Subscribe

Get the latest investment articles in your inbox.

The ValueAligned Model Portfolio (“VAP”) is up +11.4% for 2021 as of Thursday May 20, 2021. The S&P 500 Index is +11.4%.
The broader market bounced back nicely yesterday following the past week’s selling.  Tech stocks were particularly strong, with the S&P Technology Select exchange traded fund (ETF) up more than +1.9%%.

 

Our top three stocks were Broadcom (AVGO, +3.0%), NXP Semiconductor (NXPI,+2.4%) and Markel (MKL, +2.4%). MKL, our specialty insurance stock that made a new high today.
This action is especially encouraging as it signifies signs of buying pressure in many of our stocks and that the rally is more broad-based than it has been.

Inflation: The Magic Number is Four

Last week we found out that inflation measured by the Consumer Price Index (CPI) soared at its fastest 12-month pace in 13 years. The CPI rose +4.2% year-over-year and +0.8% month-to-month in April. Both exceeded economists’ estimates for a +3.6% year-over-year increase and a 0.2% month-to-month increase. Core CPI, which strips out food and energy costs, jumped +3.0% year-over-year.

The Producer Price Index (PPI) also surged in April, rising +6.2% year-over-year. On a month-to-month basis, the PPI climbed +0.6% in April. To put this into perspective, economists were only looking for a +3.8% year-over-year increase and a +0.3% month-to-month increase. Core PPI, which also excludes food and energy costs, jumped +4.6% year-over-year.

Inflation rising above 4% last week proved a shock for inflation-sensitive assets, with bond yields jumping and stocks falling, growth stocks most of all.

And in the chart above you can see that the University of Michigan Survey of Consumers shows that consumers expect inflation to exceed +4.0%.
Just look around us. The +17% year over year gain in existing home prices is the highest ever. Lumber, until a small decline this week, and other building material prices have skyrocketed. Lumber’s price is up 3x since last November; The price of a deck has also tripled in many parts of the country. Food prices are up and climbing. Gasoline prices are up +75% since November as I’m sure you noticed. And Labor costs appear more inflationary than at anytime since the early 1980s.

Wall Street does not like inflation because interest rates head up, and fears are now spreading that inflation could negatively impact companies’ bottom lines. These fears aren’t completely unfounded, but during times of booming economic growth, inflation’s negative impact on earnings is often muted as profits are higher too. Stocks are an inflation hedge if the rise in prices is accompanied with strong economic growth.

And right now, U.S. economic growth is accelerating – the Atlanta Fed expects +10.5% GDP growth in the second quarter and earnings momentum is showing no signs of tapping the brakes either. FactSet anticipates that S&P 500 companies will achieve +60.0% average earnings growth and +18.7% average sales growth in the current second quarter. That’s up from +49.4% average earnings growth and +10% average sales growth in the first quarter.
But don’t worry our Treasury Secretary does not think inflation is a problem because it is “transitory”. And for now the Fed and the Administration are probably correct.

The economy is going from 0-60 in a blink as vaccines give people confidence to buy stuff. The government has supplied so much extra money in the form of extended unemployment insurance and checks from the treasury that supplies of everything are tight and demand is accelerating, therefore, prices go up. But as their argument goes, as supply chains catch up to demand and we lap last year’s bottom in the recession, inflation will settle back near the Fed’s 2.0% target.

A Warning from the Supply Side, On the Verge of Real Inflation.

Scott Grannis at his Calafia Beach Pundit blog has for years argued that Quantitative Easing (“QE”; where the Federal Reserve buys securities from banks in exchange for bank reserves) was not “money printing”. He saw QE as a response by the Fed to the economy’s demand for zero risk additional cash and cash equivalents. This desire of the public to hoard cash, even when it pays nothing or close to nothing, was created by the extraordinary bouts of fear and uncertainty present since the Great Recession of 2008-09. By engaging in QE, the Fed was simply responding to an increase in money demand by buying longer term US Treasury notes and bonds from banks with bank reserves (which pay a floating rate of interest and are default-free, just like short term T-bills). The huge increases in the money supply that we saw in the late 2000s and early 2010s were not inflationary because the Fed was essentially converting notes and bonds into cash equivalents, which in turn was necessary to avoid a shortage of money (cash). Grannis has maintained that when the Fed adds to the money supply to match an increase in the demand by the public to hold cash, it is not inflationary; inflation only happens when the supply of money exceeds the demand for it.
But just this week he now worries that the public’s demand for cash is waning and, therefore, the Fed is making a monumental policy mistake by not withdrawing QE now. He says: I am now arguing that we are in the early stages of a monetary policy mistake that the Fed is committing. Last year the Fed boosted M2 by over $4 trillion in response to the unprecedented, catastrophic and extremely costly shutdown of the US economy. That was fine then, but it’s not fine now. The economy is rebounding, confidence is returning, fears have eased, and the demand for money is consequently no longer increasing and in fact is decreasing. But the Fed is not reversing its QE in response, and so unwanted money is accumulating. That shows up in dollar weakness, rising commodity prices, rising housing prices, and rising inflation expectations. Lots of unwanted money is likely helping stock prices to rise as well.
 
If monetary policy is too easy or too tight, that affects the current and future value of the dollar, and the future thus becomes less certain. Uncertainty is the enemy of investment, and investment is the source of growth and prosperity. An uncertain future inhibits growth by encouraging investors to choose safety over risky ventures which promise to enhance productivity and living standards. As my mentor John Rutledge used to say, inflation is like a thick fog that settles on the highway, forcing everyone to slow down. Deflation is just as bad. A strong and stable dollar is nirvana. Huge increases in the money supply coupled with massive deficit-fueled government spending is most definitely not nirvana. It’s time to get very worried that policymakers are going to be too slow to respond to the huge improvement in the economic outlook.

So the Fed may be too loose especially with a federal government hell bent on reversing the business friendly supply side policies of the last four years. We need to increase supply, not restrict it. But that discussion is for another day. In case you wonder what I mean, look at the evidence below: Small business have NEVER found it harder to get jobs filled.

Summary

Nevertheless, earnings continue to rapidly rise relieving some pressure on valuations. With earnings beating analysts expectations at rates far above the historical norm, add in strong guidance by management for the year ahead, and we have analyst estimates surging and are likely to keep rising. The global economy led by the United States may have reached its peak growth rate but strong growth is expected through at least the end of the year. While commodity prices are rising rapidly thanks to extremely tight commodity markets, inflation pricing does not seem to reflect out-of-control pressure yet, and the Fed remains accommodative. But policymakers may be making a big mistake. Low interest rates and a Federal Reserve willing to accept what it calls “transitory” inflation means we are in a sort of sweet spot for stocks. The only place to make a return is in the rising income businesses of great companies. All bets are off if the current macro policy turns into a monumental mistake. We’re watching so you don’t have to. I trust you’ve found this review to be educational and informative. Thank you for being our clients. It is a privilege to serve you and your families. I’m at david@valuealigned.com or 732-800-2375. Feel free to call me direct on my cell phone at 732-284-1267 (or text me too). Best regards, David

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

The performance and volatility of the S&P 500 index may be materially different from the individual performance attained by a specific investor in the funds and managed accounts managed by ValueAligned Partners, LP. Also, the funds’ and managed accounts’ holdings may differ significantly from the securities that comprise the S&P 500. The S&P 500 has not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather is disclosed to allow for comparison of the investor’s performance to that of a well-known and widely recognized index. You cannot invest directly in an index (although you can invest in an index fund that is designed to closely track such index).

ValueAligned® Model Portfolio (VAP)

The ValueAligned® Model Portfolio (VAP) performance information presented and discussed pertains to a model portfolio available for clients of ValueAligned Partners, LLC on the Folio Institutional platform. Performance is based on a model Folio and does not constitute a composite for purposes of GIPS reporting. Cash distributions (e.g. dividends, capital gains, returns on capital) earned in a model Folio are automatically reinvested into the securities that paid them. Models are not validated or audited.

Model Folio returns are calculated using the same methodology used on the Folio site to calculate performance for funded Folios in investor accounts-the Mid-Weighted Dietz Method. At launch, each model Folio has a hypothetical market value, which then changes over time based on the changing value of the underlying holdings. Corporate actions such as dividends, splits, spin-offs, etc., are processed in the same fashion as for funded Folios, with hypothetical money, and shares exchanged rather than real dollars or shares. Model corporate actions are not validated or audited, which may result in errors in the performance results presented. Cash distributions (i.e., dividends, capital gains, returns on capital) earned in a model Folio are automatically reinvested into the securities that paid them.

When Model Folios are rebalanced, buys and sells are calculated to return the model Folio to its target weights- these hypothetical transactions assume a full execution of the shares needed at the closing prices on the day of rebalance. When the buys and sells cannot be offset exactly the resulting cash difference is hypothetically invested into FDIC insured bank deposits. In most cases, this cash investment is a negligible portion of the model and will be hypothetically invested in the model holdings (if possible) in the next rebalance. For all model performance results, there are inherent limitations which investors should understand. Unlike an actual performance record, model results do not represent actual investment performance or trading. Since the trades have not been executed, the results may under- or over-compensate for the impact, if any, of certain market factors, such as the effect of limited trading liquidity.

ValueAligned Fund, LP – The Hedge Fund Fund Performance

HFRX Equity Hedge Fund Index – Equity Hedge strategies maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision,including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. Equity Hedge managers would typically maintain at least 50%, and may in some cases be substantially entirely invested in equities, both long and short.

The historical HFRX Equity Hedge Fund performance results are provided exclusively for comparison purposes only to provide general comparative information to assist an individual client or prospective client in determining whether ValueAligned Partners, LP performance meets, or continues to meet, his/her/its investment objective(s). It should not be assumed that Fund account holdings will correspond directly to any such comparative index. Fund performances results do not reflect the impact of taxes.

The interim returns as set forth here are estimates. Individual fund performance, portfolio exposure and other data included herein may vary between the various funds and separate accounts managed by ValueAligned Partners, LP. Fund performance results are based on the NAV of fee-paying investors only and are presented net of management fees, brokerage commissions, administrative expenses and accrued performance allocation or incentive fees, if any, and include the reinvestment of all dividends, interest, and capital gains. While performance allocations are accrued monthly, they have been deducted from investor balances only annually or upon withdrawal. The performance reported represents fund-level returns and is not an estimate of any specific investor’s actual performance, which may be materially different from such performance depending on fee arrangements and entry times into the Fund. All performance results are estimates and should not be regarded as final until audited financial statements are issued.

No representation is being made that any investor will or is likely to achieve results like those shown. The results presented reflect past performance and should not and cannot be viewed as an indicator of future performance. The results shown are not an indicator of the returns a client would have realized or will realize in relying on any model mentioned.

NOT AN OFFER OF SECURITIES:
THIS REPORT SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY INTERESTS IN ANY FUND MANAGED BY VALUEALIGNED PARTNERS, LLC OR ANY OF ITS AFFILIATES, SUCH AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY INTERESTS MAY ONLY BE MADE UNDER DEFINITIVE SUBSCRIPTION DOCUMENTS BETWEEN A FUND AND AN INVESTOR.