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: https://www.shelterboxusa.org/
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
Correction
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
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
Does the Fed Have Our Back
March 24, 2021
Dow: 32,420
The Fed has a dual mandate: pursue full employment while keeping inflation low. As the years have passed, they seem to have added even more to their plate. They have shown concern for instability in both domestic and overseas markets, a weakening or strengthening dollar, the fiscal deficit and debt, climate change, and income inequality. Some say they have one arrow and multiple targets. Actually, they have created more arrows for themselves by becoming a key purchaser of both Treasuries and mortgage-backed securities. Once again, the markets are leaning on the Fed for continued support and fearing when that support might begin to be curtailed.
The last rate increase cycle that took place in 2017-18 is instructive. From December, 2016 through December, 2018, the Fed implemented eight quarter-point increases, moving the Fed funds rate from 0.375% to 2.375%. At that time, we did not believe there was any compelling reason for the Fed to start a tightening cycle; CPI vacillated between 1.5% and 3% even as unemployment continued to drop below 4%. The S&P 500 gained over 20% in 2017, but fell 5% in 2018, with a 15% correction in the fourth quarter of 2018. We always believed that the markets would have to force the Fed to stop the increases, and the first cut came in July of 2019 as inflation and GDP drifted lower and the stock market was close to flat for nine months prior to the cut. At no point in the last decade did consumer inflation move over 2.5% per year on a sustained basis, even as unemployment moved below 4%.
In addition to what was learned in that rate cycle, the Fed now has the added uncertainty of the pending COVID-19 recovery. Will businesses be willing to rehire anywhere near as quickly as they laid off employees? The Federal debt has ballooned, and the Fed certainly worries about the ability to finance that debt at low rates. They also know that those on the lower end of the income scale suffered disproportionately from the economic effects of COVID-19. They know that easy money doesn’t significantly help that portion of the population until the unemployment rate again moves towards past lows. Those with non-specialized skillsets are the first to be laid off and the last to be rehired. The Fed has already told us that they will allow inflation to run above 2% for a period of time. Will they let it run at 3% or more if they believe that there is still work to do on the employment recovery? That certainly is more likely now than it was a few years ago.
Recent economic numbers have come in below expectations due to winter storm Uri. Almost ten million people lost power, the greatest number since the New England storm of 2003. This resulted in a downtick in home sales and first quarter GDP, which is now expected to be in the 6% range rather than 8%. Don’t be fooled; the economy continues to move toward a broader reopening as the U.S. vaccinates millions of people per day, and the caseload for the virus continues to drop even as people increase their activity, travel, and interactions. We will see a move up in the CPI, potentially above a 4% annualized rate, in the coming months. Supply chain bottlenecks will exist as the economy rebuilds inventory. Some of those supply line constraints already exist in the semiconductor space, and the shortages have been so severe as to lead to temporary shutdowns in major automotive plants. We would expect inflation to settle back after the spike over the next few months.
The uptrend in the stock market should continue broadly in line with the reopening and increased vaccinations. The market leaders of the past year have corrected, with the NASDAQ Composite Index down over 10% through March 8th. Value stocks have outperformed growth stocks this year in anticipation of the economic reopening.
Longer term interest rates have also risen over the last two months, resulting in negative returns in most longer fixed income portfolios. This move off last year’s lows was also expected, but impossible to time. It is also another sign of the forthcoming economic recovery and can be managed through proper portfolio positioning and allocation. With higher portfolio yields currently available, portfolios should be less price sensitive to similar rate moves going forward.
The Fed does have investors’ backs this time. They want to see the economy heal, and they want to do all they can to help those who were hurt most by COVID-19. Expect them to continue to resist a push for tightening, regardless of the inflation numbers, until the unemployment rate has moved below 4% for a significant period of time.
Random thought: “Our greatest responsibility is to be good ancestors.” – Jonas Salk, inventor of the polio vaccine
Auld Lang Syne
December 29, 2020
Dow: 30,336
The traditional New Year’s Eve song has its origins in Scotland in the late 18th century. It was a song of longing and melancholy for better times past. That can certainly describe the feeling we have all had for most of this year. In the investment world, this time of year usually involves a summary or reflection on the past year as well as a look forward to what the next year may bring. Let’s skip the former.
We look to 2021 with excitement and anticipation. The prospects for a broader return to a more normal economic and social environment are strong. COVID-19 vaccine distribution has begun, but success will not arrive on a given date, it will come over time. The more individuals that gain immunity by experiencing a bout with the virus or by getting vaccinated, the more difficult it will be for the virus to continue its spread. There will be a balance, and precautions will still be needed for a period of time. Expect continued disagreement over the level of precaution that will be necessary, as has been the case throughout the pandemic this year. Nevertheless, risk in any given situation will begin to decrease.
We find many reasons to be optimistic about economic and market prospects for 2021. Housing has been a beneficiary of changes in behavior and outlook during the pandemic. New and existing home sales have skyrocketed, and backlogs at many builders remain high. This building boom is supported by a surge in existing home prices and sales, and by a move in borrowing rates to historic lows. Both new and existing home sales rates are up over 20% since 2019, and prices are up more than 10% this year. An uptrend in home prices supports consumer optimism and future spending.
At the corporate level, inventories have been drawn down to lower levels, and capital expenditures have been cut at many companies to preserve cash through these uncertain times. Both have room to grow to much higher levels in 2021. Both will need to be triggered by an increase in consumer expenditures, but that too could be on the horizon as vaccines are more widely distributed. Weakness in the dollar could add a tailwind to the earnings of multinational companies going forward.
The Federal Reserve has pledged to stay out of the way during the recovery. Fear of the Fed “removing the punch bowl” has tempered rallies in the past. Currently, the Fed is telegraphing rates near zero for at least the next two years, and possibly longer. They also have claimed that they are willing to tolerate a rate of inflation above 2% for an undetermined period of time. This could allow companies to raise prices while still taking advantage of low borrowing costs, resulting in more positive leverage to margins and earnings.
The household savings rate has ballooned during 2020 and could be another source of funds for spending and growth in 2021. Total household savings has increased by approximately $2.5 trillion dollars through the first ten months of 2020. This increase has taken place even as consumers have paid down debt this year. This level of savings has been a net detractor from GDP in 2020 and could be a significant add to GDP in 2021 and beyond.
Regardless of the positives, equities and fixed income markets have moved up significantly in 2020. If we look back to the market correction in 2018, we may find some indication of a potential signal of a market top. One place to look is to those areas of the market that have had the largest moves up over the past year. The S&P 500 peaked on January 26, 2018 and did not show a 10% gain over that level for more than 20 months. Bitcoin peaked on December 17, 2017 and fell 40% over the next five weeks as the S&P 500 continued to rise. The most volatile areas of the market may provide early clues for the next correction.
We thank you for the trust you have placed in us, and please share our best wishes for a happy, safe, and prosperous 2021.
Random thought: Success is a lousy teacher. It seduces smart people into thinking they can’t lose. – Bill Gates