Hall Capital “Market Views” Newsletter January 2020

This is the 39th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

There is a Time to Sow and Time to Reap
- now is a good time to start some reaping

The US market has "pulled forward" a good portion of the expected future year returns due mainly to dovish moves by the Federal Reserve including flooding the banking system with liquidity. The Fed moves were motivated by declining growth expectations (driven in part by trade tensions) and technical problems in the repo market. We would feel better about the outlook if the economy's growth rate had increased, rather than decreased, in 2019 compared to 2018. Growth has not turned up in the rest of the world either which arguably needs it worse than the US does.

It appears the Federal Reserve will do whatever it takes to support the market, especially if inflation remains subdued. The Fed is indeed powerful as witnessed by its impact on soaring asset prices last year. However, the timing of the unwinding of the process is unpredictable. While we are content to continue to rely mostly on equities in terms of asset allocation, the recognition of the risk of a change in Fed policy, or a weakening of the economy despite the Fed's assistance at some point, argues for a reduction of risk in portfolios at this time.

Consensus expectations for the New Year are usually not fulfilled. The consensus view of money managers for 2020 is that the US economy will continue to grow slowly, (around 2% GDP), progress on China trade will continue, inflation will stay subdued, the Fed will stay on hold, interest rates won't change much, global conflict will not erupt into something major and US stocks will deliver a return of 5% to 7%. This view is not unreasonable. The problem is that the "most likely" expectation for any single year has in fact a low probability.

If a silver dollar were tossed 100 times, you could bet on heads and wager up to $50, one dollar at a time, and feel relatively safe that you would come close to break even. That is, the "expected value" of 100 bets is $50, just as the expected value of a single toss is 50c. The chances of winning close to $50 over 100 bets is pretty high. However, on a single toss the chance of winning 50c is zero. Likewise, the chances of all the economic variables mentioned falling in line with expectations AND the market producing the expected return in a single year is, maybe not be zero, but close to it.

This is the nature of uncertainty. One invests based on the long term expected return with the understanding that the short term is exceedingly difficult to forecast. The difficulty is compounded by the fact that for security markets we are dealing with risk, not merely uncertainty.  The uncertainty associated with a coin toss is known: 50/50. The uncertainty with respect to markets is unknown. That is called risk.

The investment failures of most individuals usually involve taking too much risk at the wrong time or not taking enough.  To ensure the staying power for the inevitable volatility in the long term, some hedges are appropriate along the way to manage risk exposure. The long term expected return for equities exceeds bonds and cash which is why we remain tilted toward equities, though less aggressively so.

Within equities there are very interesting investment opportunities outside the stock market with higher long term expected returns AND lower risk than stocks, if illiquid. (There is not enough room in this short letter to discuss, but contact me if you wish to.)

The Threat of Military Conflict
- is usually over blown

The wars in Vietnam and Iraq were costly mistakes. Yet, we prospered despite them. While the current tensions between the US and Iran (not to mention N. Korea) are alarming, they are unlikely to erupt into a major military conflict that would dent the US economy. This does not mean that a retaliation from Iran would not rattle investors for awhile but any damage Iran could inflict would be contained given the relative military advantage of the US. Iran (and N Korea) probably have a greater chance of making a statement through cyber attacks than military ones.

Investors prefer a reduction of global tensions rather than an escalation of the type that we just saw. But other factors are likely to be more important to the market. What happens when the Fed reverses QE or the outcome of the trade war with China are key questions in the outlook for stocks over the intermediate term, more so than how determined Iran is in taking revenge on the US.

Focus List Soars 34% in 2019
- ahead of a strong S&P 500

The Focus List provided a return of 15.4% in Q4 well ahead of the S&P 500's 10.5% return. This brings the 2019 return to 34.0% for the FL compared to 31.5% for the S&P 500. Over the long term since inception almost 10 years, the Focus List provided an average compounded annual return of 17.3% vs 15.3% for the S&P 500. $1 mil invested in the Focus List in 2010 would be worth $4.8 mil today. Note our trading is limited and all gains taken are long term.

We are expanding the list with China Mobile, Exxon and Footlocker to the list this month. All of these are slow growers but offer value with good dividends and rock solid balance sheets.

We are also changing the format of the FL table to show some key qualitative comments rather than the quantitative data which can be gleaned from other sources. Since competitive position is a key driver in our selection, our short comment will frequently address this factor. Though the case for a stock is more complicated than what three or four lines can capture, we hope to impart the most salient comments that are relevant as to timing or competitive position.

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

Hall Capital Focus List

Exxon Mobil - largest refiner in the world. Has 6 barrels (BOE) per share in reserves. 5% safe dividend yield.
Footlocker - surviving retailer as shoes not as easy to buy on the internet. Depressed stock. No debt. 4% dividend yield.
China Mobile - largest cell phone operator in the world with 942 million subscribers. 5G adoption should edge up growth. 4.7% 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 >$100bil to use for add on acquisitions.
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.
Carnival - largest cruise ship operator with Carnival, Princess and Seaborne brands. Cruises are value vacations. 4% yield.

Follow Up – from our letter one year ago

"Though we are always concerned about recession risk this long into a recovery, we are more sanguine about the impact of a garden variety recession."
- No recession materialized and we see no signs of one in the near future.

"Hopefully a trade deal will be struck before long."
- We got a trade deal "light" which settled tensions and allowed markets to elevate.

"We still lean toward equities and alternatives."
- The S&P 500 outperformed the Bloomberg bond index by over 22% in 2019.

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

HALL CAPITAL | 199 S. Los Robles Ave | Suite 535 | Pasadena | CA | 91101