Hall Capital “Market Views” Newsletter october 2021

This is the 46th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

A Key to Successful Long Term Investing
- is knowing what issues are most important

There always seem to be several issues swirling in the minds of investors. The question is which of these issues should impact your portfolio selection and positioning.

While the US economy is enjoying several positive developments such as: continued recovery from the pandemic induced recession, stronger than ever balance sheets by US consumers, especially those fortunate enough to own stocks and/or a house; and for the rest an apparent end to stagnant wage growth; not to mention a relatively peaceful world, notwithstanding some trouble spots here and there -- you are likely to hear less commentary in the popular press on those positive developments than these negative ones:

  • The threat of new virus variants

  • The impact of "anti-vaxers"

  • Supply chain disruptions

  • Labor shortages

  • Housing prices that are too high

  • Potential default on US debt due to political gridlock

  • Political divisiveness generally

  • Lower expected earnings growth

  • Proposed higher tax rates

  • Infrastructure spending or lack thereof

  • Tension with China

  • Energy shortages

  • Threat of higher inflation/interest rates

This list is no mean exhaustive. So what does an investor do? Run for the hills? No. Instead, don't get distracted by short term issues and focus on what really matters and how to hedge against the downside of the key issue.

More than one of these factors may warrant a rebalancing down to portfolio targets, but only one is impacting our long term investment strategy: the potential for higher interest rates. This is not to say that the other issues are unimportant. Any one of them could bring the market down short term. But for the most part these issues should correct to a great extent over time. However, higher interest rates, if driven by persistent inflation, could last for many years, even decades. We have enjoyed the opposite effect now for 40 years. More on this in the next section.

Space does not permit a discussion of each of the other issues and why I choose not to let them meaningfully impact long term positioning now, but I will speak to one very current item: the potential default on US debt.

As you know Congress has to raise the debt ceiling from time to time to allow the US Treasury to issue debt to pay for programs already approved. The Democrats have proposed the usual limit relief but the GOP is blocking it for the sole reason to inflict pain on the Dems, or, at a minimum, put them in an awkward position. This reminds me of the old Buddy Hackett joke retold by Jack Hough: A city slicker hunter shoots a duck that falls across a fence on a farm. The hunter works through the fence to retrieve his duck only to face an angry farmer, who says sternly, "This duck is mine as it is on my property." They argue until the farmer proposes a peculiar local custom of settling disputes: "We take turns kicking each other in the groin." Not wanting to give in, the citified hunter agrees and immediately suffers a mighty blow by the farmer's boot. After a couple of minutes of grimacing and groaning, the hunter finally straightens up and says, "I guess it's my turn." And the farmer says, "You can keep the duck."

We need responsible budget approvals, not a debt ceiling that has to be raised. While there are no guarantees, we are counting on this "groin kicking" process, which has been put off to December, to blow over before our next letter.

Taper Time?
- Not yet, according to Fed Chairman

As noted last quarter and again above, the level of inflation and interest rates is the most important factor driving the current value of all long term assets. The main reason stocks and bonds have enjoyed near 40 years of impressive returns is that inflation has been tame and interest rates have trended down.

Jerome Powell, our Federal Reserve Chairman, recently suggested that he is comfortable enough in the current $120 billion per month bond buying program (which helps keep interest rates low) for the time being, and the Federal Reserve will not likely start to "taper" their buying until the middle of next year.

There are two important issues for investors to ponder: 1. Will the market take the clear taper notice in stride and not dive 18% like it did in Q4 of 2018 as a result of taper action? and 2. Will inflation heat up faster forcing the Fed to tighten earlier?

Our view on (1) is that the clear and advanced communication from the Fed will encourage investors to take the taper in stride if it occurs as expected, notwithstanding some minor volatility as we approach that time. However, if, in (2), the Fed is forced to taper earlier than planned, then both stocks and bonds are likely to take a meaningful hit. We are already hedged by not owning long bonds, but If it appears that much higher inflation and interest rates are indeed persistent, then cutting exposure to equities too would make sense until their prices reflected the implications.

Meanwhile, if any number of the issues mentioned in section one impedes the economy's recovery, earning's growth will be challenged. Stocks could struggle, but this scenario is not as toxic as the kind of inflation that would prompt an early tightening by the Fed.

Focus List Returns 21% YTD
- vs 16% for the S&P 500

It was a lackluster quarter for the stock market with the S&P 500 earning less than 1%. The Focus LIst managed to edge a bit higher, up 1.5%. Since inception, over 10 years ago, the Focus List has returned 17.1% vs 15.9% for the S&P 500.

Sometimes we can take advantage of two attributes at once:, a bargain priced stock which offers a hedge against a key uncertainty. We are adding Allstate to the FL. Allstate is trading at just 10x adjusted earnings. While the stock could sell off some in a general market pullback, we would expect it to hold up relatively well if the pullback is due to concerns over higher interest rates. "You are in good hands with Allstate."

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 4.4% 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.
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. 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.
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 expect $2 Trillion or so of additional stimulus to be forthcoming which will be welcomed by investors and main street alike."
- Stimulus was showered on the economy. Stocks rallied and employment rose. (Now talk of more.)

"Developments on the health front are mixed, still"
- Indeed. The virus has been throttled but not extinguished.

"Our worsening relationship with China remains a concern as well as the impact of the pandemic's second wave - and we WILL have a second wave."
- Unfortunately, the tension with China has only increased. And the pandemic is arguably in it's FOURTH wave some places.

"Nevertheless, our position remains cautiously optimistic with equities as our asset of choice long term."
- With the advent of the vaccine stocks marched higher over the last year.

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