Hall Capital “Market Views” Newsletter October 2023

This is the 54th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

Higher for Longer?
- that’s the Fed’s stated plan

Yes, the Fed has been consistent in its messaging: they will be diligent in raising short term interest rates yet further if that is required to slay the inflation dragon – even if that triggers higher unemployment and potential recession. The Fed Funds short term interest rate has risen from 0.1% at the beginning of last year to 4% at the beginning of this year, and to 5.3% currently. Meanwhile, the stock market has recovered most of last year’s losses, even after taking into account the -3% sag in the quarter just ending.

Does this mean that higher rates don’t matter? Trust me, they matter. At 4.7% the current 10 Yr UST is not yet attractive enough for us, but it is a whole lot more attractive than it was 18 months ago. As the 10 Yr. UST approaches 5% there will be many investors who will sell equities to lock in a risk free 5% return. This will be a headwind to stocks if interest rates rise to that level or beyond. It will take continued improvement on inflation to preclude that scenario.

The Key to Long Term Wealth
- is to buy and hold

The best way to create wealth (apart from starting one’s own successful business) is to buy strongly competitive companies at reasonable prices and to hold them for the long term. When I say, “long term”, I mean 10 years or even longer. I realize that this is easier said than done, but it helps to have the right mindset to find long term winners.

The right mindset requires knowing what you are looking for and adhering to a discipline in selection. Our own investment selection process involves casting a wide net and rigorously subjecting all investment options to a few key factors in a systematic way.  We have found it more productive to focus on a few factors systematically, than 50 factors unsystematically. One of the most important factors we consider in determining an appropriate purchase price for any stock is competitive position. We have a competitive position rating for each stock in the S&P 500.  This emphasis is different from most value-oriented approaches.

We have found that long term winners, or “ten baggers”, can come from both Stalwarts and Fallen Angels. There are 18 stocks in the S&P 500 that are now at least 10x more valuable than they were 10 years ago. Not surprisingly, this list of ten-baggers includes several big tech names such as Apple, NVIDIA, and Microsoft. But this list also includes the likes of Fair Isaac, which has a dominant position as a provider of consumer credit scores (FICO), Old Dominion Freight, the leader in LTL truck shipping, and Cintas which dominates the institutional uniform rental business (which is basically a laundry service company…laundry!) Indeed, while technology is the ultimate competitive advantage, there can be other ways to dominate a market. Stocks that have gone nowhere, or that are down for the last decade, are far and away those of companies that suffered a loss of competitive position, such as Bath and Body Works, Walgreens, and Ralph Lauren.

Price is a key consideration in our stock selection. The lower the P/E the better all other factors equal. But all other factors are seldom equal.  The appropriate P/E is adjusted based on the competitive position rating, along with other key factors. Interestingly, the three ten-baggers mentioned above that were non-tech, FICO, ODFL, and CTAS, all had premium PE’s between 22x and 25x in 2013. So did the three losers. The three tech giants were selling for even LESS, between 14x and 18x. Note that while competitive position may have been a key driver in the relative returns over the decade, the starting price level was also important. With the benefit of hindsight, it is easy to see that AAPL, MSFT and NVDA, were deeply undervalued in 2013 and FICO, ODFL and CTAS were only good values once their competitive position was considered, which made them reasonably priced.  Likewise, if there were any signs the three losers were losing their competitive position, then they were NOT reasonably priced at the same level of 22x to 25x.

Good stock selection requires avoiding both “sins of commission” (buying stocks that are too richly priced or that have a waning competitive position) and “sins of omission” (missing an improving competitive position at a reasonable price). And then there is the urge to take profits prematurely. The best advice in many cases when a company’s competitive position is improving is, “Don’t just do something, stand there.”

Focus List Returns Returns 15.9% YTD
- including -1.1% for Q3

After outperforming in the first half, the FL held up better than the market in the most recent quarter when the S&P 500 sagged -3.3% vs. -1.1% for the FL. (see right).

Arguably the Focus List performance is understated to the extent we do capture some long term winners. The way we calculate the FL performance is to equal weight each stock's performance each period. This means the FL performance calculation does not receive the benefit of the added weight of a growing position size of a long term winner.

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. Steadily higher dividends.
Verizon - largest cell phone service provider in the US. Some debt but safe 8% dividend yield.
Shell - lowest multiple of the global energy giants. Leader in LNG.
Heidrick and Struggles - a leading global recruiting firm with strong balance sheet and depressed stock price.
Alphabet - Google is the "oxygen of the internet". Competes in cloud computing, AI and many other forward technologies. Cash on hand >$100 billion.
CVS Health - with Aetna insurance and growing in store clinics, CVS has the chance to become the most integrated US health care company.
Apple - premium 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 - global medical device giant serving 130 countries. Holds over 49,000 patents on life science devices.
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. Potential to exploit treasure trove of data further with AI.
Micron - a leader in memory chips with strong balance sheet able to withstand the current 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.
Invesco S&P 500 Equal Weight ETF - expect a reversion to mean given massive outperformance of the cap weighted index vs average stock.

Follow Up – from our letter one year ago

"It makes more sense to seek out information that refutes your beliefs than confirms them. This is because you are already biased to look for confirming evidence."
- More important than ever. If only voters would take this to heart.

"Higher interest rates can help reduce inflation before it gets out of hand. Having higher interest rates at a level well above zero gives the Fed some ammunition to stimulate the economy when needed by bringing rates back down."
- Indeed the impact of higher interest rates has moderated inflation, surprisingly without a recession. Investors may appreciate the "ammunition" the Fed has now that was unavailable a year and a half ago.

" … our base case includes a mild recession eased next year by a Fed pivot."
- The mild recession risk has been pushed out until 2024.

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