housing and auto markets are very strong, and wage growth is robust. Corporate America in aggregate has over $1 trillion in cash on their balance sheets, and they’ll likely continue to use it in ways that benefit shareholders, including boosting dividends, buying back stock, investing in their businesses and doing accretive acquisitions.

Even though cost pressures are intensifying, many companies have been able to overcome both increasing cost pressures and supply chain dislocations over the past seven quarters. Oil prices have spiked during the conflict, but the U.S. economy is far less dependent on oil as an input than it was fifty years ago. U.S. petroleum consumption has been roughly 20 million barrels per day for the last 45 years, even as GDP has more than tripled. The U.S. has also gone from importing 60% of its consumption in 2005, to being a net exporter of petroleum products in 2020.

As most of our clients understand, we are investors and asset allocators, not market timers. The events taking place in Eastern Europe are horrendous, but the state of the U.S. economy is strong. Equity investors should be aware that -10% market corrections are a normal and regular occurring event. While they can be stressful for investors, they typically occur every year even though U.S. equity markets have advanced over 10% annually since 1926. After a rough 2022 start, many equity investors have begun to forget how strong markets were in 2021 with the S&P 500 Index hitting 70 new all-time highs and only briefly experiencing a modest 5% decline. Last year’s 28.7% advance for the S&P 500 Index without significant volatility was exceptional and not typical. Corporate earnings of S&P 500 Index companies are forecasted to grow more than 10% over the next few years, and U.S. productivity and innovation remain strong. Based on this backdrop and on yields of other asset classes, we expect equities to remain the best performing long-term asset class and see no reason why they won’t provide returns similar to their historic average over the next market cycle.

While we caution clients about making emotionally driven allocation changes based on temporary setbacks, there are opportunities to reduce risk and generate consistent investment income with bonds and other asset classes. The Federal Reserve is meeting this week and is expected to begin a tightening cycle by increasing the Fed Funds rate by at least 0.25%. Our adjustable-rate focused Limited Volatility bond strategy will certainly generate higher income as the Fed increases rates. In our equity strategies, we are focused on adjusting our industry exposure within the industrial sector and taking some profits in higher valuation stocks that have been perceived as safe havens over the past few years. We continue to monitor inflation expectations, which we believe will be higher and more persistent.

Clearly these are challenging times for investors, and we are ready to meet these challenges by following our time-tested investment strategies and making adjustments based on our evolving outlook. We will continue to share our insights and welcome your questions.


Random thought:  “There are decades where nothing happens; and there are weeks where decades happen” – Vladimir Ilyich Lenin


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January 28, 2022
Dow: 34,725

That’s something we haven’t had to talk about in a while. The S&P 500 Index has been on a fairly relentless path upward since the beginning of the COVID-19 shutdown in March of 2020. Through all of the twists and turns of the battle against the virus, through shutdowns and partial reopenings, through the discovery and rollout of vaccines, the market has trudged higher. We have had slight pullbacks in the S&P 500 that have lasted days or weeks, but the market has always resolved higher. Most of the dips are not even worth noticing – declines of a few percent lasting a few days. Until this month, the largest decline for the S&P 500 was slightly over 5% in September and early October 2021. Following that decline, it took exactly twelve trading days for the S&P 500 to reach a new high. By the end of 2021, it is possible that all of the non-believers had been swayed and had now purchased equities. When everyone is ‘in’ the market, there is no dry powder left to provide support when the market dips.

We have had turns in relative favoritism between value and growth companies over the last year. Value outperformed in the first half of 2021, only to see growth companies make up the difference and end the year ahead. Higher valuation growth companies have borne the brunt of the current correction. The S&P 500 is down about 7% this month, but the NASDAQ and small cap indexes have fallen somewhere in the mid teens. Maybe this represents a long-anticipated change in leadership, but it is far too early to tell. When the market climbs steadily, regardless of events, investing appears easy. Anyone can be successful. Buy and hold, buy the dips, etc. Corrections have a tendency to alarm investors and cause them to think short-term which can lead to mistakes and costly long-term decisions.

Future actions by the Federal Reserve seem to be a key concern of investors. The Fed is still buying securities in the open market, pushing dollars into the economy. They suggest that they will stop by March, allowing maturities to run off and their balance sheet to shrink. There are numerous constraints on potential Fed action, on both the stock and bond sides of the ledger. Although this correction seems normal, if it were to snowball into something larger, that would get the Fed’s attention and might cause them to walk back their rhetoric or postpone action. The Treasury market also must “allow” them to take action. The entire Treasury curve provides market feedback on expected Fed action. Ideally, the ten year Treasury yield creeps up methodically, and the two year Treasury increases as well. Normally, the Fed does not begin raising rates until the yield difference between two and ten year Treasuries is 1.5% or more. Right now, the difference in those two yields is less than 1%. The two-year yield is at 1.15%, which would seem to allow for a couple of Fed rate increases, but if the ten-year Treasury yield moves down from 1.8%, it doesn’t leave much room before the yield curve becomes inverted. We believe they will begin raising rates in March as long as the stock market and ten-year yields do not fall further from here.

We continue to believe there is still room for further economic expansion in this cycle. Omicron cases may be peaking, and it has shown to be a more virulent but less deadly strain. Demand in the housing and auto sectors is still strong, which is typically a very positive sign for the economy as a whole. Consumer credit balances have been paid down significantly over the last two years, so there is room for an expansion in spending, even at levels consistently above income levels. Fourth quarter GDP was 6.9%, boosted by a recovery in inventories. Full-year GDP was 5.6%, and the trailing three-year average is 2.9%, a respectable growth rate that includes the COVID-19 trough. Fourth quarter wages grew at over a 5% annualized rate, which should help support consumer confidence and spending. We are also confident that the beginning signs of a market turn from growth to value will provide an expanded range of potential investment opportunities for our portfolios. On the fixed income side, our prudent strategies provided strong relative performance in 2021, and higher interest rates will provide opportunities to earn higher income in the future.


Random thought:  “A market downturn doesn’t bother us. For us and our long term investors, it is an opportunity to increase our ownership of great companies with great management at good prices. Only for short term investors and market timers is a correction not an opportunity.” – Warren Buffet


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How We Work

November 29, 2021
Dow: 35,136

For those of us who have “desk jobs,” COVID-19 changed the way we work, and we probably will never go back to how and where work was done in 2019. The implications are significant for almost every aspect of our economy. As a nation, we have become more productive, and report that our lives feel more balanced.

More than 18 months after the initial shutdown from COVID-19 in March of last year, only a fraction of white-collar employees have returned to the office in many major cities. Kastle Systems International is the major provider of card swipe systems for office access that have become ubiquitous in most cities. They collect data from 2,600 buildings in over 130 cities around the country. They show that New York City card swipes are down 52% from pre-pandemic levels. In San Francisco, swipes are down 57%. Chicago figures are comparable. New York subway ridership is below 50% of pre pandemic levels, and that is after recovering from levels that were far lower. Kastle Systems’ weekly index of U.S. metro areas currently shows that employees are still going to the office only an average of two days per week. As one would expect, southern states with more liberal reopening policies show a higher in-office presence, but still substantially lower than two years ago. It is fair to say that a significant portion of the workforce has settled into some type of hybrid work routine.

A hybrid environment lets individuals have the best of both worlds – no commute and none of the commensurate costs and hassles. It still allows collaboration through messaging and video apps, and in-person collaboration on in-office days. As many jobs have evolved into an interface between an individual and a terminal or computer, being “together” has become less of a priority.

The implications for both cities and less densely populated areas are significant. Large coastal cities and other major population centers may see a material plateau or decline in values for both commercial and residential real estate. The tax base will decline for sales, real estate, and income taxes. This will be a major funding issue for these areas. Service sector jobs that supported the urban commuter will disappear. Demand for support services in suburban or rural areas will increase, as new services will be needed for those working from home. The $1.9 trillion American Rescue Plan passed earlier this year funneled massive grants to municipalities, but this was a one-time funding. Cities that experience permanent population declines will experience declines in quality-of-life issues.

Many employee surveys have shown that most employees want to continue to work under a hybrid office/remote schedule. We all were forced into it last year, adapted to it, and don’t want to completely give it up. The reason many want a blend is that they see the benefits of both. We shouldn’t push too hard against this change; the experiment will allow us as a group to find the proper equilibrium. It has encouraged a more rapid rate of job change as well; resignations are at record levels, as individuals reassess their priorities and think about how they want to work. Economically, it has been for the better. GDP is at record highs, even with a smaller aggregate workforce. A satisfying and rewarding work life helps us all to live happier and more rewarding lives.


Random thought:  “The only way to do great work is to love what you do. If you haven’t found it yet, keep looking. Don’t settle.” -Steve Jobs

“Look for the job that you would take if you didn’t need a job” -Warren Buffet

Repressed, Not Impressed

September 28, 2021
Dow: 34,299

Why are bond yields so low when inflation is increasing? Why is the cost of food, housing, automobiles, and rent all going up faster than incomes? Welcome to the world of financial repression. The U.S. government is a net debtor. They have borrowed, spent, and now they owe. Inflation reduces future purchasing power. This is bad if you own assets, unless their value increases even faster than the rate of inflation. The total U.S. debt is now over 130% of GDP, while it was under 100% less than ten years ago.

Annual Federal spending from 1953 through 2019 was between 16% and 22% of GDP per year. Generally, it ran below 20% if the economy was growing, and increased to slightly over 20% during recessions. It rose to 24% in 2009 before dropping back down, but spiked to 31% of GDP in 2020, the highest level since the Second World War. Debt and spending typically grows along with the economy, and that generally causes no fiscal issues or stress.

As the debt load has increased, the burden has been lessened by generally low interest rates. Interest expense for the Federal government as a percent of annual GDP was less than 2% until the 1981 recession and interest rate spike. It was between 2% and 3% annually from 1981 through 2000, and then moved back down below 2% per year as interest rates fell and Treasury debt matured and was reissued at lower interest rates.

With current debt levels at record high percentages of GDP, and enormous future spending commitments as the boomer generation retires, higher interest rates would endanger the fiscal position of the U.S. government. The Treasury (Janet Yellen) and the Fed (Jerome Powell) would like to keep interest rates below the level of inflation. While this is not a good deal for bond investors, it certainly helps the Treasury repay the debt as tax collections increase due to inflation but the cost of borrowing stays low. Financial repression is the ability of governments to borrow and pay interest at a rate below inflation. Repression helps them as the seller of Treasuries but hurts investors as the buyer of Treasuries.

So, Powell and Yellen like the current status quo; low bond yields and high asset prices. High asset prices and low borrowing costs keep the economy humming. If we could run with this kind of status quo for a while, maybe the debt to GDP ratio would start to come down.

Unfortunately, Congress wants to get in the game with an enormous spending bill. Both Republicans and Democrats are responsible for the current dire state of fiscal affairs. The Democrats increase spending and claim they favor fiscal responsibility through higher taxes, and the Republicans cut taxes and claim they favor fiscal responsibility through decreased spending. Both parties usually only get half of what they want, and deficit spending grows.

There are some economic and market positives. The employment picture is strong, and wages probably have to go up across many industries. Consumer confidence may continue to support the economy and the recovery from the impact of COVID-19. One big positive is that the employment situation looks positive across the spectrum. Professionals that sit in front of a monitor have seen increased flexibility with work from home and are hesitant to give it up. Many are demanding and getting greater flexibility from their new employers when they change jobs, in addition to increased pay. Skilled industrial production workers are in short supply and will be able to gain pay increases as well. Direct service workers, usually among the lowest on the pay scale, will gain greater pay as it is necessary to get them to return to the workforce.

As the COVID-19 Delta wave recedes, there should be another surge of consumer spending, travel, and confidence. This will serve to support earnings and the market. Our shorter duration fixed income strategies will provide some level of protection against higher rates, especially at the long end of the curve where the Fed has less of an impact. Municipal bonds have also been strong performers in fixed income, with positive returns year to date versus negative returns in most other fixed income sectors. For most economic and fiscal issues, economic growth is the salve that makes things better.


Random thought:  “I have not failed. I’ve just found 10,000 ways that won’t work.”  -Thomas Edison

Good vs. Bad

August 4, 2021
Dow: 34,793

So many of the decisions we make in life are tradeoffs, both the big decisions and the little decisions. We evaluate the pros and cons of where to live, where to work, what career to choose, etc. As investment professionals, we do the same thing when making an investment decision. Often, we are evaluating many variables on both the good side and the bad side. We also have to assign a certain weight to each variable; what is more important to investment success, and what is less important? We also have to evaluate the certainty of our judgement on each factor. If we expect a likely outcome, how certain are we? If we are wrong, is the downside risk large or small? It’s complicated.

There are significant crosscurrents of good and bad affecting the markets and the economy right now. Most immediately concerning is the Delta variant, resulting in rising cases across many countries. Viruses often mutate, typically becoming more infectious but less deadly, as appears to be the case with Delta. From an economic point of view, our behavioral reaction to the Delta variant is as important as the medical consequences. Even a semi-voluntary, significant reduction in mobility and economic activity can have wide ranging consequences. If people choose to travel less, stay home more, and spend less out of fear, there will be economic consequences.

So far, the surprising strength of the economic recovery is outweighing the fear and uncertainty generated by the Delta variant. Air travel has recovered to 80% of pre-pandemic levels, restaurant visits have fully recovered, and gasoline consumption has recovered to more than 95% of pre-pandemic levels. Consumer confidence going forward is still a concern; the percentage of individuals in a recent Gallup survey that believe the COVID-19 situation is getting better has dropped significantly. As we saw in 2020, when confidence in our political, health, and journalistic institutions is at odds, the societal fabric frays.

The economic and market news has continued to be better than expected. Both revenue and earnings have continued to surprise on the upside each of the last four quarters, with the magnitude of the surprise increasing. This probably explains the positive return of the S&P 500 through earnings season in the month of July, after a 15% gain in the first six months of the year.

Why worry? The level of debt and borrowing is exploding, and it is being monetized through purchases by the Federal Reserve. The Treasury issues debt and the Fed purchases a significant portion of it. They also are the major buyer of debt in the home mortgage market. This is effectively “printing money” and distributing it through various government programs. Few have stopped to think that the $20 bill in their wallet is actually an IOU. It is non-interest bearing government debt. We work for two weeks and receive a paycheck; that chit can be exchanged for something of value we want to consume in the future, be it seven days or seven years from now. Governments throughout world history have succumbed to the seduction of printing money. It has ended badly for all of them.

The generally shorter effective maturity debt we utilize in many of our fixed income strategies reduces risk and exposure to changes in expected inflation and interest rates. This is the best investment approach we found to mitigate risk in fixed income investing. High-quality bond investments have proven to be the best way to mitigate equity investment risk.

Even if a ‘return to normal’ move continues after the Delta variant subsides, we now know we are not going back to the normal we had before the COVID-19 pandemic. Life and work in 2022 will be different from life and work in 2019. Many have used this period to evaluate their work/life balance, seemingly to the benefit of both the companies and their employees. Real GDP is now higher than it was pre-COVID-19 with five million fewer individuals employed. Higher GDP is the good, and we have made a positive step in overall economic productivity through this period. Fewer employed is the bad, and we need to continue to work to find a place for all who can contribute.


Random thought:“I have dreamt of this moment since I was a kid, and honestly nothing could prepare you for the view of Earth from space”  Richard Branson, Virgin Galactic Founder

Let’s Get Real

June 28, 2021
Dow: 34,283

Inflation has been the topic du jour during the last few months. For the past year, the Consumer Price Index is up 5%. Over the last 30 years, it has only been higher for a short period in 2008. Should we be concerned as investors and consumers? Persistent inflation can harm economies, and if it is not controlled, it can bring down economies and governments. We believe both inflation and deflation can be very harmful and cannot always be controlled by what many believe to be an omnipotent Federal Reserve.

Inflation is corrosive. It lowers the value of our work, our savings, and casts uncertainty on long-term financial agreements. It can reduce economic risk taking, which is essential for growth. If you are a lender or a borrower, what should you assume for the value of the dollars that will be repaid at a later date? Will the interest rate on the loan compensate for the risk of losing principal, and any unforeseen inflation, that reduces the return on the dollars that were loaned? Many equate price increases directly with inflation, although that is not always the case. Prices can change significantly in short periods of time in order to allocate scarce resources, such as when demand spikes before an economic supply chain can fully restart. This is part of the “noisy” inflation numbers we are getting now. Jerome Powell and the Fed believe the current jump in inflation is related to supply chain and reopening constraints, and will prove to be transitory. We believe it is prudent to accept this explanation until it is disproved.

Many economic indicators are adjusted for inflation to get at a “real” number, that is, the change in value or level that is not caused by inflation (or deflation). Economic growth is usually measured by a change in GDP; this is announced quarterly and is a real, or inflation-adjusted, figure. Growth over the last few decades has trended in the 2% per year range, with higher or lower figures in recoveries or rescessions. While Real GDP contracted in 2020 due to COVID-19 as parts of the economy were shut down, it is expected to grow as much as 7% or more this year. Real growth is fundamental because it is the core source of real asset growth and improvements in quality of life over time. It is also the source of real wage growth, which had been rather stagnant for decades before it began to rise in the years before COVID-19. If inflation were to stay at an elevated level, this virtuous cycle would run in reverse; investors would demand higher returns for risk, fewer new investments would be funded, risk taking and innovation would decrease, and consumer purchasing power and real wage growth would decline.

The Fed would like to keep interest rates low to keep the economy humming for an extended period of time. They do this by both taking action and through their communication about when they may take action. After their last meeting, they made policy by communicating their thoughts about the timing of changes in rates and bond purchases, both of which influence the economy. Effective market direction through communication allows them to limit actual changes in rates and bond purchases, and we believe this is their preference now. Low real interest rates, which is the rate paid after accounting for inflation, helps debtors repay the debt and decreases the cost of borrowing. Coming out of a downturn, this is good for individuals, corporations, and the government, which has borrowed heavily over the last year.

As we have said before, the economy is actually more productive now overall than it was before COVID-19. Economic output per worker is higher now than it was prior to COVID-19. Nevertheless, the economy has to continue to expand to bring unemployed and discouraged workers back into the economic fold. Keeping the economy humming is the way to do that, and, ultimately, continued investment, optimism, and economic growth should bring the benefits of real growth after inflation to more members of society.

Random thought: “All growth…is the result of risk-taking” -Jude Wanniski

New Highs

May 27, 2021
Dow: 34,465

The first quarter earnings reports continued to provide upside surprises as the economy expands and the COVID-19-based restrictions are eased. The average earnings surprise for the S&P 500 has been near 20% for the last four quarters, and the average upside surprise to sales for all S&P 500 companies in the first quarter was 4%, the highest upside sales surprise of the recovery. Every sector of the index delivered positive sales and earnings surprises. These strong results have allowed the index to gain almost 6% so far in the second quarter, equaling the 6% gain in the first quarter.

As we have discussed before, the areas of the economy that were more productive were less affected by COVID-19 than the sectors of the economy that are less productive, namely the leisure and hospitality sectors. As a result, the economy has recovered to nearly the same level of GDP output that it had prior to the decline, but has done so with a level of employment that is only 95% of pre-COVID-19 employment. This higher level of productivity is good for investors, good for those who remain employed, and good for the economy as a whole. Higher wealth stems from increased levels of productivity. Higher wages also stem from increased productivity, although a higher level of skills will be required of the employee in exchange for the higher wage. A higher wage mandated by the government will result in lower levels of employment if prospective employees do not possess the required skillset to offer in exchange for the higher wage.

Different sectors of the market have been going through stealth corrections and consolidations in 2021, even as the S&P 500 moves towards new highs. The largest drawdown peak to trough for the S&P 500 this year is about 4%, and it has happened twice. Looking at several indexes that represent other areas of the market, the Russell 2000 Small Capitalization Index fell almost 10% in just seven trading days in March. The NASDAQ Composite Index fell over 10% in three weeks during the first quarter, and dropped 8% in the two weeks ended May 12th. The Philadelphia Semiconductor Index fell over 14% during a three-week period in the first quarter, and fell over 13% in the five-week period ended May 12th. These rolling corrections in different sectors of the market can go largely unnoticed, and they are a healthy way to limit the frothiness in some sectors while allowing the overall market to remain in an uptrend. One reason the S&P 500 has not had a correction of 5% so far this year is that the index contains companies that have benefitted during the period of COVID-19’s heaviest economic impact, but can also benefit as the economy moves back towards normalcy. Even with large tech companies making up a significant portion of the index, the S&P 500 has proven its resiliency.

We have seen over the last five weeks that Bitcoin and other crypto-currencies are not a one-way trade. While Bitcoin is still positive for the year, it had a 24% decline during mid-January, and was down almost 50% from its mid-April high through last weekend. Some may find it ironic that the pseudo-currency marked a high on April 15th, the day tax payments are usually due in the U.S. The jury is still out on whether Bitcoin can deliver on any of its promises as a secure, valid currency broadly accepted in exchange for other goods, a store of value, and an inflation hedge. Due to the extreme volatility and drawdowns, it does not appear a reliable store of value. This volatility causes it to also get a failing mark so far as an inflation hedge. Have Bitcoin price movements been at all correlated with longer term changes in inflation? No. It has also been hailed for its benefits of privacy and anonymity. These features also have their downsides, as funds are very difficult to track and are the accepted method of payment for some forms of criminal activity and corporate blackmail. Those crypto backers that utilize the new exchanges for trading and investment are sacrificing most of the privacy and security benefits in exchange for convenience. Will the original benefits win out in the long run? We have a long way to go and there will be many twists and turns along the way, including environmental concerns over the carbon intensity of mining and processing Bitcoin.

Random thought: “For greater privacy, it’s best to use bitcoin addresses only once.” -Satoshi Nakamoto, presumed alias used by the founder of Bitcoin