Take A Breather

Stock prices are now up an impressive 12.6% year to date. After eye-opening results in February, March and April, prices were more muted in May: up only 0.5%. The push and pull taking place behind the scenes is between those investors buoyed by the stimulus and high growth expectations, and those concerned with the threat of runaway inflation. Of course time will tell but I am in the growth camp until evidence mounts to show that excessive inflation is here to stay.

Since mid-April, the stock market has been moving in a sideways pattern and interest rates have stabilized. This period of consolidation is a good sign and supports favorable expectations going forward, while I think stronger economic growth over the next few years will both steepen and shift the yield curve higher. Yield curve shifts can result from either increased inflation expectations or increasing rates of real GDP growth. Markets have a long history of generating healthy returns in both rising and falling rate environments.

From a more fundamental perspective, the current backdrop supports attractive earnings forecasts. Q1 ‘21 earnings data from FactSet Research indicate the highest percentage of companies reporting positive EPS surprises and the highest net profit margins (12.8%) since FactSet began recording this data in 2008. The forward P/E ratio is 21 (5 year average is 16). FactSet bottom-up EPS estimates for CY22 are $210 per share (and recent J.P Morgan research indicates $225 for CY22 and introduces $245 for CY23). These earnings estimates are the foundation of today’s stock prices.

There are concerns brewing with respect to peak earnings and peak margins, causing some rotation in investor focus, though it is not a threat to the broader outlook (it’s more akin to a head-fake than a true deceleration or change in the directionality of the market). There is also the concern that the Federal Reserve will modify its guidance with respect to interest rates. This is a question of when, not if. As long as any policy changes are well communicated and incremental, rising rates may have a short-term impact on stock prices but should not produce a long-term effect.

Inflation is a natural occurrence in a growing economy. When a tariff war and then a global pandemic cause breaks in supply chains, and shuttered businesses come back online, there is reason to expect a period of adjustment before production, distribution and pricing realign. It is premature to label the global economic restart as the onset of systemic inflation and I think it will prove to be less of an issue than many, on Wall Street and off, are postulating.

The meme-trading frenzy continues, making it difficult for many investors to keep their eye on the ball. Skyrocketing stock prices and energized news reports are quick to catch investors’ attention, however this type of stock trading is not investing. It is no more grounded than playing the tables at your local casino; not many beat the casino and being lucky once is no assurance of winning again. In the stock market, making informed bets, managing risk and managing one’s emotions are critical to producing long term investment results.

In a similar vein, Crypto has reared up again with a related conversation over digitized central bank currencies. Institutional investors are getting on board, and I expect the regulators will initiate some oversight. I think the many crypto currencies are akin to an emerging market – an asset class with expanding influences, particularly in fin tech. The narrative is compelling (similar to the dot.com era) and participation is broadening. We are centering our attention on businesses that can thrive from the continued establishment of crypto assets and blockchain technology.

Our focus in this market remains on owning a full weighting in quality stocks well positioned in their respective markets. We are focusing on a mix of big growth and technology stocks, as well as more economically cyclical value stocks. We are less incentivized to buy fixed income with interest rates as low as they are, though a nice positive to the low-rate backdrop has been the enhanced interest in high dividend yielding stocks and REITs.

Take good care and please be safe out there.

Bruce Hotaling, CFA
Managing Partner

Blockchain & Cryptocurrency, blog from Matthew J Mulholland, Investment Advisor

It seems like everywhere you turn, someone is posting about Bitcoin, Ethereum, or blockchain in general, but like most people, I merely thought of this as a passing tech gimmick. Since starting at Hotaling, I wanted to find some way to make my mark on our client base, so as the resident millennial, I figured that the fledgling world of cryptocurrency would be a great place to start.

Cryptocurrency is a broad term to describe any digital, encrypted asset that serves as a medium of exchange. While concepts of cryptocurrency date back to the end of the 20th century, the term truly caught on with the invention of Bitcoin in a paper published in 2008 by the pseudonymous Satoshi Nakamoto in 2008.

In the paper, the author lays out a plan for a fiat currency build around “block chain”. Blockchain is an algorithmic way to securely and openly maintain a list of records. Ownership history is stored through a public record attached to the individual asset (the bitcoin), and the public record is adjusted every time the asset changes hands. These changes are then distributed throughout the entire network. Through this peer-to-peer storage and the NSA-created, one-way encryption algorithm known as SHA-256, the more widely adopted the currency, the more secure the blockchain. The supply of bitcoin is also controlled through this open-end encryption, as new blocks are only created as users are able to crack parts of the algorithm through a process known as “mining”. Instead of pick axes and hard hats, customized computers with multiple GPU (Graphics Processing Units) attempt to verify the blockchain. Successful attempts slowly decipher new blocks, and the discoverer is subsequently rewarded with new Bitcoins. While the most common usage of GPU’s has been for high-end video gaming, miners have found that these chips are better at doing many simple calculations (which is required for mining) than CPU’s, which traditionally do most of the labor in a home PC.

A change is coming to the Bitcoin encryption technology on August 1st, 2017. The change, called “Segwit2x”, increases the block size, as well as having many other stabilizing effects. Market participants are divided on whether or not to begin utilizing this code in their mining, with the dissidents believing this change will lead to a corporatization of bitcoin. They want to retain bitcoins status as a libertarian currency, which differentiates itself from Ethereum, a similar blockchain-based currency whose price has surged in 2017 due to its more corporate-friendly approach. If a majority of miners do not adopt this new technology, Bitcoin would split in two after August 1st, with a SegWit-only bitcoin, and a duplicated non-SegWit compliant bitcoin. Such a deviation is almost certainly bound to increase volatility in the already volatile cryptocurrency.

While investors may be enticed by the exorbitant returns in the currencies themselves (Bitcoin up ~140% YTD, Ethereum up ~15,000% YTD), the volatility and liquidity of these currencies makes them too risky for direct investment for most clients. However, there are many other ways to profit off the recent surge of interest in these currencies, if you believe this trend to continue. The surge in mining requires many more graphics cards to be sold, so a long position in the leading providers of these cards, could act as a proxy for Ethereum/Bitcoin. The surge of interest in these cards has left suppliers with limited inventory. Chipmakers with larger scale production already in place are in a better situation to profit from this short term burst of interest.

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