Time to Dial Back

361 Capital Market Commentary | March 15th, 2021

Like many, I have been running my portfolio at either a zone 4 or 5 since the middle of last year. Once the Fed and Treasury gave us the green light to get long in the final week of March 2020, we took it and dialed it up in the summer and fall. While I do think that the portfolio still has legs to ride further up this equity market mountain, I think it’s time to dial it back to zone 2 or 3 for a while.

Why? The most important reason is that so many valuation targets are either being hit or are being rapidly approached. For those companies where I think a Roaring 20’s economic recovery could accelerate the top line and create leverage to the bottom line, I am giving those stocks more room to run. But I do think the market is now expecting a full COVID recovery and it has embedded much of the future earnings upside into today’s stock prices.

At the same time, some companies are running into supply and transportation bottlenecks that could keep them from hitting their targets. This is also impacting some of the price spikes that we are seeing which is causing so much angst in the bond markets. And while I think inflation should be fine in the long term, I have no idea what the bond market will interpret in the short term. The 30% retreat in long Treasury bonds has had an impact on growth and tech stocks. At some point, will this broaden out to the rest of the market? I don’t know. But I also don’t want to be shouldering a massive, long equity portfolio if that were to occur. I want much more rainy-day cash to buy a big correction in the broad market and take advantage of special situations that occur.

From a technical perspective, the financials, industrials and energy stocks have done everything that I have asked from them as holdings. Unloved and undervalued last summer to now leading the market higher. At the same time, I am not a fan of falling 50-day moving averages or stocks falling through their 200-day moving averages—and it seems like that is what many growth and tech names are now exhibiting. In addition, those former best-performing areas of the market are seeing increased volatility and reduced investor fund flows which makes me very uncomfortable. Again, there are some names in which I have sizable gains and am very much biased toward the long term, that I want to own them for many years. But where the upside is limited in the near term, and where the tax gains are manageable, I will be dialing it down.

“All great investments begin in discomfort. One thing we know is that there’s great discomfort today.” (Howard Marks, 3/11/2020)

I came across this great quote from Howard Marks over weekend. Today I feel that the market is very comfortable, and I see everyone wanting to rush into it. I don’t know if this means that all future investments will be terrible, but I am fairly certain that they will not make returns like we made over the past year.

Thanks for checking in today. Denver did survive but with most side streets closed due to the 2-3 foot snowdrifts, few made it out of their driveways today. Schools and most businesses closed for a snow day. Thanks to the Fuji Motor Company for getting me to the office today to write today’s Weekly Research Briefing. Here comes the sun to melt away our snow. Have a great week.

Four and a half million vaccines injected on Friday…

Covid Vaccines
(@PantheonMacro)

April and May are going to be such big months for the U.S. vaccines…

When the US Population Might Be Vaccinated
(@nytimes)

NYC is watching the data and warming up the city for our fall visits…

“Beginning March 19, restaurants will be able to allow 50% capacity, up from the current 35% capacity limit. The announcement follows New Jersey’s announcement that also increased its indoor business capacity, which includes restaurants, to 50%.
(@nytimes)

Las Vegas isn’t even waiting: “I couldn’t even get into the Bellagio parking lot to see the botanical garden. It was filled to capacity.”

Thousands of revelers are already trying their luck against social distancing by packing the Las Vegas Strip as capacity restrictions begin to ease — with photos showing crowds packed shoulder to shoulder in the gambling hotspot.

Nevada Gov. Steve Sisolak signed a “Roadmap to Recovery” ruling Friday that allows casinos to increase capacity from 35 percent to 50 percent as of Monday.

But the news seemed to spark an influx of visitors over the weekend, even before the ruling took effect, according to the Las Vegas Review-Journal — which said only masks and social-distancing signs made it clear it was not like any other year.

(NYPost)

Airlines have quickly added back your favorite U.S. springtime destinations…

Flights to leisure destinations

And today, five major airlines gave positive guidance on Q1 trends due to higher bookings and traffic…

Those airline were: Southwest Air, Delta, United, JetBlue and Alaska Air. Expect others to see the same trends.
@bespokeinvest: US Airline Stocks are on the verge of full climbing out of the COVID hole.

US Global Jets ETF

Covid-free and a pocket full of cash is going to send the U.S. economy into orbit…

The combination of trillions of dollars of fiscal stimulus, ultralow interest rates, and a newfound sense of liberation means the U.S. economy in coming months will be unlike any the country has experienced in decades. Growth will be faster. Inflation will run hotter. The job market could bounce back more speedily than even the Fed expects. This environment won’t be easy for investors to navigate, as a likely rise in interest rates and a rebound in economically sensitive stocks could diminish the lure—and performance—of stocks that worked so well in 2020, including highflying tech shares, work-from-home plays, and speculative special-purpose acquisition vehicles, or SPACs. For those who can pivot as the market shifts, however, multiple opportunities await…

As economic activity resumes, consumer spending should provide a big boost. Americans are sitting on lots of money, and are about to get more: U.S. consumer net worth hit a record $130.2 trillion at the end of the fourth quarter of 2020, up 23.3% from the level in the corresponding 2018 period, and Congress just approved another round of stimulus, checks for most Americans, this time $1,400. “We have never seen the consumer emerge this strong from a recession,” says Chris Harvey, head of equity strategy at Wells Fargo Securities…

As the recovery continues, investors will do best to buy not simply the cheapest stocks, but also those of companies that can out-earn analysts’ estimates. The focus on earnings will be particularly acute, given that 40% of S&P 500 companies had rescinded or stopped giving guidance during the crisis, resulting in a wider range of forecasts than usual from analysts.

At the same time, operating leverage should start to kick in. As the economy perks up, and as GDP estimates rise, profit forecasts should, too. “Once earnings-per-share estimates are revised upward, we anticipate further positive [estimate] revisions,” Harvey says. “Stocks will follow earnings revisions higher.”

(Barron’s)

Earnings estimates are already on a solid uptrend…

S&P 500 EPS growth estimates
(@EarningsScout)

The question will be: “Have stock prices outrun the earnings gains?”…

S&P 500 Change in Forward 12-Month EPS vs Change in Price
(@HumbleStudent)

Valuations one pays for stocks does matter…

Look at these great lists of S&P 500 stocks from 1999 and 1989 and see what trailing 12-month P/E multiple you would have paid for them back then and how well they would have performed for you through 2019. Not a lot of big multiple stocks in these lists. Buying at a lower multiple and getting the long-term growth assumption correct basically guaranteed you 10-20% annual growth.
@Jesse_Livermore: Master List: Cheapest & Most Expensive stocks in the S&P 500 as of 1999 & 1989, measured by FWD P/E (price on date in question divided by 2019 EPS, w/ all interim dividends converted into buybacks that boost 2019 EPS).

Valuations

Valuations

FANMAG’s headwind is that they now have competition from earnings-focused investors…

@edclissold:The 6 FANMAG stocks went from 14% of SPX earnings in 2019 to 25% in 2020. That’s probably going to partially reverse in 2021. Median FANMAG est. is +19% (great in a normal year!) vs. +44% for SPX.
Growth’s EPS tailwind in 2020 is a headwind in 2021.

FANMAG earnings nearly doubled

FANMAG stock price volatility tells you that there is more second guessing going on…

The Nasdaq 100 Index has moved at least 1% in either direction on eight of March’s 10 trading days, a string not seen since the depths of the pandemic-fueled bear market a year ago.

After enjoying bullet-proof status for most of 2020, uncertainty over tech stocks is building as 10-year Treasury yields push above 1.6% and the strengthening economy focuses more attention on cheaper cyclical companies…

All told, the Nasdaq 100 is down 0.2% this month compared with a 3.5% gain in the S&P 500, making the gap between two the biggest since April 2016. This, in turn, is influencing traders’ expectations of future price swings. The Cboe NDX Volatility Index is hovering near 30, compared with 21 for the VIX Index, with the spread between them at a level last seen in September.

(Bloomberg)

No Calm For Tech Giants

What a flip between the best and the worst sectors this year…

“Last year, growth was scarce and growth stocks were doing well, and now growth is abundant and the most underpriced stocks are the ones that are doing well,” said Juha Seppala, director on the macro asset allocation strategy team at UBS Asset Management. “This year, that rotation is going to continue and value is going to outperform growth.”

“People rotating out of large-cap growth and momentum and into these more value, cyclical-type factors . . . has definitely ramped up,” said Michael Lewis, head of US equity cash trading at Barclays. “It’s become something that everybody’s focused on in the past two months.”

(FinancialTimes)

Wall Street's shifting leaderboard

Look Ma, no tech…

Even the top S&P 500 performances YTD through 3/12/2021 have a much different tone.

Top S&P 500 Performers
(@LMT978)

Dow Theory. There I said it…

Dow Jones Industrial Average
(@HumbleStudent)

That is one tight-looking correlation…

Higher Treasury yields have been driving the Russell 2000 outperformance vs. the Nasdaq 100. This makes sense as rising yields are typical with a strengthening economy which small caps are better performers in.

Russell 2000 Relative to NASDAQ 100 vs Ten Year Yield

Time to fire up your Google Translate…

Better equity valuations are found overseas right now. You will need a steel stomach to invest in Brazil. I would sleep much better at night investing in Canadian, Japanese, and German equities.

Global Valuation
(SPDR Monthly Chart Pack)

You think my 60/40 portfolio will earn what?

Two of the world’s largest sovereign wealth funds say investors should expect much lower returns going forward in part because the typical balanced portfolio of 60/40 stocks and bonds no longer works as well in the current rate environment.

Singapore’s GIC Pte and Australia’s Future Fund said global investors have relied on the bond market to simultaneously juice returns for decades, while adding a buffer to their portfolio against equity market risks. Those days are gone with yields largely rising.

“Bonds have been in retrospect this gift,” with a 40-year rally that has boosted all portfolios, said Sue Brake, chief investment officer of Australia’s A$218.3 billion ($168.4 billion) fund. “But that’s over,” she added, saying “replacing it is impossible — I don’t think there’s any one asset class that could replace it.”

Thanks to declining returns from bonds, the model 60/40 portfolio may eke out real returns — after inflation — of just 1%-2% a year over the next decade, said Lim Chow Kiat, chief executive officer of GIC. That compares with gains of 6%-8% over the past 30 to 40 years, he said.

(Bloomberg)


Stock equity up, Home equity up. What a great time to own assets…

@jsblokland: The equity exposure of US households has reached a record- high!

Equity allocation of the US household sector

Consumer spending is 3/4 of the economy, so companies had better be feeling good…

The Evercore ISI business survey index is above pre-COVID levels.

Evercore ISI Company Surveys

What a great time to be a headhunter…

Small businesses will increasingly face one of the most difficult hiring environments ever. The cost of labor will rise to reflect this.

Small Business

Increasingly, future unemployment rates are finding ‘3’-handles…

Path for Job Gains Drives the Unemployment Rate Lower

Meanwhile, inflation spikes refuse to make it through to the consumer…

The CPI report was a bit softer than expected as the core inflation continues to drift lower.

US Core CPI YoY

But we know that airline prices will not stay low for long…

US CPI YoY: Airline Fare

Vacation travel hotel prices will also rebound. How will business hotel pricing react?

US CPI YoY: Hotels and Motels

Today’s Empire State Manufacturing Price Paid was another hand wringer…

@IanShepherdson: Nothing to see here. Please stop talking about inflation, it’s irritating.

Empire State Manufacturing Price Paid

But even with the short-term spikes, economists expect long-term inflation to remain in check…

@vtg2: JPMorgan forecasters barely expect core inflation to get above 2% this year

Inflation

Ditto for Morgan Stanley…

Core PCE Inflation Forecast Profile

But while the economists and the Fed could be correct, the financial markets control the prices and yields of long-term bonds…

After being wrong about rising inflation over most of the last decade, the Fed is now betting the house on red instead, believing that any inflation revival will be temporary. The Fed intends to exit the monetary swimming pool very slowly: first by announcing they will slow bond purchases (currently $120 bn per month); then they will actually start to scale them down; then they will stop purchasing but still reinvest interest; then stop doing that; and then they will raise rates (markets are pricing in Fed 4 hikes by Jan 2023). I’m not sure the long bond will wait that long.

(JPMorgan/MichaelCembalest)

And right now, the long bond markets are screaming in pain…

Bond Markets
(@MattHarrisCMT)

But the markets typically over-react to the first early inflation readings as Henry McVey notes…

Early Inflation Readings
(KKR)

So, when does the market expect the Fed to tighten their Fund’s Rate?

Economists expect liftoff in 2023. But the market has assigned a substantial probability of a rate hike by the end of next year.

Market-Based Probability of Fed Liftoff by End of 2022

While Goldman Sachs increases its GDP forecast (again), it also thinks inflation will be tame and thus has a manageable yield curve forecast…

We have raised our GDP forecast to reflect the latest fiscal policy news and now expect 8% growth in 2021 (Q4/Q4) and an unemployment rate of 4% at end-2021—the lowest among consensus forecasts—that falls to 3.5% in 2022 and 3.2% in 2023. But we expect inflation dynamics to mirror those last cycle, and therefore expect this forecast to translate to only 2.1% core PCE inflation in 2023.

(Goldman Sachs)

US Treasury Yield Curve

Interesting thoughts from Credit Suisse that rising commodity prices will actually help S&P 500 margins…

WTI is up 23% from pre-pandemic levels. Copper 54%. Lumber 116%. Far greater when measured from post-pandemic lows. Rising commodity prices line up almost perfectly with often-cited inflation expectations (breakevens).

Not surprisingly, as commodity prices have risen, business leaders and investors have begun to raise concerns about profit margins. Our work finds a positive relationship between raw material prices and EBIT margins (commodity prices lead by 3 months). Put differently, higher materials costs mean higher operating margins.

The tightness of this fit, shown below, is driven by (1) the relationship between commodity prices and broad-based economic growth, (2) the amortization of fixed expenses over greater sales, and (3) the ability of companies to pass on higher costs (pricing power) in key industries. The recent increase in raw materials prices points to margin upside in 2021.

(Credit Suisse)

S&P 500 EBIT Margins vs. Industrial Commodity Prices

Inflationary stocks are already blowing out the non-inflationary stocks…

The market is increasingly pricing in higher inflation ahead. Stocks sensitive to rising prices have outperformed sharply since the vaccine announcement.

Inflationary stocks

New home prices are surging…

Homebuilders – monthly big data report where 81% of base floor plans saw m/m price increases, surpassing the highs we saw in the fall of 75%. The average m/m price change was +2.6%, by far the highest we have recorded. The most obvious factors are the continued demand strength coupled with rising input costs and tight inventory.

(RBC Capital)

As are new home sales surveys…

Evercore ISI Homebuilders Survey: Sales

This is all because there are no houses for sale in the United States…

Home Sales
(JPMorgan/National Association of Realtors)

Need proof the market was bubbly last week?

Tweet from @charliebilello

If you thought that was bubbly, did you see the Christie’s auction?

“I feel super lucky,” said an artist who calls himself Beeple, in an online forum, upon learning that bidders lifted his digital collage to $20mm in Christie’s virtual auction. “Everydays – The First 5000 Days” ultimately sold for $69.3mm to an investor who calls himself Metakovan, the founder of Metapurse, a fund that collects non-fungible tokens (NFTs). Metakovan paid in ether, which for the 7.70bln of earth’s 7.75bln people who do not yet know, is the digital currency of the Ethereum network. That network resides in the cloud, which virtually no one can quite comprehend even as it becomes integral to nearly all our activities. And Ethereum, despite almost no one understanding what it is, now races toward becoming the foundation of a rearchitected global financial system. “I didn’t see this coming,” remarked Beeple, now the world’s 3rd most expensive living artist. Such is the pace of change, that not even our artists can see beyond the horizon. We now live in a world where a Beeple can produce a virtual image, tokenized into an NFT, and purchased in a virtual auction by a Metakovan for 38,382 ether, settled on the Ethereum network, instantly, securely, all in the cloud, without the need for a legacy bank, or a single dollar. Every aspect of the transaction, from Beeple’s creation of something from nothing to Metakovan’s acquisition of something in exchange for nothing, is high performance art. Sublime. A testament to human imagination, ingenuity, evolution. A glimpse of a wild, unrecognizable future.

(OneRiverAMWeekendNotes)

‘The George Michael Sports Machine’ library could have been worth billions today…

Michael Levy was scrolling Twitter last September when he noticed someone mention something that he wanted to know more about. What is NBA Top Shot? he wondered.

This platform to buy, sell and collect officially licensed video highlights was months from becoming a market that would captivate and mystify basketball fans, cryptocurrency enthusiasts, sneakerheads, pandemic day traders and thousands of people stuck at home. But it wasn’t long before Levy texted his friends: “This could be big.”

He was so convinced that he decided to spend $175,000 over the next six months on digital trading cards. They are now worth $20 million.

The investment was a sizable one for Levy, a 31-year-old financial analyst who says his interests are sports, poker, markets and “trying to identify advantages and edges,” but it appears that he found the latter in Top Shot. It’s why he’s not selling.

“I continue to think it’s an asymmetric bet with fantastic upside,” he said.

(WSJ)

Shoot, my mom probably has at least $5 million in baseball and football cards boxed up in the attic…

@FatTailCapital: It’s not just NFTs – eBay seeing 300-500% growth in basketball and Pokémon cards…

Sporting Goods & Memorabilia Category

Stadium naming deals usually signal the top…

I just hope that Miami-Dade County signs the contract in U.S. dollars.

Tweet from @doug_hanks

Jared Dillian takes note of the increasing ‘never sell’ narrative…

Today, we have people in bitcoin, and the mentality is infinity or bust. Bitcoin is either going to infinity, or going to zero, and I am willing to ride it to zero in order to make infinity. Guess where it is going?

Same attitudes towards stocks, too— nobody is in the mood to sell anything. TSLA got up to an $800 billion market cap or something like that and it was not enough for people—they thought it was going to an $8 trillion market cap. They key point is that nobody is selling anything, because they’re waiting for infinity. That’s different even from the 2000 dot com bubble; back then, at least, people were taking some profits.
The new attitude is: infinity or bust. I should make a hat…

And that’s the thing about the current risk environment—there is no such thing as enough money. People think they’re going to be deca- or centimillionaires. It’s never enough. This is the point in time in which you want to have some humility, and stop at second base instead of trying to stretch it into a triple. You never want to make the final out at third base.

As for bitcoin, well, the market cap of bitcoin is now large enough that the economic impact of it going to zero would be pretty massive—a trillion in wealth wiped from the earth. It’s something to think about if you’re Janet. Not that the government cares about libertarian neckbeards with bitcoin, but there’s definitely a wealth effect here. Because they will hold it to zero.

(TheDailyDirtnap)

But you have to feed the ducks when they are quacking…

GS Risk Appetite Index

Watch what Wall Street does…

The global market for initial public offerings is headed for its biggest-ever first quarter, even as skepticism grows about the U.S.-led boom in blank-check listings that fueled the frenzy.

A record $162.4 billion has been raised by more than 600 issuers in 2021, the most ever at this point in the year, data compiled by Bloomberg show, with special-purpose acquisition companies accounting for half of the proceeds. In comparison, just $37 billion was raised in the first three months of 2020.

Unprecedented monetary and fiscal stimulus, ultra-low interest rates and — until recently at least — global markets at record levels helped fuel both traditional and SPAC listings, with issuers rushing to sell while investor demand is hot and valuations high. Stock prices have been underpinned by optimism that vaccines will tame the coronavirus pandemic, helping the economy to recover.

(Bloomberg)

Best-Ever Start

An important comment by Ed Studzinski in his last Mutual Fund Observer as it relates to Private Asset investing…

I also am becoming more of the mind that the maximum ability to devote time to properly run a business, without the distractions that appear to take away from the profit maximization goal is to be found in private equity situations rather than public equity. My sources involved with private equity tell me that the private equity firms have tended to concentrate on and develop specialties. And resultingly they concentrate their efforts in those situations where they have a skill-set advantage, allowing them to be laser-like focused. Private equity boards and management teams are not cluttered up with individuals or managers who are not attuned to making the business as profitable as possible.

(Mutual Fund Observer)

There are also 6.5x more private companies to evaluate…

In the U.S. there are over 17,000 private companies with annual revenues over $100 million vs. approximately 2,600 public companies with the same annual revenues.
(Hamilton Lane)

U.S. Public & Private Companies By LTM Revenue

Yes, Jerry Seinfeld was right. New Yorkers will return…

“The main problem with moving to Florida is that you have to live in Florida,” said Jason Mudrick, who oversees $3 billion at Mudrick Capital Management and has resided in Manhattan for more than two decades.

“New York has the smartest, most driven people, the best culture, the best restaurants and the best theaters,” he said. “Anyone moving to Florida to save a little money loses out on all of that.”

“It will be like the Roaring Twenties — you’ll see a resurgence here like never before,” said Mudrick, who predicts some of his friends who moved to Miami will soon be back. “You want to be buying New York and selling Florida — that’s the contrarian in me.”

(Bloomberg)

The first complete collection of this comparable data across states…

Life expectancy
(CDC)

Climate change is making its way through bank lending portfolios…

In the last week, Citigroup, Goldman Sachs, and Royal Bank of Canada made commitments to reach “net zero” financed emissions by 2050. This now makes nine large banks that have made such a
commitment, including three of the top five largest financiers (C, BAC, and RBC) of global fossil
fuel activity. It also likely adds pressure to Wells Fargo (second largest financier of fossil fuels) and JPMorgan Chase (largest) to follow suit, with the latter already making a “Paris Aligned Financing Commitment” and will establish 2030 emission targets for its financing portfolio in 2021.
Additionally, the 11 banks we track have earmarked ~$3.5 trillion towards sustainable financing
activities over the next decade.

(Credit Suisse)

Don’t expect to find indoor-grown marijuana companies inside of ESG portfolios…

Most legal marijuana is grown indoors, with some pretty hefty electrical use to match. Now, researchers have attempted to quantify the greenhouse gases emitted, and they came up with some impressive figures. Based on their calculations, cannabis production results in over 2,000 kilograms of carbon dioxide emitted for every kilogram of product (defined as dried flowers), and its legalization has had a measurable effect on Colorado’s greenhouse gas output…

Obviously, cannabis could also be grown outdoors—the authors estimate that switching to outdoor production would drop greenhouse gas emissions by 96 percent and lower Colorado’s total emissions by 1.3 percent. Even switching to a greenhouse, which would handle many of the security issues, would cut emissions nearly in half. Of course, Colorado would have to make changes to its legalization statutes in order to make off-site agriculture a reasonable option.

(ARSTechnica)

Someone is lying…

Global auto sales in 2025 will be about $25B. So, unless truck, bus and helicopter taxi sales become equal-sized markets, all these new EV companies are not going to achieve $10B in revenues anytime soon. Also, have you seen the videos and reviews of the new 2021 Ford Mustang Mach-E? The incumbents are not going to be closing their factory floors to EVs. In fact, they will likely become the winners.

It took Google eight years to reach $10 billion in sales, the fastest ever for a U.S. startup. In the current SPAC frenzy, a spate of electric-vehicle companies planning listings are vowing to beat its record—in some cases by several years…

The forecasts for record-setting growth illustrate the extent of the fervor for electric-vehicle startups, particularly for those going public by merging with SPACs, which are shell firms that list on a stock exchange with the sole purpose of acquiring a private company to take it public. More than 10 electric-vehicle or battery companies that struck deals with SPACs have been valued in the billions of dollars before producing any revenue, as amateur traders and many traditional investors have flocked to the buzzy sector.

(WSJ)

Auto Sales

One wonders what the person at the SEC was thinking about this two sentence 8-K filing this morning…

SEC Form 8-K
(SEC)

Keep an eye out for this one…

Green energy tech company just got a $150M check from NextEra Energy. The company is top tier backed by big brains and AEP. Units are being rolled out to customers now. Energy cost savings plus near nil emissions.

Startup Mainspring Energy Inc. has landed a $150 million deal with a unit of renewable giant NextEra Energy Inc. to deploy a little known power-generation technology that could help businesses avoid grid outages.

Called a linear generator, it uses a non-combustion reaction of air and fuel to move magnets back and forth through copper coils, generating an electric current. In a video illustration on Mainspring’s website, it looks something like a constantly moving pogo stick lying on its side.

Mainspring’s generators are the latest technology targeting businesses that want to cut their greenhouse-gas emissions and generate their own power at the same time, shielding themselves from the kind of blackouts that have recently struck Texas and California. Packed into box-like units the size of a parking space, they can ramp up to full power within seconds and run on natural gas, biogas or hydrogen, which offers the possibility of lower-carbon or carbon-free electricity produced on-site.

(Bloomberg)

Mainspring Linear Generator

Finally, Tweet of the Week…

Tweet from @DavidAGoodman

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