The Bull

Stock prices forged ahead during October, gaining 7.01% for the month (24.04% YTD) as measured by the S&P 500. This is a bull market, no question about it.  September’s challenges and 4.65% price drop seem a distant memory with the market’s recent strength.  A multitude of interesting headlines have changed the landscape:  Tesla share price rose 47%, lifting its stock value above $1 trillion; Microsoft surpassed Apple as the largest US stock by market cap; and Facebook has re-named itself Meta. Prices are a little punch-drunk having recorded new consecutive daily and weekly highs.

The backdrop is based on a generally positive narrative.  In the US, the pandemic seems to be largely in the rear-view mirror, and there are also positive signs across the globe. Vaccines and recently announced therapeutics from Merck and Pfizer have turned the tide; medical science and effective public health protocols have won. The employment outlook is encouraging as October payrolls showed strong gains in multiple respects and the unemployment rate fell to 4.6%. Wages are improving and jobs are available.

The world around us is changing rapidly and we’re not going back to the “good old days”.  Hybrid work has enabled many businesses to thrive by offering employees modified work from home arrangements and cloud computing is continuing to transform business productivity. Emerging alternative sources of energy and technology that are coming to market exponentially faster and the adoption of EV’s and the related technology (batteries, charging infrastructure, etc.) is advancing at a frantic rate.  It’s fascinating that 25 years ago, the three largest companies in the US were General Electric, Coca-Cola and Exxon.  Today, they are Microsoft, Apple and Alphabet (Google).

In my opinion, while we should expect continued strong economic growth into 2022 and a constructive fundamental backdrop, there are some things to watch.  One is weak consumer confidence; it has not rebounded in synch with the overall economy. The worry is that the pandemic led to a pull-forward of buying that has not yet normalized and is causing a demand slowdown. Consumer sentiment may also be related to the insidious inflation conversation.  The irony is that while jobs are plentiful and wages are higher, consumer mood may be dampened by highly visible price increases in things like gasoline.   

Other obvious concerns across the globe include the impacts of climate change, evolving international tensions and political polarization gridlocking policy making.  In the US, there is an emerging urgency to pay for many of the things (infrastructure) long neglected, some of which may be repaired with the recent $555 billion infrastructure bill. We are also experiencing a change in the culture of work with persistent low participation rates (high quit rates) we’ve not seen before.  Finally, the persistent concerns over inclusivity (specifically racial equity) is a weight on everything. 

As I look forward to 2022, there is good reason for optimism.  The market typically will climb a “wall of worry” during a bull market, rising in spite of investor fears.  I think the inflation scare is largely that: a scare. Core PCE for September indicates a reversion to the mean after the pandemic related surge. With interest rates low, and likely to remain low for an extended period, we are actively looking at other investments we can use to bridge the gap. These include private credit, impact and value-based investing, and some opportunities in the alternative investing space. We are also investigating possible investments we can make in the crypto and carbon credit space that may prove useful in the current marketplace.

Please do not hesitate to reach out if you would like to catch up.  We are working from the office if that helps.  We are happy to review your capital gains in light of the pending tax law changes, or other aspects of financial planning we may be able to help you with as we approach year end.  The last three years have produced some remarkable returns; our goal is to help you preserve your wealth as we navigate the ever changing markets in the years ahead.  Please be safe out there.

Bruce Hotaling, CFA
Managing Partner

Sit Tight

What a difference a month can make?  There was increased volatility and tension this past month as September saw stock prices fall 4.6% (as measured by the S&P 500), the first substantial drop since the March 2020 onset of the virus. Investors had been lulled by seven successive months of positive returns even though September is historically a challenging month for stocks.  According to Barron’s, the average September return for the S&P 500 has been a loss of 0.99%, dating back to 1928.  While the better known calamities (the great crash of 1929, Black Monday in 1987) both took place in October, September is the more likely month for stocks to underperform.  Even still, stock prices are up an impressive 15.9% year to date.

On the margin, several things changed during the month that may well influence stock prices through the end of the year.  One was the potential insolvency of Evergrande, the Chinese real estate development company inflamed by the media referring to it as the next “Lehmann moment.”  Late in the month, interest rates inflected upward, amplifying fears of “sticky” inflation even though supply chain and labor constraints are amply well known.  We also saw a curious positive correlation between stocks and bonds, which has temporarily eliminated the important diversifying effect of owning bonds in a portfolio.

Washington DC once again took center stage with the looming government shut down and concerns over the debt ceiling.  In my opinion there will not be a default.  It is equally unlikely we will see the birth of a $1 trillion coin to mop up excess borrowing.  I think President Biden’s $3.5 trillion Build Back Better plan will have to be rationalized as Washington is divisive.  The attention around DC is not necessarily investible, unless of course you are an “insider” which we are not, and it is extremely hard to make bets on congressional outcomes.

In better news, more people are getting vaccinated and many are lining up for the booster, at least in the US.  According to the Centers for Disease Control and prevention, 77% of American adults have at least one shot; we may indeed achieve some level of herd immunity.  It seems that the Delta variant that has been sweeping the globe spurred more people to get vaccinated.  The economy, the workplace and our social patterns are adapting to a post pandemic “normal”.  One area where this is not the case is the political sphere, where efforts to politicize the handling of the virus for political gain over public safety are shameful.

While some effects of the pandemic may be winding down, several aspects are not.  We should expect the supply disruptions to continue on-and-off for some time; we do not now know how to put a time frame around this.  Low inventory levels in certain industries is also an issue.  The same goes for the bouts of inflated prices that keep appearing like a whack-a-mole.  Surges in prices for copper, lumber and coal have created noise and confusion and the apparent tight job market has improved wages, something long overdue.  Some of these disruptions will likely put some downward pressure on corporate earnings, but I doubt there will be any sort of long-term effect.

My view that some additional cash makes sense at this point has not changed.  This is not with a mind to opportunistically buy if the market suddenly drops, but to allow you to sustain a longer, more challenging period when “sitting tight” is the best course of action.  Bond yields remain historically low and quality stocks remain the best game in town.  We have adjusted our stock models to more appropriately align with the value and dividend factors driving returns. 

As we head into the final quarter of 2021, I remain optimistic that our research and analysis have positioned your portfolios well.  I expect there to be strong earnings into 2022, and the effects of the virus on the global economy to abate.  We are continually revising our view and modifying our holdings with the evolving landscape.  Please feel free to reach out if you would like to discuss this with me or our team.  We are also more than happy to address any tax or financial planning concerns you may have.  Take good care.

Bruce Hotaling, CFA
Managing Partner

A Bird’s-Eye View

The market’s year-to-date returns are impressive, no doubt about it.  For the month of August, stock prices advanced 2.9% (as measured by the S&P 500) and are now up 21.6% year to date.  Stock prices have been positive for seven straight months.  To a degree, I think the stock market is an effective leading indicator of its future price level; at the same time prices will eventually correct and fear will emerge – and it’s a fool’s game to attempt to guess when that might happen. 

The greater forces effecting prices are, in many ways, unique this year.  The gamification of trading financial assets has attracted many new participants.  Robinhood Markets, Inc. and other low/no commission trading platforms give people the impression that because they can trade, they will make money.  That is a dangerous misperception.  According to Bloomberg, 37% of Robinhood’s Q2 ’21 transaction-based revenue was from options trading, and an eye popping 52% was from users trading cryptocurrencies.  Financial news and social media meme platforms such as Reddit and Twitter actively promote casino-like trading.

This type of highly speculative trading is vastly different than long-term investing.  Investing in financial assets has historically improved people’s financial condition over time.  For example, Bespoke Research recently produced data showing the S&P 500 has generated a positive total return over every rolling 2-year period dating back to 1928 in excess of 82% of the time, no matter when the measurement period began.  While daily returns to stocks are more or less a coin toss, stocks stand a very good chance of making you money in the long term.  The day-to-day attribution of current events to the behavior of the stock market can often be interesting, but not necessarily important in the long run. 

There are several macro shifts in the greater playing field that I think merit some attention in how we invest your portfolios.  One significant and obvious one is climate change:  we have wildfires in the west and floods in the east and EV’s and green energy are here to stay.  China is a large and important player in the global economy and its recent transition (or return) to “common prosperity” may confuse the rest of an otherwise capitalist-ish global playing field.  Not new, but growing in importance, are crypto currencies, decentralized finance (DeFi) and the move toward central bank digital currencies.  Finally, the virus and lacking public health have spotlighted dire need across the globe.  The virus will have long lasting effects on everything and is fueling a cultural war based on entrenched beliefs. 

Our goal is to generate positive returns in a complex and competitive market place.  We nuance our portfolios to align them with the best performing factors and style characteristics at that moment.  Currently, quality stocks (blue chips), dividend payers and stocks with somewhat long durations (stocks that are valued largely on strong future cash flow expectations) are in vogue.  I think crypto assets and technology are here for the long run and reflect a transformation in both emerging finance and the smart contract capabilities of blockchain technology.  I don’t think this reflects a bubble, as many old guard investors have opined.  I do think there are multiple aspects of the old regime that are transforming quickly, leading to a somewhat precarious crossroads between the old and the new. 

It is easy to get too close to something, so close we cannot see it with true clarity.  Stepping back can often generate a degree of perspective that seems to change everything.  With the stock market making regular all-time highs, there is considerable hand wringing.  The simplest solution is to take some profits and feel good about the market having done some true work on our behalf.  We cannot guess when the next downturn will occur, and attempting to hedge a portfolio is expensive.    I think we need to factor in higher capital gains taxes in the future, so taking some profits now is reasonable. 

Please feel free to check in with us if you would like to schedule time to review your portfolio in greater detail.  We always look forward to connecting with you.  Be safe out there.

Bruce Hotaling, CFA
Managing Partner


Stock prices, measured by the S&P 500, advanced 2.5% in the month of July, and are now up an impressive 18.1% year to date.  Stocks have posted gains in each of the last six months, a sturdy run.  According to Bespoke Research, after six-month periods of positive returns, stocks generally continue to advance in the ensuing six- and twelve-month periods of time.  Seasonal tendencies can be misleading but are based on actual historical return trends. 

Earnings for the second quarter are wrapping up.  They have been impressive and there is ample reason to believe they will continue to trend higher.  At the start of 2021, analysts projected $175 a share for the S&P 500.  That number has since risen to over $200, and the figure for 2022 is $220 a share and rising.  This is extraordinary considering the year of the financial crisis, earnings fell to just $50 a share.   According to FactSet Research, the blended net profit margin for the S&P 500 in 2Q 2021 is 12.9%, the highest ever reported by the index since tracking began in 2008.

Any good contrarian will point out that stocks are expensive.   The forward 12-month PE ratio (a measure of relative price using estimated earnings) for the S&P 500 is 21x; well above its 5 and 10 averages. When stock prices are “high” as they are today, they are referred to as overbought.  With the market trending higher, a bullish indicator, this overbought condition can persist.  The ratio has ticked down slightly as we are seeing earnings grow faster than stock prices. While the measure may apply to the market as a whole, our effort is to buy individual stocks with attractive relative valuations.

Inflation has been the leading topic of conversation among market watchers for some time now.  I do not think inflation will derail the stock market.  Inflation is inherent in any growing economy; it is also a hot button.  We are seeing increased inflation figures due to the numerous reopening (transitory) pressure points leading to price spikes in used cars, airfare, hotels, transportation, and warehousing and we will also see these normalize.  Separately, though not widely acknowledged, one of the best asset classes to navigate the threat of inflation are common stocks. 

Patience will be important here, as the labor market slowly gets back on its feet.  Fair wages and working from home will be cumbersome for the old guard to step forward and address.  Office occupancy rates remain in the 30-40% range.  The rate of vaccination (appaling in some areas) is important, as is the gradual re-start of global supply chains.  The pandemic is global and far more present in certain communities and countries around the word, causing economic friction.  Unfortunately, fewer people are promoting and adopting mask wearing and the recent surge in COVID case counts in the US is concerning. 

We ought to expect some increased volatility in stock prices: there has not been significant drop since September 2020 when the S&P 500 dropped over 10%.  The issues at hand then related to uncontrolled waves of the pandemic, fears over the upcoming election, and the general state of the economic recovery.  Today, the delta variant is looming, fiscal and monetary policy are diminishing as drivers, and there is an obsession relating to Federal Reserve policy and inflation.  The point is, the market has been complacent, and that’s often worth heeding.

In my opinion, interest rates will remain low for some time, with the Federal Reserve well aware of the challenges the economy faces.  Focus remains on quality growth stocks – ones that can bring above-market growth, earnings, and continued innovation to the table in what may be a continuation of a declining growth and lower inflation marketplace.  I also think there is an extended trade in reopening stocks, which will benefit the most from the eventual normalization of the global economy.  We are putting more emphasis on stocks with longer term sustainability and ESG criteria.

Please feel free to check in if we have not been in touch recently.  We do try and respect your summer holiday and family time, but we are here if you need us.

Bruce Hotaling, CFA
Managing Partner

Musical Chairs

A surprisingly profitable first half of the year is in the books and we have the midsummer holiday to sit back and reflect. Since the market effectively crashed with the onset of the pandemic, stock prices have been rallying for the ensuing 15 months. Stocks ended June up 2.2%, and are now up an impressive 15.25% year to date. We are in a bull market, and there is a risk of missing out if investors cannot overcome their inherent doubt.

According to Bespoke Research, the market is up 5% in each of the last 5 quarters and prices have been higher 12 of the 15 months since April 2020. That is an impressive batting average and presents a favorable backdrop in support of remaining well invested. When stocks are in a bull market, or trending upward, history has shown it is typically profitable to stay long and avoid trying to guess what might derail the market, or more importantly, when the trend might end.

There are a number of factors to support continued strength in stock prices. Stock prices are enjoying the continued messaging from the Federal Reserve that the emerging signs of inflation are transitory and any rate hikes will be more closely linked to signs of strain in the labor market (low unemployment and higher wages). Consumers are flush with cash and spending money on houses, cars and, now that the pandemic has subsided, dinner out and travel. Job formation is robust and it appears likely that US schools will re-open again this fall as the pandemic here subsides.

Corporations are issuing positive guidance for the remainder of ’21 and the technology sector is leading the way. According to FactSet Research, analysts expect double digit earnings growth for 2Q and the second half of ’21. Earnings estimates have increased notably since the end of Q1. Analysts project a 12% increase in stock prices over the next 12 months (S&P 500 price target of $4,785) and also expect S&P 500 forward earnings of just under $210 a share in the same time span, putting current prices at approximately 20 times forward earnings.

The fears investors are wrestling with are many. The one most often discussed today is inflation – will structurally higher prices in wages and goods ultimately bog down the economy, to the detriment of stock prices? Another worry is valuations. If interest rates are in fact on the rise, will that have a negative effect on what is already a relatively high PE ratio? Seasonally lower liquidity may lead to higher volatility as summer comes into full swing. This is because many investors will head for the beach and leave their concerns behind – possibly more so in the aftermath of the pandemic. The obvious fear as we near the end of the stimulus-induced bull-run is that when the melt up is complete, stock prices will inevitably melt down.

The key to success will be diligently holding on to an appropriate asset allocation. Investors with ample liquidity, income or time can well afford to hold on to a full stock weighting. Investors without other sources of liquidity, income or with near term spending needs will want to continue a disciplined adherence to their diversified asset allocation. This aspect of the investment process has been made more difficult with the historically low interest rates.

We remain confident in our stocks in the growth camp, those with higher PE ratios, but also with long histories of exceptional growth and innovation. We are also taking positions in stocks in the value camp, with lower PE ratios. These stocks are poised to benefit the most from a continued post-pandemic economic boom. Importantly, good stock selection is critical. Investors making indexed bets may will likely be left wanting.

Finally, I am pleased to introduce you to the two newest members of our talented team. Colton Growney, CFA recently joined us as an investment advisor with a specialization in portfolio management. Hannali Patidar joins us from JP Morgan and will begin by assisting Jennie in back office administration. Separately, Jennie and Jesse are immersed in the CFP certification process, sharpening their financial planning skills to better serve your needs. As always, please do not hesitate to reach out if life brings you change and you would like our help.

Bruce Hotaling, CFA
Managing Partner