Hall Capital “Market Views” Newsletter April 2021

This is the 44th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

Recovery is Underway
- and growth will be faster than expected

Clearly with the virus on the run and the country opening up in earnest, expectations for a strong growth year are in everyone's forecast. The Federal Reserve as well as the Conference Board now expect this year's GDP growth to be some 6% vs the year earlier. In all due respect to the economists at the Fed, i would bet that growth will be higher - not that we have economic models, but because I have observed that economists move their forecasts incrementally. And the growth forecasts have been inching up. Though 6% is a large number, GDP growth could easily exceed 8% due to pent up demand, the unprecedented government spending already approved and possibly more spending on the way. The $2.8 Trillion of consumer excess savings over the end of 2019 alone represents 13% of the GDP.

Of course a "fourth wave" or new variants could become a challenge. However, unlike last year when this observer was cautious given all the unknowns associated with the implications of the first global pandemic in a lifetime, most of the unknowns have been answered. We have treatments now. We know better how to respond to outbreaks even without a vaccine. But we DO have a vaccine - at least four of them. And they are very effective! (Pfizer just announced that its vaccine is 100% effective on adolescents.)

If the vaccines are less effective on variants, that doesn't mean that they aren't meaningfully effective. And if a variant arises that requires a new vaccine, I believe we will have one in short order. A year ago we didn't know any of this. The health outlook is much better which means the economic outlook is much better. There are concerns, however -- as always. See below.

Waves vs Tides
- knowing the difference is key

The hard-to-read chart to your right depicts the interest rate on 10 Year US Treasury Bonds over two centuries. After the generally downward trend from 1800, the yield on the 10 year UST bottomed around 1945 at 1.7% -- right where it is today.

Between 1945 and now rates went on quite a journey. From the post war era in 1945 rates caught a rising tide until 1981 when the 10 Yr peaked at 15.8%. And then the tide reversed again. The tide has been going out with rates falling now for almost 40 years. There are virtually no money managers still working who have experience with an incoming tide of persistently rising interest rates.

Recently investors have seen a wave up in interest rates since the record low of 1/2% on the 10 year UST in August of last year. While this wave may reverse for awhile, we believe the dominate tide has changed and will be pushing rates higher for at least a decade. The implications for equities are mixed. For bonds the tide shift is unequivocally negative.

For all the reasons interest rates have declined in the last four decades - technology efficiencies, aging of the population etc.-, we believe interest rates will not reach double digits like they did in 1981. However, a move back to 5%, the average since pre-WWII 1940 seems reasonable.

Why? Two reasons: national debt and the nature of politicians.

Our national debt peaked at 118% of GDP in 1946 due to war time bond issuance. Even as this debt burden was gradually reduced, interest rates started to rise. The Debt/GDP was 62% in 2007 before it jumped to 91% in 2011 due to debt taken on due to the Great Recession. As of the end of 2020 the ratio jumped again to 129% due to COVID recession and CARES Act. This level is the highest ever. Congress just passed another $1.9 Trillion of spending and there is talk of $2T to $3T for infrastructure. A trillion here, a trillion there…

The nature of politicians is not to reduce debt but to issue more debt to pay off previous debt in lowered valued dollars. I admit to not knowing the limit of this, but there IS a limit.

The risk of hitting that limit is meaningful and not reflected in bond prices in my opinion. Thus, the recommended portfolio strategy is to underweight long bonds, overweight equities and alternatives that can be hurt less, or even benefit, from higher interest rates and inflation.

Rising interest rates can be a challenge for most long term financial assets, not just bonds. While it is a certainty that our national debt will rise, there are other factors at play determining the path of interest rates. If we are fortunate and the risk of a rising tide of interest rates does not materialize due to these mitigating factors, then the recommended investment strategy will perform even better.

Focus List Returns 11.2% In Q1
- vs 6.2% for the S&P 500

The conservative Focus List only outperformed one quarter in 2020, which was during the big downdraft in Q1. However, despite the lagging for the following three quarters, the long term record remains intact, averaging 16% per annum vs 14.5% for the S&P 500 since inception over 10 years ago.

The two financial stocks added last quarter performed particularly well. If you noticed a "value" bent to the FL it would not be surprising. The portfolio will generally have a lower P/E than the market and will always be void of the highest valued stocks. Many highly valued high growth stocks which performed so well last year declined in Q1. And then there is another category, that is neither high growth nor well positioned nor undervalued, and that is the "Reddit Rebellion" stocks.

A colleague once challenged the notion of buying "value" by asking, "Don't all investors try to buy undervalued stocks?", My answer was, "Definitely not!" I then proceeded to list 57 reasons stocks are bought and sold for reasons OTHER than being undervalued. Reasons like price momentum, or the stock is down, or dividend yield, or broker recommendation, or it's added to the index, or it is socially responsible, or it has a good chart, or Elon Musk is the CEO etc.

But with the recent "Reddit Rebellion" phenomenon, I can add another reason some stocks are bought: to humiliate hedge funds. This is a driving force among many of the Reddit Rebels in pushing up stocks like GameStop, AMC and Koss. These three stocks, which were heavily shorted by hedge funds, are up on average over 600% due to the Rebels -- just this year! These companies were not particularly undervalued at the beginning of the year and are certainly not now. It is always dangerous to make predictions about speculative stocks, but I do not think I am going out on a limb to say that a portfolio of these three stocks will not only underperform, but will show outright losses five years out.

Turning back to the Focus List, looking out 5 to 10 years, non-US stocks appear to offer good relative value. While we believe the US will stay the dominate competitor in the world and will show better growth than most other developed countries, the valuation gap between the US and the rest of the world looks interesting in favor of the rest of the world. Hence, we are adding in the place of the S&P 100, the Vanguard FTSE All World ex US index fund. The projected P/E on 2021 earnings for this fund is just 16x vs 21x for the S&P 500.

For individual stocks as well as selection strategies, past performance is not necessarily indicative of the future.

Hall Capital Focus List

Verizon - largest cell phone service provider in the US. Some debt but safe 4.3% dividend yield.
Vanguard FTSE All World Ex US - developed and emerging market non-US stocks are selling at much lower P/E compared to US.
China Mobile - largest cell phone operator in the world with 942 million subscribers. 5G adoption should edge up growth. 6.2% well covered dividend yield.
NovoNordisk - Danish company has 50% of the global market for insulin. Strong balance sheet.
Alphabet - Google is the "oxygen of the internet". Leader in AI and other forward technologies. Net cash >$120 bil.
CVS Health - with Aetna insurance and growing in store clinics the chance to become the most integrated health care company.
Apple - brand with 1.4 billion users providing new growth opportunities in service revenue and wearables.
Corning - leader in glass for fiber optics and displays.
Goldman Sachs - Wall Street's premier investment banking firm.
OraSure - small, but established life science test company. No debt and large cash position to fund growth.
Unum - established life and disability insurance provider whose depressed stock price should benefit from higher interest rates.

Follow Up – from our letter one year ago

"We will recover but the path and timing are extremely murky."
- Indeed.

"Until we discover a vaccine - at least a year out - a series of practical measures could allow most of the country to resume productivity"
- The vaccine discovery was faster than anyone expected. However, practical measure fell short as the country clumsily opened and shut down with and without mask mandates.

"If the market has bottomed and we get back to work soon with an effective therapy, then I am fine with missing some of the upside. However, taking the long term view, I would venture equities will trounce bonds."
- Some of the rebound in stocks was missed but equities trounced the bond return of just .7%

"If we were to recover quickly after a bruising recession, it would be due to the impact of trillions and trillions of Federal aid."
- The aid was crucial in keeping many businesses and families afloat, not to mention boosting the stock market.

NOTE: Now in addition to ALL our quarterly letters, on our website is a tab with just the Follow Ups.

About HALL CAPITAL

HALL CAPITAL, LLC is a registered investment advisor and was formed by Principals from Arcturus Capital in 2010.
For more information, contact Donald Hall 626 578 5700 x101 dhall@hallcapitalmanagement.com

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