2021 Q2 Commentary
By Nick Fisher, Portfolio Manager
I’m not sure anyone was prepared for the wild ride that was 2020, let alone the rosy market that we have experienced in the first half of 2021. While technology investors aren’t too happy with their recent losses, we are pleased with our results. Emerging markets, international value and commodities related stocks have done well, but real economic growth (after inflation) is far from certain, as is real returns from bonds. Inflation of course has reared its head, but how stubborn will commodity and labor prices be? And will it be enough to spur longer term inflation? Our non-conventional portfolios have paid off handsomely over the last 12 months. We will likely continue to do well in this Federal Reserve, stimulus driven wonderland we are experiencing.
Occasionally investors can harvest unique and wide ranging return outcomes. This tends to happen when recent trends reverse course. We discussed the bubble that had formed in many technology stocks by the end of 2020 and sure enough those stocks have declined recently. I had previously mentioned the ARKK fund as the poster child and media darling. After some spectacular returns in 2020, it has given 25% back from its high (despite a 20% recent bounce). That’s how bubbles work and I don’t think it is finished. It took multiple legs down over 18 months for the 1999/2000 bubble to deflate.
Another trend that has reversed course, is the out of favor nature of international value and emerging market stocks. For the first time in recent memory international value stocks have become momentum stocks. As the institutional investors rebalance their portfolios, we will continue to benefit from this overweight in our portfolios as they add what we already own to their portfolios. The chart below shows the drastic change in one such index from the introduction of cheap value stocks and the related decline in valuation.
I mentioned in our last letter that these trends tend to have some persistence to them, but they don’t last forever. A market that is absolutely and relatively inexpensive and could see some benefit from value and momentum trends is the UK. In other words, this is not a market that is significantly risky from a geopolitical perspective, but it’s not exactly the belle of the ball either. We believe that the risk/reward proposition is attractive.
With the current bout of inflation we are experiencing, all eyes are on the Fed and all eyes are on every subsequent inflation measure print through this summer and into fall. We are once again leaning toward caution as our stock market returns have far exceeded our expectations.
There is no place to hide in the bond market currently. Even “high yield” bonds have a negative real return (after inflation).
On the other hand, energy stocks have been very good relative to inflation (as expected). Suncor Energy is our largest energy holding. Below is a chart showing how correlated the stock price has been to energy prices over the last several years.
This is a really interesting setup. Either the gap between the two will close by energy prices falling or the stock price will increase as profits return. There is less risk to the downside unless energy prices fall below $50 again and this is unlikely unless we have significant economic slowing around the globe. This setup is also an interesting metaphor for the broader market with respect to inflation/deflation. We see two likely scenarios:
If energy prices stay high (ie demand for energy is strong), there will likely be a government response to inflation.
If energy prices fall and we see economic slowing there will likely be a government response to avoid deflation/recession.
In both scenarios, fiscal and monetary policy will hold the key to the path forward for the inflation/deflation debate and consequently investment portfolios writ-large. I hesitate to project forward one scenario or another at this point, but we are definitively prepared to make changes to portfolios should the path become more clear.
Gold miners over the course of this crises have been a reliable source of return. More specifically, they offer an interesting dividend yield as the underlying value of gold has been steadily increasing, and the balance sheets of gold miners are as strong as they have ever been. Furthermore, gold miners have been negatively correlated to energy companies.
Similar to 2019 we are beginning to prepare for volatility, however that materializes. It’s not that we expect some impending event or are timing the market. It’s simply the calculous around the risk/reward for holding stocks in general has become less attractive.
