Hall Capital “Market Views” Newsletter January 2023

This is the 51st edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

Four Most Costly Mistakes Investors Make
- over and over; even professional investor

In my letter a year ago, I noted mistakes to avoid going into 2022 - namely, buying high P/E "story" stocks, SPACs, crypto, meme stocks, and bonds. Indeed, had you avoided these mistakes last year you would have been much better off.

Rather than focus on potential mistakes in only the current environment, here is a list of the most costly mistakes made generally:

1. Fighting the Fed. 2022 was a case in point. If you had a chance to buy a crystal ball that could make a single forecast on fundamentals you would pass on a GDP forecast and take the one that could give you the level of future interest rates. When the Fed starts raising interest rates, especially when inflation has surged, it almost always lowers stock prices.

2. Chasing the newest shiny object. Last year the shiniest were bitcoin, meme and cannabis stocks. These were down -85%, -87% and -90% respectively from their highs. IPOs of high Price/Sales companies were not far behind. Sure, every great company today had an IPO, but note that IPOs are mostly issued in speculative markets and usually suffer the consequences of a return to normalcy. Best to avoid them entirely and buy the best companies after the excitement wears off.

3. Paying too much in taxes. This comes from short term trading or from focusing on income with little regard to the tax consequences. Fund managers are notorious for both of these offences. The yields on high yield bonds and income partnerships may seem juicy at 6%, but it is hard to build substantial wealth after tax with an emphasis on taxable income outside a retirement account. The best generational wealth building strategy is to buy stocks in strong companies at reasonable prices and hold for the long term. It is even possible that your heirs will receive big gains without ANY tax due.

4. Selling out in a bear market (20% down) for fear of a recession. The famous economist Paul Samuelson quipped, "The stock market has predicted 9 out of the last 5 recessions." There are times to be more conservative or more aggressive, but the path of the economy is too uncertain to warrant selling out completely, even if you knew for certain a recession was around the corner. If you were right and avoid more of a market slide, you still have to know when to buy back in. Most investors who sell out when the market is down 20% don't have the fortitude to buy back in when the market bottoms down 30%. Generally speaking, the news at that point is no better - usually it's worse. Since WWII there have been 11 recessions. Recessions have lasted 10 months on average and in every case the market was recovering in the face of bad news before the recession.

Outlook for 2023
- a transitional year

Our base case expectations are unchanged. Inflation remains public enemy number one. We continue to believe that inflation has peaked and will continue to come down, but more slowly than the Fed desires. The slow ebbing is due primarily to buoyant wages and rents. Thus, barring a surprise on the inflation front, the Fed will continue to raise interest rates and shrink its balance sheet well into the year. Corporate earnings will come down and a "normal" recession is likely. A recession or not, our Focus List still has a long term 10% annual return potential. It will be hard to make significant gains near term, however, until we see some clarity on solving the inflation problem.

As always, there are wild cards. China is the biggest. And there are some potential unpleasant outcomes from Ukraine and the significant political divide in the US. The wildest of cards are the ones unidentified.

Focus List Bounces 8.5% in Q4
- trimming 2022's loss to -3.7%

Our FL is made up of mostly "Stalwarts", which are companies with strong competitive positions and good balance sheets selling at reasonable prices. Sprinkled in are a handful of "Fallen Angels". These may be smaller companies which have sold off sharply in a short period of time for reasons we think are temporary. We also add some hedges from time to time.

The FL 8.5% gain in Q4 compares to 7.6% for the S&P 500 which brings the 2022 return to -3.7% vs. -18.1% for the S&P 500.

The 5-year annualized return of the FL was 10.9% vs. 9.4% for the S&P 500. Since inception over 10 years ago, the Focus List has enjoyed an annualized return of 15.3% vs.13.3% for the S&P 500.

In 2022 the slump in big tech held the FL performance back. Otherwise, the year's return would have been positive due to the contributions from: Unum +73%, Shell +35%, NovoNordisk +23%, Allstate +18%, and Lennar, added mid-year, +30%.

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 6.6% dividend yield.
Shell - lowest multiple of the global energy giants. Leader in LNG.
NovoNordisk - Danish company has 50% of the global market for insulin. Strong balance sheet.
Alphabet - Google is the "oxygen of the internet". Competes in cloud computing, AI and many other forward technologies. Cash on hand >$115 billion.
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 - technological leader in glass for fiber optics and displays.
Goldman Sachs - Wall Street's premier investment banking firm. Stock trading near book value.
Medtronic - world's largest medical device company. Sales should recover when hospitals inevitably return to normal.
Unum - established life and disability insurance provider which benefits from higher interest rates.
Meta Platforms - controversial dominant social platform which 60% of US use daily. Trades now at less than a market multiple due to sharp decline in stock price.
Micron - a leader in memory chips with strong balance able to withstand a cyclical downturn.
Energy Select SPDR - hedge against energy driven inflation.
Lennar - a leading home builder facing near term slump in sales but long term opportunity as affordability eventually improves. Strong balance sheet.
iShares Gold Trust - hedge against uncertainties.

Follow Up – from our letter one year ago

"There are no factors more important to the outlook for stocks and bonds than the level and direction of interest rates"
- The Fed raised interest rates seven times in 2022 and look what happened.

"And while a major change in interest rates can impact the whole market, it will impact "long duration", high multiple stocks more, all other things equal."
- Long duration, high multiple stocks, such as Zoom, Tesla, Docusign were down over 60% in 2022.

"Our strategy is two-fold: 1) include some stocks whose earnings benefit from higher interest rates and 2) avoid long duration high multiple stocks."
- Unum and Allstate benefited from higher interest rates and were UP 46% on average. We avoided all very long duration stocks which as noted were down more than three times the market average.

"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."
- Bonds broadly were down -13% for 2022. Long UST were down over -31%!

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