Financial Advisors

The Path Forward After Stimulus

I've spent a lot of time in my recent blogs, and in our current Quarterly Investment Letter, talking over the present economic and stock market situation, but here I want to focus more on what we've done with that information and what our current view is of the probable path forward for our portfolios.

In brief, given all the short-term distortions of the economy and investor expectations generated by government actions including stimulus, financial asset purchases, and a shutdown of the economy, I believe we can have an unusually high degree of confidence that the strongest economic growth numbers we are likely to see are happening right about now. I don't even think that's a particularly contentious statement. The question is what do we do with that information.

A lot of people think we shouldn't worry about a possible peak in economic data. Many investors believe the market will keep chugging along, admittedly maybe at a slower pace. I don't think that being indifferent to changing data is generally wise, and I think it's even less wise in this case, as we had an enormous amount of artificial stimulus supporting the economy over the last year or so which we will now compare against.

We have seen sharp changes in the quarterly economic data, and that's unlikely to stop quickly. The problem, as John Hussman says, is "Most of the increase in private activity is likely to simply replace federal support, not augment it. The chickens are already here. Investors are counting them twice, and they’re paying record valuations for every one of them." Thus, being sanguine here about continuing growth doesn't seem like a good idea, particularly as we set or are near records in complacency, whether you look at valuations (high), volatility (low), leverage (high), risk premia (low), margin debt (high) or most other measurements of risk. So, do I advocate selling everything and hiding in a bunker? No. What we're doing is paring risk. Where is risk? I think we've already seen the leading edge of that answer. A lot of no/low earnings growth companies typified by Tesla and ARKK funds peaked in January and February. Bitcoin topped in April. Does that mean anything? Could they bounce to new highs? Of course, but right now they have a lot to prove. My thesis is that these are the things that soared as money growth was exploding, and as growth has moderated they no longer work, at least compared to other alternatives.

What else do we want to avoid? Cyclical reopening stocks (e.g., transportation, financials) have certainly had their day in the sun, and I would treat them with caution, as it appears that economic data is starting to roll over. While a lot look like they've peaked, it's a bit early to say that with great certainty. For example, JETS, the airline ETF, is down 15% from the top. XLF (the financials ETF) has been below its 20- and 50-DMA for several weeks, though it's bounced enough that it's only down 4% from its peak. What we've been doing is selectively selling off these types of cyclical stocks as they've potentially approached their peaks. For example, we sold a transportation company around what we thought could be its peak, which still looks like a reasonable call. Why did we sell? They reported great numbers, so great that they could turn out to represent peak earnings. Also, part of the company’s great report is that their pension plan also had a strong quarter, which is not something I'd expect to continue at the same rate.

If that's how we're selling, what are we buying? My judgment is that growth is slowing. You can have a discussion about how fast or slow it's going to move, but it's going to slow, and likely soon. Because of that, we've been looking for high quality companies that were cast aside in favor of the more popular highflyers. In general, the idea is to transition out of what has been working and into what's likely to work as things change after stimulus, and broadly I expect that to be high quality, fairly steady businesses.

Transitioning can be a difficult game, as “low” prices now may not equate with “high” prices later. Things may move faster or slower than I expect, and not everything works out. For instance, I wanted to buy a core grocery store company, and I thought there wouldn't be a great hurry, as grocery store earnings didn't seem likely to look all that impressive in the short term. As I expected, earnings have struggled a bit, but some investors seem to have the same view and bid them up sooner than I expected. Will they drop 15-20% to become attractive again? We'll see. I deal with such uncertainties by trying to have a stable of multiple potential buys. While we didn't get our grocery store, we did get COST (Costco) on sale, seemingly due to a modestly weak sales month. Finally, we were able to buy a core grocery store in our small cap portfolio.

I have to admit it creates a warm spot close to my heart that something like COST started going up immediately, but my main focus is on what will work over the next year or more, not the next week or month. If my thesis for the path forward works out over the next year or so, I will be happy. For instance, utilities have been fine investments for several years, but they haven't looked great in the recent high growth environment. Now, as growth moderates, I believe utilities are likely to chug along while other areas should struggle. Similarly, while nothing bad happened to the long-term setup of gold miners, short-term speculators took the June FOMC minutes suggesting that the Fed may eventually begin to taper purchases and raise rates as an excuse to sell gold strongly. Again, all that happened was the price of gold went down. But real rates seem more likely to go lower than higher as we pass peak economic growth, and money supply, which has been a long-term measure of gold, doesn't seem likely to reverse. Long-term precious metals miners continue to look pretty good to me.

As we progress from quarter to quarter, I'd expect the transition from one theme to another will become clearer. That's how it almost always happens. I think we've already seen the early steps, and as the boulder of slowing economic data rolls downhill and picks up speed it will become more obvious. I try to be well ahead of that type of macroeconomic change, as looking for the next turn in the market’s path can help pick up the new winners with a larger margin of safety. Other investors, with a shorter time horizon, like to treat the market more like a Formula 1 racecourse, where you accelerate to a turn, brake hard, and accelerate out to the next straightaway. It's more like each turn being all or nothing. That market approach means being in one theme until it's exhausted, dump it, and surge into the next apparent opportunity. The racecourse (or market) can get pretty crowded as people head for the next turn (or exit), or the next straightaway (or entrance). That's perfectly fine, but I think it's easier to crash that way, as tech did in 2000 and financials did in 2008, particularly if you're throwing billions around. I prefer to engage in a gradual transition, where we slowly and incrementally step out of one macroeconomic thesis of the market’s path forward and into another. I think our new thesis will look more correct as time goes on, but if it doesn't, and forward economic data picks up more than I expect, it doesn't bother me to revise our path to that likely future.

We definitely have a plan to deal with the future. The future rarely looks like the past, even though that often is the plan of many investors - essentially driving by looking in the rear-view mirror. And our plan also doesn’t involve chasing the current highflyers regardless of risk, until the next sharp turn in the market. Our plan, as set out above, is to build a thesis based on our macroeconomic research, and find a sensible, safer path to our destination of durable wealth.

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This blog is provided for informational purposes only. The information on this blog is based on SCM’s personal opinion and experience and should not be considered professional financial investment advice. The information does not take into account your own personal circumstances or risk tolerance. Our ideas and comments should never be used without first assessing your own personal and financial situation and consulting a financial professional or attorney.

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Colin Symons CFA

Mr. Symons, who holds the Chartered Financial Analyst designation, is Chief Investment Officer and Portfolio Manager of the Symons Capital Management Value, Strategic Wealth and Small Cap Value strategies. In conjunction with his portfolio management responsibilities, he oversees and is principally responsible for the company's independent equity research. Mr. Symons joined Symons Capital Management in July 1997 after working as a software developer in Washington and New York, concentrating on financial services applications for entities such as Chase Manhattan Bank and the Internal Revenue Service. While he was a software developer, Mr. Symons earned the prestigious designation of Microsoft Certified Solution Developer. Mr. Symons earned his BA at Williams College in three years, at age 20.

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