Hall Capital “Market Views” Newsletter January 2022

This is the 47th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

A New Variant
- and an old rule

Is there a silver lining to Omicron? It's a cloud no doubt about it. More contagious than Delta or even the common cold. The transmissibility is nasty but the severity is trending toward milder.

First the bad news: we are all likely to contract Omicron eventually. It has now become the dominate US strain in new infections. Companies will suffer as work is slowed and costs increase.

However, the slowing of the economy could keep the Fed tightening at bay. The old rule is "Don't fight the Fed." That is, when the Fed is easing and driving interest rates lower, you want to go with the flow and hold onto your long dated assets, even in the face of a recession or political angst.

There are no factors more important in the outlook for stocks and bonds than the level and direction of interest rates. The level of interest rates affects the borrowing cost for home buyers, businesses looking to expand and borrowers of all stripes rolling over existing debt, including Uncle Sam. So the borrowing rate affects the overall economy in a profound way. This is the very reason the Fed chooses to manipulate interest rates.

For investors, while the economy is certainly important, the risk free interest rate is perhaps even more important in driving investment decisions. If higher interest rates slow the economy, the economy usually recovers in a year or two. However, if rates are higher on a newly issued 30 year T-bond, investors enjoy the benefit for fully 30 years. Existing bonds will decline to compete on yield. Over in the stock market, on the same earnings investors will apply a different multiple if rates change. And while a major change in interest rates can impact the whole market, it will impact "long duration", high multiple growth stocks more, all other things equal.

Bottom line: we are holding our positions betting that we will manage our way through the Omicron spike, and any successor variants. As noted, the dampening of demand, if it occurs at all, should temper the Fed's desire to tighten and ease demand driven inflation pressures. Omicron illnesses could cause some bottlenecks which could continue supply driven inflation. Our view is that this the supply constraints will be temporary and not as serious as the supply chain problems we have already experienced which are being worked out. Nevertheless, we desire a hedge against possible higher inflation/interest rates. Our strategy is two-fold: 1) include some stocks whose earnings benefit from higher interest rates and 2) avoid long duration high multiple stocks.

What About Bonds?
- the low return asset class

As noted for some time now, bonds are not interesting. Ten year UST yielding around 1.6% are not only low, but are WAY below the current inflation rate and even below the expected longer term inflation rate.

In the last year the US bond market did not provide a positive return. The outlook is not much better. The best job for bonds is a hedge against uncertainty generally, especially if you think recession or deflationary risks are high. We are in the camp that prefers an inflation hedge, not a deflation hedge.

Of course, as noted about the silver lining of Omicron, neither inflation nor deflation may become a real problem. We could very well get lucky and find the economic growth path not too hot, not too cold, but just about right. While I would put even odds on a just right Goldilocks economy vs. a too hot or too cold economy, that's a long way from 100%, which suggests that some hedges make sense.

Focus List Returns 26.6% for 2021
- vs 28.7% for the S&P 500

The FL was up 4.6% in Q4 lagging the torrid 11% return provided by the S&P 500. Since inception over 10 years ago, the Focus List has outperformed 17.1% vs.16.6% for the S&P 500.

As noted earlier, we are avoiding high growth, high multiple stocks. This is especially important when the overall market is highly priced and there is a threat of higher interest rates. In the process of avoiding these exciting, but highly priced companies, we know we will miss out on some very big winners. Tesla outperformed the S&P 500 in 2021 by 26% following an even bigger surge in the year prior. We missed out. On the other hand, in 2021 we “missed out” on these high flyers which managed to decline in a market that was up 29%:

Zoom Technologies: -50%
Pinterest: -48%
Roku: -31%
Docusign: -30%
Zillow: -57%
Peloton: -77%
Teledoc: -55%
Lordstown Motors: -80%

These are all exciting companies. But there is a difference between an exciting company and having exciting potential in its stock. In these cases much excitement was already reflected in the stock prices at the beginning of the year. No room for error. For every Tesla mega winner there are a dozen Lordstown losers.

We are adding two "stalwarts": Royal Dutch Shell in place of the Vanguard international fund and Medtronic in place of OraSure.

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

Hall Capital Focus List

Allstate - strong brand. Strong balance sheet. Hedge against higher interest rates. Steadily higher dividends.
Verizon - largest cell phone service provider in the US. Some debt but safe 5% dividend yield.
Royal Dutch Shell - lowest multiple of the global energy giants. Leader in LNG. 4% secure 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 many other forward technologies. Cash on hand >$135 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.
Medtronic - world's largest medical device company. Sales should recover when hospitals inevitably return to normal.
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

"Look to April for life to feel more normal"
- Well it did feel normal there for awhile as cases plummeted only to rise again.

"Pent up demand should propel the economy forward." GDP surged x% from a year early by summer."
- US GDP surged 10% by summer. from a year earlier

"A sharp rise in inflation could prompt the Federal Reserve to raise interest rates which could be a serious challenge for asset prices."
- Inflation has certainly taken off and the Fed is contemplating a faster tamper than originally planned. Omicron may temper that hawkish stance, however.

"Of course, the most surprising surprise would be one that is not even on the radar."
- Arguably a new variant should not have been a surprise but the contagion rate of Omicron is.

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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