Hall Capital “Market Views” Newsletter October 2024

This is the 58th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

What To Do About the Election?
- not much

A common mistake investors make, individuals and professionals alike, is to move assets around based on a very murky set of odds of something happening on top of murky implications of that event even if it unfolds as expected. Folks, that is “murky squared” and not a way to earn an above average return over the long term. The election offers a great opportunity for investors to buy and sell securities unnecessarily. Repositioning for a "Trump trade" or a "Harris trade" is folly.

Looking at just which party won historically adds little insight into how the capital markets will behave going forward - other than that the stock market normally rises some right after the election when the uncertainty is over, regardless of who wins. Historically, U.S. equities have risen more under Democratic presidents than under Republican presidents. But not by much.  And even this outcome can’t necessarily be tied to the party in power during the time the market advanced more.  The lag effects in the economy are significant. An incumbent party that suffers a recession is often voted out and the newly elected party sometimes enjoys taking the baton just as the economy can’t get worse, or is even in the process of recovering. The current environment is a far cry from recession, and in some ways, it is the opposite.  Unemployment is low and the stock market is near all-time highs. Investors naturally want the new POTUS to make America better (“great” even) while not increasing risk to the economy.

It is a mistake to change portfolio strategy based on the upcoming election considering these specific candidates and the uncertainties. The two current candidates are full of promises: middle class tax cuts, no tax on Social Security, no tax on tips, tariffs on everything, a more secure border, support for Ukraine, halting support for Ukraine, higher corporate taxes, lower corporate taxes, etc. Both candidates seem to be campaigning more on “vote buying” and slogans than on how these proposals could work.  But even if we knew the specifics we wouldn’t know if the candidates would, or could, follow through, nor the implications even if they did. In any case, the race is deadlocked, and we can’t predict a winner.

Meanwhile, one issue looms that neither candidate is addressing: our growing federal deficit. While it is difficult for a president to have short-term positive influence on the economy, the policies that he or she may help to put in place, many of which are conceived by politicians who are not trained economists, can have a lasting impact on our federal deficit. Both parties are guilty of promoting policies that expand the deficit, and neither party seems to have the political will to address it.

Bottom line: we are not recommending any changes based on the upcoming election. However, we will continue to hedge against the growing deficit problem.

Some Strategists Claim the Russell 2000 Is Undervalued
- it's not

The Russell 2000 Index is made up of the smallest 2000 stocks in the Russell 3000. (The Russell 1000 is the large company balance.) The R2000 has underperformed the R1000 and the S&P 500 woefully now for many years. Over the last three years, the R2000 is up just 5% vs. 36% and 40% for the R1000 and S&P 500, respectively.

Some Wall Street strategists are recommending buying the R2000 index, betting on a regression to the mean.  Indeed, if there was a catch up in relative performance by the R2000, the move could be massive. And it wouldn’t take much of a slosh of institutional asset allocation to fire up the index. After all, the market cap of Apple is more than the market cap of the entire collection of 2000 companies that comprise the R2000. Another reason small caps are cited as attractive right now is that their fortunes are particularly sensitive to the contour of the economy, and with lower short-term interest rates on the horizon, a cyclical upturn may be in the offing.

I agree with all of that. However, many prominent Wall Street strategists are also claiming that the R2000 is undervalued vs. the S&P 500. This is where I take exception. The P/E multiple of the R2000 is promoted as 18x which is indeed lower than that of the S&P 500. The only way you can calculate 18x for the R2000, however, is to ignore almost half the companies in the index that have NO earnings. Considering ALL the companies in the R2000, the median trailing P/E is 67x.  Even if you assume a strong cyclical bounce in the economy and earnings for small caps surge next year, the R2000 is NOT undervalued relative to large cap indices. Looking at other measures of valuation rather than just P/E would not help the relative attractiveness of the R2000. So, making the case to buy the index on the basis of the valuation of just half the companies in the index makes no sense.

While R2000 is due for a bounce, I would argue that it is far better to pick and choose among individual names than to buy the index.  Our strategy is to focus mostly on large cap “Stalwarts”. However, we will find some “Fallen Angels” from time to time that could be smaller companies given their inherent greater volatility.  Due to the higher risks of small caps, however, our screening process demands that a small cap stock clear much more strenuous requirements than our large cap picks before it can be added to the Focus List.  These requirements have served us well. The two small caps that are currently on the Focus List, Unum and Heidrick & Struggles, have not only outperformed the R2000, but have also outperformed the S&P 500 with a cumulative return of 77% on average, vs 28% for the S&P 500 over the period held.

Focus List Spurts 9.9% in Q3
- vs 5.9% for the S&P 500

The FL benefited from a broadening of the market early in the period.

Over the long term, we would argue that the FL performs well because it is invested in superior businesses that are not selling at a premium price. All but a couple of the stocks in the FL sell for less than a market multiple. And the FL has hedges to protect the downside that are meant to cost us in performance to the upside. In other words, the outperformance in the last 10 years+ was not the result of an aggressive strategy applied in a strong market.

Speaking of hedges, the oil price driven inflation hedge was not needed this year. Crude has come down which has helped general inflation. Our hedge here hurt relative performance, but that is the price of insurance sometimes.  A hedge we shifted out of last year to make room for something else was gold. That was a mistake. We can afford to expand the list and it still be appropriately concentrated. We are adding back gold as a hedge against the implications of too much federal debt and general uncertainties.  As with all hedges, we don't want it to pay off.

We are also adding JP Morgan as a stalwart in the financial sector and Raymond James Financial which is smaller but has stalwart characteristics that are captured in our valuation process. We are removing Goldman Sachs. All three of these financials trade around 13x forward earnings. Both JPM and Goldman Sachs have outperformed the market over the last year, with GS being the stand out, up 57% and near fully valued per our valuation model. RJF, on the other hand, has lagged the market and due to catch up.

All of our selections go through the same screening process which is designed to tilt us toward opportunity and away from risk.

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. P/E Foward: 13x.
Verizon - Largest cell phone service provider in the US. Some debt but 6% dividend yield.
Shell - Lowest multiple of the global energy giants. Leader in LNG.
Heidrick and Struggles - A leading global recruiting firm with large cash position and no debt. P/E Forward:15x.
Alphabet - Google is the "oxygen of the internet". Competes in cloud computing, AI and many other forward technologies. Controls 92% of Search. Most Googled word is YouTube. Fortress B/S.
CVS Health - With Aetna insurance, large store footprint, and PBM, CVS has the chance to become the most integrated US health care company. P/E: 11x.
Apple - Most recognized brand in the world, with 1.4 billion users providing new growth opportunities in service revenue and wearables.
Everest Group - Leading reinsurer with good record of risk control. Concerns over impact of climate change overdone as pricing is adjusted regularly. P/E: 6x.
JP Morgan - Well managed leader in commercial and consumer banking, investment banking and wealth management. Fortress balance sheet. P/E:12x.
Medtronic - Global medical device giant serving 130 countries. Holds over 49,000 patents on life science devices.
Unum - Largest disability insurance provider in US. Benefits if interest rates stay higher for longer. P/E: 9x.
Meta Platforms - Controversial dominant social platform which 60% of US use daily via either Facebook, Instagram or Whatsapp. Successfully exploiting treasure trove of data with AI.
State Street Bank - Being a custodian of scale for $37 trillion provides durable competitive position, but stock is valued like a commercial bank at 11x Fwd P/E.
Energy Select SPDR - Hedge against energy driven inflation. 40% invested in Exxon and Chevron.
Lennar - A leading home builder growing despite high mortgage rates. More long term opportunity as affordability eventually improves. Strong B/S and cash generation. P/E: 12x.
Raymond James Financial - Steady expansion in wealth management/private banking helped grow EPS 15% per year over the last decade. 12x Forward P/E. Strong balance sheet.
Amgen - A leading biotech company with a strong pipeline including a potentially superior obesity treatment drug according to phase I results. 16x Fwd P/E.
Cigna - A leader in value based healthcare (payments to providers based on outcomes rather than fee for service). Solid position among large employers and government. 12x Fwd P/E.
IShares Gold Trust - Hedge against weak dollar, long term inflation, mid-east turmoil and other uncertainties.

Follow Up – from our letter one year 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."
- The 10 yr UST didn't quite reach 5% and has backed off to 3.7% and investors choose to stay in equities for the most part.

"Good stock selection requires avoiding . . . '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."
- META was up 150% in the first nine months of 2023 and it would be tempting to take profits then. Yet, it's competitive position in AI was improving. META gained another 90% in the following 12 months.

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