Weekly Email 05/21/2021

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Hello!

Surprise, we're talking about inflation again. Last time for a while I promise, there is just so much important info over the last month I can't help but share it. Next week, I'll tell you about our research roll-out! We're performing a study of 3 sustainability factors and 3 financial factors and working to isolate a few to include in a new satellite strategy. We will also be generating company-specific research reports and making them public so stay tuned for those.  

Let’s recap 

On May 5th, we pointed out that PPI and commodity prices were surging but the effects hadn’t carried through to the CPI yet. Seven days later, we got the newest inflation numbers from the Bureau of Labor Statistics and CPI is finally catching up. The April data shows a 4.2% annual increase compared to 2.6% the month before.  

So… what? 

This news is not a reason to sell any investments. As I mentioned in the last letter, inflation is a great reason to hold anything except the US Dollar. Selling stocks because inflation may harm them is counterintuitive, though changing your allocation may protect you from short-term losses. Holding USD isn’t necessarily bad because the current inflation numbers suffer from the “base effect” which occurs when the previous number was so low that any increase appears outsized by comparison. My long-winded point: don’t panic, but join me in understanding what this economic shift means for your portfolio.  

How markets are reacting 

Concerns about inflation and the general health of the economy have spurred a shift away from “risky assets”. Risky assets in this case are primarily growth stocks, SPACs, recent IPOs, and cryptocurrencies. For the first time in over a year, investors want to make their portfolio safer instead of riskier. Investors are achieving this goal by reducing their investment in “growth” companies like Zoom, Tesla, and Square, and replacing those holdings with “value” companies like Home Depot, Campbells Soup, and Walmart. 

We can see this shift by comparing the performance of VUG, Vanguard’s Growth ETF, and VTV, Vanguard’s Value ETF. VUG has fallen 2.83% in the last month while VTV has risen 2.81%. Similarly, $2.2 billion flowed out of VUG, and $5.3 billion flowed into VTV. It’s important to note that investors are not selling, they are rotating. This means that certain sections of the market are expected to rise while others are expected to fall. Positioning your portfolio on the right side of this rotation is crucial. 

How we’re adjusting our strategies 

We expect the rotation toward value to continue because of a certain domino effect we’ve talked about before. Many investors are already looking past the spooky inflation numbers and eyeing the Federal Reserve. While inflation has a rather ambiguous effect on stocks, the Fed raising interest rates has a very real, very negative impact. If inflation numbers become too hot, it may force the Fed to raise interest rates ahead of schedule. This change would shock valuations (particularly in growth stocks) and most likely cause a market correction. Accordingly, we’re shifting our Omnia strategy toward companies that are sitting on cash and carry less debt compared to their competitors. We are also focusing on products and services that have relatively inelastic demand to allow the companies to pass along the cost of inflation to consumers. Despite the shift, all of our strategies have a growth tilt and we will be maintaining that bias throughout the year. 

In our Salvus strategy, we have reduced the average duration of our bond holdings to 2.71 years (from about 5) with a focus on bonds with higher convexity. The largest holding in Salvus is now short-term Treasury Inflation-Protected Securities (TIPS). We chose to purchase short-term TIPS back in February because these securities are designed to correlate closely with realized inflation in the near future. Holding STIPs allows us to hedge client portfolios against the potential jump in inflation while maintaining low price volatility in a rising interest rate environment.  

Achievable changes 

Many of these changes we’re making can be replicated on your own, it will just take some research. For a comfortable investor, it is possible to screen investments by cash and liquidity ratios, which will offer up a list of stable companies that are cash-rich and not overly leveraged. For a less comfortable investor, a value ETF or mutual fund like the Vanguard fund mentioned above may serve the same purpose. 

Wrap up 

Markets move fast and it’s often difficult to keep your portfolio up to date. If you struggle with this, don’t fret! In many cases investing passively and never touching your investments is as good or even better than making adjustments. Invest passively or actively, but don’t sell. The global economy is continuing to rebound and the vestige of COVID-19 is starting to recede even from India and South-East Asia where it has been particularly devastating these past months. This past year has fundamentally changed our world, in many ways for the better! It would be a shame to watch the incredible innovation and progress being made without taking part. 

If you have any questions you can always schedule a meeting using my calendar link at no charge. 

I hope you have a wonderful Friday!

Warm regards,

Nate Hoskin, CFP®