Happy Holidays from The Ignorant Investor

Best wishes to you and yours for a Merry Christmas and a Happy New Year! We've had a few wrinkles in the market this holiday season, but thankfully that's all they look to be: wrinkles. Meanwhile, The Ignorant Investor has put up a "gone fishing" sign in his office because, well, that's literally what he's doing right now! Here's to a happy, healthy, and successful 2022!

Farewell to the old, and in with the former?!? Some things to consider as we wrap up 2021!!

Looking to the Future | Supply Chain Stuff | An Energy Market Case Study | Stories of Note

Fundamentals are key: energy usage and oil prices are again dominating discussions as energy has roared back to reclaim the mantle of best sector performer in the S&P 500. [Image ©torwaiphoto/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com]

Sometimes things that look too good to be true can yet be true. When the world seemed to be ending in the depths of 2020’s economic lockdowns (okay, I’m taking some literary privilege here), who could have possibly imagined life beyond those slow, painful days indoors when societies and economies would get back to a new normal? Let alone predict just how quickly and powerfully the stock market would come back. It’s truly incredible. As 2021 marches onward, this will likely be The Ignorant Investor’s final substantive post to wrap up the year, and which, as a warning, contains four-months’ worth of commentary!

First, let’s see where we are today. Incredible economic growth, partially in response to expansive global stimulus measures, and the accompanying strong global energy consumption have propelling energy to again reclaim the mantle of best sector performer in the S&P 500 for 2021 (to be expected with oil prices hovering near multi-year highs!). It took an absurd amount of time, with The Ignorant Investor left scratching his head in disbelief as he began building extensive positions even as the sector sold off as recently as July- but eventually the market did catch up to the reality on the ground.

But that’s not all! Yes, Energy is up an astounding 51.9% year-to-date, but this is closely followed by Financials at 35.9% and Real Estate at 32.1%, both over the same time frame. Fairly incredible stuff, especially when contrasted to Big Tech’s powerful moves last year (which could indicate these are more “catch up” moves coinciding with resumption of normal economic activity). These themes are likely to continue to shift and jostle each other through the end of the year, however, as more post-pandemic clarity is obtained. Many of 2021’s moves can be attributed to policy shifts, geopolitics, and fundamentals (want the laundry list? Vaccine efficacy, stubbornly high inflation, rising yields tethered to the Fed, passage of the infrastructure bill through Congress, solid retail data, etc). After all, investing in the stock market is essentially a bet on the future- and that future is ever changing! Speaking of the future, let’s examine some things that may affect the stock market in 2022.

The Crystal Ball: future themes affecting the S&P 500

The S&P 500 looks richly valued by many historic metrics but may yet have some room to run. Goldman Sachs in recent months had set a year-end closing target for the S&P 500 of 4,700, just a handful of points (not even percentage points!) above where we sat on Friday. Now, specific companies within component sectors? That is where one may still find the proverbial “diamonds in the rough.” Selective stock picking of quality companies from specific sectors, done in close collaboration with a trusted financial advisor, may be the best way forward for the new year! Just keep in mind some of the themes outlined below.

1. Fed will begin stimulus tapering. Next up, interest rate increases?

As widely expected, the Fed announced a plan earlier this month to cut $15 billion per month from its existing $120 billion per month pandemic stimulus program. While that statement in and of itself sounds pessimistic for the stock market, let’s focus on that phrase: BEGIN tapering. And why is the Fed beginning to taper? Well, basically, life is returning to normal, and inflation is looking to be quite stubborn this time around.

By the numbers: the initial rate posited by the Fed of reducing the $120-billion-per-month spigot by $15-billion-per-month still leaves the Central Bank supporting the US economy with $540 billion in additional purchases by the expiration date of July 2022. Compare this with the $1 trillion spending bill that just meandered through Congress, and you can see just how far the Fed went to support the US economy through the pandemic. And why equities, even at current lofty valuations, may not be too overvalued (at least while the music is still playing).

But what if inflation is not as “transitory” as the central bank appears to think? Those interest rate increases may be much closer than projected- and history can be important. Keep in mind that several vicious taper tantrums occurred in 2015 following years of low interest rate policy first adopted by the Fed in the Great Recession.

2. Inflation is “here to stay”, NOT “transitory”

Wow, talk about full circle: read the last paragraph and then the above headline. Case in point, the consumer price index came in at a sizzling 6.2% year-on-year reading on Wednesday (and hey, should you prefer the flavor of the producer price index, that reading was up an astounding 8.6% over the same period). Among the breakdowns, we see fuel prices and food rocketing higher to send the headline number to a multi-decade high. Companies have broadly passed rising costs to consumers with little pushback. However, as stimulus checks continue to fade into the rear-view mirror and should inflation be allowed to continue (more likely if Lael Brainard is selected to supplant existing Federal Reserve Chair Jerome Powell, for example), then this level of inflation will eventual start hitting the bottom line for companies in certain “consumer-facing” sectors. And if inflation is NOT allowed to continue unchecked, well, that means the Fed is raising interest rates and pushing players back down the risk curve- also not exactly friendly to stocks.

3. Supply chain disruptions will continue for some time

Large shipping imbalances across the global economy have occurred as demand for goods exploded amid the pandemic lockdown, exasperated in the USA by a persistent labor shortage in the distribution network (see more information below under “Supply Chain Commentary”).  A consensus among leading businesses appears to be forming around the expectations of everything coming back to normal sometime in the second half of 2022 (who would have guessed all those quarterly earnings reports would have been so informative?) as the disruptions transition away from bottlenecks at ports and move inland. This can create potential opportunities within several industries on either side of, or integrated with, the supply chain.

4. Will cyclicals benefit at the expense of growth as yields rise?

Value stocks have been generally scorned and derided by many investors for some time now as growth has far outperformed the sector in recent years or, um, decades. And by far outperformed, I mean crushed (the shining example is Tesla; $10,000 invested in early 2011 would be worth something like $2,000,000 as of Friday after an astounding 20,560% gain). Just look at Big Tech. These are true giants that march ever onwards, oblivious to viral pandemics while resiliently spewing out cash in vast enough quantities to make any investor starry eyed. Nevertheless, while cyclical stocks have been lagging growth, as the economy continues to charge forward - and as the central bank begins to contemplate interest rate hikes - these companies may finally be poised for a comeback (as demonstrated in recent months by the phenomenal gains in upstream energy companies).

Supply Chain Commentary

For now, global supply chain disruptions have been occurring primarily at ports (container ships) but are expected to eventually move inland before normalizing sometime next year [Image ©enanuchit/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com]

The integrated global supply chain is a thing of exquisite beauty to anyone that appreciates complexity. Take a banana, for example (bet you didn’t see that one coming!). Perhaps that banana is grown in Costa Rica by a producer. It’s then picked before being exported by a Costa Rican company and imported by an American one. It’s then ripened and distributed before being sold to a retailer in Manhattan. The floor trader then walks out of the New York Stock Exchange and buys the banana from the retailer- hopefully finding it ripe and delicious. Many people, multiple companies, and possibly trucks and cargo ships using specialized shipping containers are involved in the process. And if that isn’t complex enough, consider the supply chain of something like a hard disk drive, and its journey from raw materials found in the earth to final product in the hand of the consumer!

The point here is that during the economic shutdowns to contain the coronavirus in 2020, people, bored and sitting at home, started buying stuff online. Warehouses emptied as replacements stopped arriving (everyone the world around was under lockdown, remember); and ever since then the global supply chain has struggled to return to a normal balance. Further aggravating the situation, demand for goods has continued to increase. Shipping imbalances occurred as finished products steadily flowed to the US, where the cargo ships waited for days in a long line to unload their goods at overcrowded ports before returning empty to their port of origin to repeat the process over again (this is an oversimplification to make a point). What gave The Ignorant Investor pause was when he read in a Home Depot release that the company had acquired a ship and had even resorted to occasionally purchasing from the spot markets to help cope with heavy demand and constrained supply.

In addition to the physical aspects of the global supply chain, the current supply chain disruptions have been magnified in the US by a labor shortage. Now, what exactly has caused that shortage is in dispute (of note, Americans are quitting their jobs in huge numbers, with a near-record 4.2 million Americans quitting just last month) but rising wages in other areas of the economy may be attracting supply chain workers to other industries (restaurants, etc). Commentary by various large players in and benefiting from the supply chain during recent earnings reports show that these disruptions are expected to last well into next year. 

Why do these things matter? Well, they might explain why your Butterball turkey will be more expensive for Thanksgiving dinner this year. Or why your favorite brand of fresh mincemeat from England is no longer in stock at the local supermarket. In the investment world, however, these inefficiencies result in opportunities across the entire space as the market struggles to accurately value quality companies. These are companies the avid investor can identify (as always, with the help of a professional financial advisor) and then potentially profit from.

An Energy Market Case Study

Mere months ago, media reports around the world were dismissing companies dealing with fossil fuels as members of an archaic and truly outdated industry. The argument was that Big Oil needed to transition away from the stuff ASAP, or they would go bankrupt as the world left them behind as countries transitioned to renewables. Big Oil was suffering setbacks in court rooms and even their own sacred board rooms were no longer safe. The solution? Sell off those dirty assets (a la Shell)! Whenever commentary like this (in any industry) becomes widespread, investors should pay close attention to what is being said, who is saying it, who is repeating it, and who the target audience for the message is. If there is a disconnect between commentary and underlying fundamentals, there will likely be inefficiencies created that investors could benefit from through deft positioning.

For his part, The Ignorant Investor was left shaking his head at these statements. Yes, the world should strive to move in a sustainable direction, but what about global oil demand sitting somewhere near one hundred million barrels per day? And sure, the developed world can start utilizing renewables, but globally, developing economies will be expanding their usage of fossil fuels for at least many decades to come- even to the point of (eventually) eclipsing current usage by “developed economies”. In the end, publications and pundits were rudely jolted back to the real world in recent months as energy usage and power production crunches forced oil prices higher and higher.

The underlying fundamentals (a simplified story): demand increased, and supply remained flat. A perfect storm for higher oil prices was created when societies and economies roared back to life thanks to the development and deployment of effective vaccines. Meanwhile, industries roared back to life, global demand for goods skyrocketed (requiring increased shipments which aggravated supply chain disruptions) and a combination of wary oil producers (think OPEC+, shale oil companies), still smarting from heavy losses incurred during last year’s deep bear market for fossil fuels, exercised strong production restraint at the behest of investors and other interested parties.

Stories of Note

Pfizer’s covid-19 drug is remarkably effective

Pfizer’s November 5th press release offered some remarkable information: clinical trials show that their antiviral cocktail (antiviral combined with HIV drug) administered in the form of an oral pill can reduce hospitalizations by up to 89%. Now THAT is remarkable. The first part of the solution for fighting Covid-19 has been to grant some level of resistance to the virus through vaccines. The second part of the solution is to easily treat people who come down with the virus so that it becomes more like a common case of the flu. You can read more details about the study directly from Pfizer.

US-listed Chinese stocks remain a risky proposition

As a follow-up to a previous post, US-Chinese brinkmanship on the world stage continues to be a cause for concern for investors considering new positions in US-listed Chinese companies. On the one side of the pond, China continues to crack down on Chinese companies and industries in the interest of a broad-based “reform.” In the crosshairs of this crackdown appears to be Chinese companies that flout local regulators or are listed on US stock exchanges. 

This brings us to the other side of the pond. US regulators continue to chafe at the lack of clarity provided to them by Chinese companies- who, by state law, are not permitted to share information with US regulators. In the past, this has allowed several US-listed Chinese companies to commit outright fraud or hide material information from international investors. Tellingly, in late October, a member of the Congressional investor protection subcommittee stated he would like to introduce a law requiring foreign compliance with US regulators. This could effectively force Chinese companies to delist from US stock exchanges.

The Ignorant Investor is certain value does exist for investors in Chinese companies but 1) doesn’t know which companies would be “safe” from a crackdown by either player, and 2) expects the situation to remain highly volatile as the US and China continue to jostle each other on the international stage. I mean, at the core it seems as if China doesn’t want Chinese companies listed on US exchanges, and similarly US regulators don’t want Chinese companies listed on US exchanges. Perhaps the best path forward for investors is to buy some shares in safe, boring companies in unaffected regions, and grab a bucket of popcorn before sitting back to enjoy the show?

Still interested in Chinese stocks? To learn more, read this informative article by Morningstar on Chinese public companies; apparently, the type of stock you own may sometimes be more important than the type of company you own!

Alternative energy companies look promising

Alternative energy companies can refer to companies seeking to utilize renewables like solar and wind for power generation, companies seeking to utilize “clean” energy like electricity and hydrogen to power vehicles, and everything in between (oh, and if we want to remain practical, throw nuclear into that mix! There is no worldwide movement to renewables without nuclear- the numbers simply don’t add up). Tesla has done remarkably well in the eyes of stockholders in recent years and has even managed to hit its production targets in recent quarters as well. But Tesla as a car company remains remarkably miniscule when compared to the traditional car manufacturers (especially surprising when comparing volume of press coverage across all vehicle producers). This outsized news coverage has been very beneficial for all alternative energy companies as developed nations (ie USA) lurches back in the direction of renewables and away from fossil fuels. With such favorable tailwinds as policy changes, legislative initiatives (the so-called Infrastructure and “Build Back Better” bills), and increased investment as agreed upon by developed nations, the alternative energy space has grown rather crowded. Still, there are some quality names hidden among the throng- quality companies that provide excellent entry opportunities for investors over the long term (these investors should make sure to enlist the help of their trusted financial advisor in identifying these opportunities!). For more information, Bloomberg has a decent discussion on the recent power shortages in Europe and China and provides an argument for expanding clean power.

Shell sold Permian assets for the tidy sum of $9.5 billion

True to its word, and in the spirit of a “recent” European court ruling, Shell has decided to trim down dirty fossil fuel production so that they can become a cleaner energy company. What better way to accomplish this than to sell off some of that dirty fossil fuel to another company? ConocoPhillips stepped in to purchase Shell’s Permian assets for $9.5 billion. A smart move, expanding the company’s footprint in the best shale oil field in the USA. Doesn’t do much for global warming, but Shell is now a cleaner – and cash richer! – energy company in the eyes of the EU and ConocoPhillips is now a better oil company in the eyes of the investors- so I guess that means everybody wins! You can read ConocoPhillips triumphant announcement in their news release here.

Note that this is another update (old news, but recent compared to our last post). The previous rumor that Shell was shopping around its premium oil lands in Texas turned out to be accurate! 

Why not work from the beach? Oh, and markets keep moving higher while keeping a wary eye on delta spread, inflation readings, and stimulus news

Market Performance Update | Work From Home Is Here To Stay | Notable June & July Stories

Work remotely from a beach in the tropics? The formerly-years-away-now-realized dream to untether workers from the workplace via the internet has transformed portions of corporate America and is surely here to stay. [Image ©guruXOX / Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com]

And with that, July is long gone! Vaccination efforts are in full effect across the United States and its territories around the world. Pfizer, Moderna, and Johnson and Johnson remain available in clinics and local pharmacies. And the US came up with a truly capitalist approach to help prod the unvaccinated towards becoming vaccinated: pay them (The Ignorant Investor thinks this is a brilliant way to save time and energy while pushing forward with general reopening- no sarcasm intended). 

July Stock Market Review 

As for stock market indexes, the Nasdaq and S&P 500 saw strong gains for the month of July, pushing them to record territory even as market breadth continued to narrow. Looking under the hood, we can see how several of the strongest performing sectors for 2021 were brought into check while the entire reopen trade experienced weakness. 

And was that weakness warranted? Well, the Covid-19 Delta Variant certainly did throw a wrench into things! New health and travel guidelines started to creep back into vogue around the globe as nations weighed a return to old restrictions (the CDC reversing earlier decision to recommend masks as no longer needed: now, again, they are highly recommended for indoor areas) and an introduction to new restrictions (vaccinated individuals are the only ones wholly free to travel in this post-covid world as decided by Canada, parts of Europe, and some Asian nations. To be fair, the US is considering a similar rule as well).

The fact of the matter is that even amid fantastic quarterly earnings reports, markets were experiencing weakness as analysts fretted over peak this and peak that (earnings, economic growth) just as the government looks to wind down monetary stimulus (fiscal stimulus likely to continue in the form of the infrastructure bill, with another $3.5 trillion spending bill up in the air). Meanwhile, the S&P 500 valuation remains elevated by most metrics against historic norms, so some trepidation at these levels - especially when bond yields swoon – comes with the territory. 

Finally, to wrap up forward-looking market concerns we must examine inflation. As mentioned in previous posts by The Ignorant Investor, inflation remains a wild card. The Fed has done a remarkably good job overseeing the economy over the years by sticking to its two nominal mandates: 1) maximize USA employment, and 2) keep prices relatively stable (ie inflation in check). Difficulties begin to occur when readings for these two mandates diverge. In recent months, inflation numbers have skyrocketed to near multi-decade records while unemployment remains stubbornly low. Anyone shopping at the grocery store for steak or buying a laptop online will notice that prices seem high these days. Despite the Fed sticking to the “inflation is transitory” theory, The Ignorant Investor suspects that inflation may actually be here to stay, and the US central bank may be forced to begin tapering very soon- and perhaps *gasp* adjusting its rate forecast.

Covid too, will pass. Covid’s effects on the employment landscape? Not so much.

The USA’s outlook has improved significantly now that the country is (somewhat) vaccinated with about 50% of the population receiving both doses. Not only are vaccines plentiful enough that anyone can get their “jab” down the street at the local pharmacy, but people can breathe a sigh of relief as life gradually returns to normal. Wait, normal? Employees now familiar with the increased freedom of working from home are now facing the troublesome inconvenience of returning to office life. The genie is out of the bottle, however, and a telling Bloomberg News survey (read the full article at Bloomberg) showed that workers are in earnest, with about 39% of respondents indicating a willingness to quit without some work flexibility offered by their employer. Indeed, management and workers both are locked in a complex, introspective struggle to determine what “normal” will potentially look like going forward.

Companies across the industrial spectrum have largely been responsive and appear to be formulating new policies that offer some flexibility for employees to Work-From-Home (WFM) while maintaining wariness towards Work-From-Anywhere (perhaps video conferencing with an employee based on a beach in Bali would be detrimental to NYC office moral?). This so-called hybrid approach would allow workers to divide working days between home and the office. Of course, the implications are quite significant and the stakes high for all parties involved and affected, including (not exclusively):

• Employers concerned about everything from worker productivity to company culture
• Employees seeking better work life balance and lower costs away from major cities
• Industries that support the traditional work-at-office lifestyle or the new work-from-home lifestyle (childcare, commercial real estate, commuter transport, etc)
• High/low tax cities and states as employees and employers become more relocation-flexible

While this trend will likely result in a systemic change to the employment landscape, it is also important to note that some professional trades can better adapt to this kind of work (Amazon software developers for example) than others (say investment bank JP Morgan *cough* which intrinsically requires in-person business interactions). Such a transition will take time and be nuanced as all players adapt. Additionally, many highly skilled professional employees may decide to avoid WFH aspects of a job altogether for greater professional visibility or social reasons.

Let’s look at this scenario from the point of view of the employee (since the employee is the driving force behind this change). One fundamental challenge of working from home is the amount of self-discipline required to maintain productivity over time in a comfortable space. This primary challenge is probably matched only by the need to set up personal/professional boundaries: ‘Am I truly working from home, or am I now living at the “office”?’ The Ignorant Investor has had significant work flexibility for many years now yet can still occasionally struggle with this exact question. Other questions from the employee perspective include:

• As an ambitious young professional, how are my soft skills and negotiating skills progressing through occasional conference calls? Do I miss spontaneous meetings in the office?
• Am I creating the deep, influential networks that I need to propel my career forward in later years? Limited networking opportunities can be a headwind to a successful career.
• What is my status? Are my visible on-site coworkers gaining the attention of and promotions from the boss? Remote workers can be remarkably efficient yet easily overlooked and forgotten.

For reference, many of these observations come from The Ignorant Investor’s conversations with working professionals in various fields. One stark example of post-Covid migration plans are several private funds actively leaving storied New York City for tax-friendlier locales with no plan on returning. The pandemic was apparently an excellent proving grounds for working remotely in some corners of the financial world. 

Now why does all this matter? Surely these rambling notes must have some deeper meaning to them, meaning that an investor could take hold of and profit from? And the answer is a resounding yes. Should this transition to WFH prove to be more than transient, then opportunities abound in one group of companies. Should it prove to be transient, then opportunities abound in another group.

With WFH looking to be at least a partial systemic change to the US employment landscape, one might – in close consultation with an investment advisor – consider creating quality buy lists across some of these potential themes (note that within this space there is plenty of overlap among public companies). 

• Cloud-based solutions
• Virtual work technology (virtual workstations, etc)
• Messaging, sharing and collaborative communication systems
• Security solutions (cybersecurity, content delivery networks, etc)

Notable Stories from June and July

Regulatory reform or asserting control? US-listed Chinese companies have seen heavy losses in recent weeks

The stock market has always been viewed in Asia with a semblance of wariness and admiration. Wariness for those old enough to remember past steep declines, and admiration from the younger crowd familiar with only the steady gains of recent years (“The stock market? That’s gambling!” a remarkably successful Asian businessman once told The Ignorant Investor). And Chinese companies, for their part, have all the while jostled and competed to raise foreign capital in the US stock market, even while sometimes playing fast and loose around facts, disclosures, and regulations. 

Indeed, The Ignorant Investor has been somewhat puzzled by lack of US SEC regulatory action of late (especially after Didi neglected to alert US investors of potential risk of *forewarned* Chinese regulatory action). Congress has been unhappy with the situation for several years and intends to reduce the number of misbehaving listed foreign companies (think fraud at Lucking Coffee, etc) and level the playing field with China (US-China tensions *yawn*). 

The Chinese government, in the meantime, has decided to crack down on corporate China for the posited reason of re-asserting control over raucous and unruly private enterprises and bringing about more accountability, stability, and security through “reform” (whatever this broad term might imply). This has resulted in US investors losing hundreds of billions of dollars as the US-listed stocks* of these Chinese companies fell sharply amid heavy selling resulting from uncertainty on the length and scope of these crackdowns.

The Ignorant Investor is content to watch this play out from the sidelines until more clarity is provided from both sides of the pond and would urge wariness and caution on the part of investors considering new stakes in US-listed Chinese companies at this time. 

Believe it or not, Shell is considering the sale of its Permian Basin oil field assets

Shell is one of those energy majors that has come under withering criticism from environmentalists because the company has “enabled” fossil fuel consumption by producing, processing, and transporting fossil fuels. Beyond minority shareholder discontent (think Exxon), however, the company was also ordered by a European court in May to significantly cut its carbon emissions** by 2030 (twenty years before the company’s own timeline; read about the original court order at The Guardian). 

Later, in June, Reuters revealed that Shell is considering a partial to complete exit from the Permian Basin to help meet these aggressive targets (read the original article at Reuters)- an event that would have been considered unthinkable even several years ago. Interesting news to be sure, but why discuss them now? Well, the headlines may have well passed*** but developing a plan to divest up to $10 billion of assets in this premiere US shale field will take time- and we can be certain that Shell’s competitors are waiting on the sidelines to snap up whatever is put on sale. This story isn’t over yet!**** 

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*Technically, US investors are NOT buying shares in a Chinese company but instead buying shares of an offshore entity that mirrors the performance of the associated Chinese business through a convoluted set of contracts (reduces US regulatory scrutiny from a legal standpoint)

**Note that this usually results in the European energy entity divesting itself of “dirty” Asian assets like coal power plants through sale to overseas energy companies; the European energy company’s carbon emissions therefore appear to improve even though there is NO net effect on global emissions.

***Yes, yes, the downside to posting once every two months is that sometimes a major story gets missed. 

****This corresponds closely to an article in The Ignorant Investor’s previous post entitled “The Fight for the Environment (or the war on fossil fuel, take your pick!) is creating opportunity”

What new normal? From sea to shining sea, the United States is seeing a return to the old normal. It feels good, and the stock market likes it too!

Free (from masks) again! From sea to shining sea, the United States begins to experience a resumption in normal life. And investors wisely positioned for the reopening trade see continued gains. [Image ©IRStone / Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com]

Internal thoughts like “Wait, they’re smiling? Oh, right, I should smile back!”, “I never would have guessed my coworker looked like that…” or more tongue-in-cheek observations “I preferred you with your mask on!” have been dominating in-person *gasp* discussions. And we most recently gathered for Memorial Day family picnics, passing out hamburgers and hotdogs, while enjoying the fresh air and our oft-taken-for-granted freedom once again. As vaccinations continue to progress by leaps and bounds within the USA, the CDC issued guidance earlier this month that masks were no longer necessary for fully vaccinated people. Beaten-down companies that benefit from full reopening (Carnival’s cruises, anyone?) roared higher as the entire reopen trade cheered even as the broader markets were jostled by the volatile mix of highly valued growth stocks, skyrocketing inflation data, and a Fed caught between the desire to keep a good thing going while reigning in a potentially heated economy (raising legitimate questions like is more stimulus really the answer here?).

The May Conundrum

Sell in May and go away* is an old adage that may or may not have been good investment advice for 2021. After all, if one had sold at the beginning of May, then that individual would have had ample opportunity to profit in the short term from the weakness seen towards the middle of the month and could easily be sitting on a free gain well north of 10%. But then again, timing the market can be a bit like rolling the dice even for the best investment professional out there- and keep in mind that a professional’s analysis of prevailing market conditions and expectations can be remarkably accurate (separate thought, but since as a market participant this professional also forms a part of the market and is thus influencing and influenced by – hello, professional peer pressure! - prevailing market sentiment of big players, one could also argue that this professional’s consensus forecast may be at least partially a self-fulfilling prophecy in the near-term as a result of "consensus" fund flows. But we digress and will leave that conversation for another day).

What we can be CERTAIN of is that infrastructure-related, energy, and financial companies led equity sector gains for the S&P 500 while growth companies struggled (hey, the Nasdaq saw its first monthly decline in more than half a year). Okay, this makes sense. After all, the economy is reopening, Congress is kicking the infrastructure/stimulus debate back and forth, and we saw multi-year record increases in the currently favored inflation indicators; the producer price index reading was up a sizzling 6.2% year-on-year and the consumer price index up 4.2% year-on-year. An even more stark comparison can be made between this data and anemic inflation readings prior to the Covid-19 shutdowns. 

And despite all reassurances from the Fed that they plan to stay the course, even former Fed Chairwoman - now Treasury Secretary - Janet Yellen commented that raising the funds rate may be necessary to keep the stimulus-fueled economy from running too hot (which also makes perfect sense). After all, the economy is chugging along indeed: the second estimate for second quarter GDP came in at 6.4% on the back of a wave of increased consumer spending.

Among many different topics to close off May, The Ignorant Investor would like to address political risk. Stimulus plans, infrastructure redefinitions, and bipartisan debates are all well and good, but whether it is the Republican’s $1 trillion infrastructure plan or Democrat’s $1.7 trillion infrastructure plan, the big, dirty question both parties like to avoid is HOW are they going to pay for it (which really means WHO is going to pay for it)? President Biden proposed raising capital gains tax to 39.6% on high earners (more than half a million per year if memory serves correct), but then leave the dividend rate at 20%. The Ignorant Investor will avoid the mundane dreariness of the debates over fairness and instead ask, if this were to become reality, what does it mean for the market? How will funds be re-allocated by high-net-worth individuals and institutional investors? How do international institutions, not subject to US capital gains taxes, react? Such drastic measures as that proposed by President Biden have - when taken at face value - the power to reshape the stock market.

Energy Market Snapshot

Energy markets have been adjusting to changing political terrain as country after country lurches towards more stringent environmental regulations (positive for renewables, headwind for fossil fuels; more info in “The Fight for the Environment…” under “Notable Stories” below). The outlook for fossil fuel consumption (ie refined oil products) looks rosy even in the face of uneven global recovery with the IEA predicting that combined North American and Chinese demand growth will more than make up for challenges posed by severe covid-19 outbreaks in India and Japan. Their arguments include supply-side constraints (lack of investment, voluntary cuts a la OPEC+) that may become less compelling should Iran sign a nuclear accord (releasing the country’s added oil production into international markets) and US shale producers begin ramping up production. In the meantime, US inventory and rig data from this month appear to support the bullish oil price thesis by showing American producers are being fiscally responsible this time around (but again, take this with a grain of salt- has any person accurately predicted near-term oil price fluctuations over the last seven years?).

Notable Stories from May

Cyberattacks are very real and have serious real-world consequences

The Colonial Pipeline is one of those incredibly important systems that keep the US economy humming yet remains relatively unknown and unappreciated by the general public- that is, until it stops running.  About half of the US East Coast’s refined fossil fuel needs are accommodated by the pipeline, and the entire system was forced to shut down for five days following a successful ransomware attack- the quick restart also involved paying a “ransom” to the hackers (who, understandably, were quick to deny acting on the part of any state and likely eager to escape the media spotlight). The turnaround time from discovery to resumption of services for the pipeline is remarkable (read the CEO’s rationale for paying the hackers for the decryption tools in this article by the Wall Street Journal), but the event once again shines the spotlight on the significance of cyberattacks and the need for international corporations to increase their cybersecurity efforts. 

The fight for the environment (or war on fossil fuels, take your pick!) is creating opportunity

Traditionally, The Ignorant Investor would have no reason to ever feel sorry for Big Oil. After all, these juggernauts plod onward year after year, secure in their mammoth size and financing while smirking at any political or financial storm. But this last week has been historic in its brutality for the industry. After all, Exxon Mobile was forced through the efforts of an insignificant hedge fund to accept two new environmentally-focused members to the company’s board!! The fight has now been brought to the inner sanctum of the board room. And what can a fossil fuel company, excellent at all things finding, drilling, extracting and processing fossil fuel do in the face of societies fixated on renewable energy? Well, they also can pivot to renewables- at least, that is what European-based energy companies have been doing in recent years by jettisoning overseas carbon-producing assets and streamlining businesses to align with improving environmental goals. But what exactly happens to these jettisoned oil fields, coal mines, and fossil-fuel consuming power plants? Why, they get offloaded to other energy companies of course! While the fossil fuel energy sector adjusts to stricter environmental oversight across the globe, the energy space remains subdued relative to a fairly rosy near-term future, resulting in “inefficiencies” as far as value is concerned- an opportunity outside of Big Oil for those developing buy lists in close consultation with their investment professionals! Meanwhile, the Guardian has a good article summarizing the sentiment and setbacks confronting international energy giants here.

Not all vaccines are equal and difficulties remain on the road to "herd immunity"

While the technology behind the various types of vaccinations do indeed differ**, questions about efficacy between the vaccines as well as what herd immunity actually means remain. For example, the islands of Seychelles became one of the most vaccinated nations on earth by relying on Sinopharm and AstraZeneca’s formulation. Public confidence rose. Then a significant number of fully vaccinated inhabitants came down with the dreaded Covid-19 (albeit a less severe illness). Notably, exactly which vaccine these sick individuals received remains unreported. This raises legitimate questions on vaccine effectiveness, vaccine effectiveness over time, as well as what percentage of inoculated inhabitants results in the fabled herd immunity. Bloomberg has a good article summarizing the situation as well as relevant questions in this article.

A rare opinion piece

The perils of weakening vaccine patents

Life-saving medicine and medical care should be available to all, regardless of whether they themselves can afford to pay for it. Life-saving medicine and medical care should never be withheld. These important statements, in spirit with the Hippocratic Oath taken by physicians, is not, however, mutually exclusive to the weakening of pharmaceutical drug discovery patents (in this case, vaccine patents). 

The staggering amount of funding that drive the development of new types of medicine (statistically, north of two billion dollars to develop a single pharmaceutical drug) requires some form of reward at the end of a long and treacherous development road to make the trek financially worthwhile. This reward comes in the form of fast-expiring patents that grant temporary exclusivity of a pharmaceutical drug discovery to the organization that discovers it. After all, about 90% of drugs will fail in various development stages- failure, not success, is the norm. Even the appearance of weakening protections around pharmaceutical drug discoveries can send a chill through the world that finances it, and the result of pursuing this course of action has the potential to negatively impact the number of future critical drug discoveries. Remember, this is the industry that developed Covid-19 vaccines in record time, allowing a resumption of normal life and saving the lives of countless millions. The industry that discovered a cure for Hepatitis C a mere several years back. Not a treatment, a cure. 

Slow global vaccine rollout is NOT a result of intellectual property hoarding but primarily due to difficulties associated with sourcing raw materials, constructing specialized facilities required to produce vaccines, and finding specialized professionals capable of running them. Besides, Pfizer and Moderna already allow free production of their vaccine by anyone after publicly declining to enforce their patents. And what about legal routes through which pharmaceutical companies are compelled to allow production of their specialized discoveries for poor countries? Many uncomfortable questions can RIGHTLY be asked about unfair early vaccine distribution between developed and developing nations- but attacking patent protections? What does this prove? Rarely does The Ignorant Investor address a hot political topic, but this positive-looking-in-the-near-term decision solves a problem that doesn’t exist AND has potentially unpleasant and hazardous long-term consequences. Forbes has an opinion piece here that outlines industry confusion around this decision and emphasizes (better?) alternatives available to the Federal government in times of emergency.

* Historically, positive equity market activity in the early summer months has been relatively limited

** An oversimplified explanation of the two main types of vaccines: mRNA (see the definition from the US National Genome Research Institute here) in the case of Pfizer and Moderna, or a traditional viral vector in the case of Johnson and Johnson and AstraZeneca, create proteins that cause the body’s immune system to recognize Covid-19 as a tenacious enemy

The sky's the limit! Improving fundamentals continue to drive the US stock market higher and higher

Since our last post, the financial sector has outperformed and energy and infrastructure-related companies have seen significant buying pressure. There isn’t too much surprise among market participants. [Image ©kinwun / Adobe Stock]

Between the beginning of March and the end of the first full trading week of April, the S&P 500 has moved more than eight percent higher – an impressive rally that managed to surmount the proverbial “wall of worry.” Looking further under the hood, we see that nine component sectors have now gained more than 8.5% during that period, lagged only by Health Care and Energy (which moved close to the flatline). Drivers are broad-based and include:

• Rising inoculation rates
• Solid economic data (US, China).
• Unprecedented monetary and fiscal support
• Expectations for an infrastructure bill

This winning combination helped push both growth and value names higher as the rally moved beyond the reopening trade. Tempering investor enthusiasm and causing concern for many fund managers, Treasury yields flexed their own muscles in March, demonstrating that they, too, can rise rapidly. Also helpful to keep in mind that such a long winning streak has driven valuations by most metrics to historic levels- levels that will have to rebalance once, say, a new tax regime appears on the horizon.

The Ignorant Investor has been attempting to emphasize over the past year that market movements don’t always make sense, and investors need not pay too much attention to daily fluctuations as long as the fundamental story behind their long-term vision remains intact (caveat: keep in mind the John Maynard Keynes adage that “markets can remain irrational longer than you can remain solvent”). And what better way to craft that investment story and curate a buy list of associated companies than in close consultation with your financial advisor?

Market Tabloids: The dramatic collapse of a massive, unknown hedge fund

The US stock market recovery from the dark depths reached a mere thirteen months ago has been remarkable. And the stories that have accompanied the market’s spectacular run have been equally remarkable- think the hydrogen vehicle craze, cryptocurrency boom, and Gamestop short squeeze saga. More recently, market participants have been fixated on the drama surrounding the blowup of the Archegos Capital Management family office run by Bill Hwang. Family offices are quite common for ultra-high net worth individuals who prefer the privacy afforded by such funds. Mr Hwang successfully maintained relative anonymity until achieving fame for all the wrong reasons when he managed to lose around $10 billion (yes, with a “B”)- all in less than a trading week. There are billionaires in history who have lost it all, with the closest match to Mr Hwang perhaps being the Stroh family, whose $9 billion fortune stemming from their beer business evaporated over several decades. But perhaps no one (at least, among “honest money” in the “free west”) has ever lost their fortune with the speed and ferocity of Archegos.

In the vein of market participants behaving badly (a theme we have followed over the past year), we could talk about how regulatory oversight could be improved so that everyday market participants could have better understood the risk associated with Mr Hwang’s ultra-concentrated positions (estimated far north of $50 billion after including leverage extended by various prime brokers- indeed, losing $10 billion in a trading week without leverage would be an incredibly difficult feat; Bloomberg has a decidedly excellent opinion piece that summarizes what happened). We could also talk about how leverage is most definitely a two-edged sword for both hedge funds and prime brokers- but these stories are already heavily covered across business and financial news media. And yes, the positions and strategy that Archegos employed appears to have been staggeringly reckless in recent months. Let us pause for a minute here and look beyond the current drama to focus on something else: assuming no untoward legal activity, Bill Hwang must indeed be a brilliant investor, with almost a decade of spectacular success in the regular stock market before his even more spectacular demise. What positions did he take? What strategies did he employ? The Ignorant Investor finds it is far better to learn from others’ achievements AND mistakes to enhance our own market performance!

Had this blowup had been a better-known fund, Wall Street might have simply shrugged and gone on about its business. There is something more intriguing (mysterious?) about a relatively secretive player – a scion of dotcom hedge funds past to boot – exercising sizable influence in large, publicly-traded names. But in the meantime, stay tuned! More details will likely emerge as banks update investors on their performance for the first quarter of 2021.

Notable Stories from March

Infrastructure, definitions, and corporate taxes

Mere weeks ago, the word infrastructure referred to transportation networks and other physical elements responsible for keeping the United States moving. Now that definition may be expanding to cover other areas as well, all thanks to the Biden Infrastructure Plan. The plethora of news on the proposal has since become tainted with accusations and opinion pieces on either side and discussions on how the government is going too far or not far enough. In this surrounding storm the details have become murky. But The Ignorant Investor likes to ignore the winds of chaotic and emotional commentary and get down to the cold, hard facts: thankfully Forbes has provided an excellent BREAKDOWN of exactly WHAT is in infrastructure proposal. Keep in mind that the bill’s hefty (nearly) $2 trillion pricetag is meant to be partially paid for by raising the corporate tax to 28% (likely 25% after pushback from corporate America) and introducing a “global minimum corporate tax”. Should these measures be enacted, markets are reasonably expected to rebalance according to how those dollars are spent and the associated tax regime. Which brings us to another great article, this time by Barrons, which discusses technology names that could benefit from the plan as well as some commentary by analysts.

Rising yields spook the stock market

In March, the stock market suffered some weakness as Treasury yields suddenly shot higher over a period of weeks. This matters since solid economic data in combination with accommodating fiscal and monetary policy for a nation awash in stimulus funds forms fertile ground for inflation (data has shown that inflation is rising). As Treasury yields rise, so do stock market risks since at some point participants will desire to climb back down the risk curve and pick up higher-yielding Treasuries. While the Fed has managed to talk down some fears by emphasizing commitment to unchanged rates, bond markets initially responded with a degree of skepticism. Strong economic growth coupled with continued easy money policy? How long can that last before inflation starts accelerating? These questions will linger, but bond traders appear to have capitulated- at least for now - according to this Bloomberg newsletter.

Ever Given aggravates existing supply chain challenges

The Ever Given is that ultra large container vessel which managed to block the Suez Canal for almost a week before being freed on March 29th (yes, The Ignorant Investor did do a quick check for fun: this mammoth ship is 50% longer than the RMS Titanic and has twice the breadth). And for an intra-article comparison, the global economic blow resulting from the grounding of the Ever Given is roughly equivalent to a large portion of the leverage that the Archigos Capital Management had drawn from its prime brokers. Beyond a large fixer-upper bill from Egypt, the grounding of the Ever Given also demonstrates the fragility of a global supply chain that is currently creaking and groaning from heavy use. VOX has a good article summarizing how shipping disruptions like the Ever Given may affect consumers in the months to come. 

The Stealthy Bull Market: Strong tailwinds drive the reopening trade higher even as Big Tech treads water

January market performance | Consensus expectations for 2021 | Notable Stories since the New Year

Exuberant investors are cheering as favorable tailwinds are converging to push the stock market higher [Image ©interstid / Adobe Stock]

January was a mixed month as far as equities were concerned. Certain names and sectors saw strong buying pressure in one part of the month balanced by weakness in another part of the month (energy is one great example here- rising sharply in the first two weeks of January but seeing strong selling pressure in the second two weeks of January). The relatively muted performance of the major indexes does miss relatively strong undercurrents in component sectors. The more-comprehensive list of smaller public companies in the Russell 2000 rose a whopping 5%, and biotechnology saw some strong buying pressure too.

What was driving these disparate moves? One big driver was investor expectations under an improving economy and aggressive vaccination goals. Another was rotation around Democratic control of Congress and the White House; companies that benefit under the Democratic agenda saw significant buying pressure, while companies that will face headwinds saw selling pressure. The reopen trade also saw new bullish moves as expectations grew for additional stimulus measures and improved vaccine rollout.

Consensus market expectations for 2021

Strong fiscal support of US economy will continue

Democratic control of Congress assured passage of the proposed $1.9 trillion coronavirus-related stimulus package (yes, that is a “T”). This in combinations with massive support of the economy by the Fed will prove to be a significant tailwind.

The dollar will continue to face weakness

All this extra money flowing into the economy (increasing supply) will reduce the real value of the dollar, which will also be helpful for US exports. 

Economic data will remain relatively solid

Vaccination efforts have been mishandled around the globe, but the outlook continues to improve, and progress has been made. With multiple "good" vaccination options available, economic reopening will continue to increase as large portions of society become vaccinated against the virus.

Inflation will likely be rising, possibly significantly

All of this extra money floating around, with Treasury yields near zero, will likely accelerate price increases in the United States.

The regulatory environment will be tightening

Scrutiny of everything from financial markets to energy markets is likely to increase. Hey, Gamestop’s recent YOLO moves alone will likely also bring some unwanted attention to “stonks.”

The tax regime will likely be less favorable for the stock market

All of the discussion around wealth disparity, enhanced by 2020’s moves around economic shutdowns and reopenings, will likely result in a higher tax rate for both corporations and stock market participants. Retail investors will likely see little direct impact from this, although markets will rebalance to account for any tax adjustments.

The policy train is just pulling away

One theme? Renewables are in, fossil fuels are out. Amid a much longer list on President Biden’s agenda is an return to intense focus on environmental protections (and hence additional regulations).

Notable stories since the New Year

Staggered global recovery is causing a shortage in shipping containers

Supply chains are stable and various brands and types of food available in, say, the grocery store is very stable and incredibly diverse. Or at least this is the case in the United States. Travel across the pond to developing nations and this stability is not always guaranteed- various brands come and go, some are in plentiful supply, others less so. Behavioral change in global consumption as the United States and China reopen and economic activity in these juggernauts accelerate is beginning to strain supply chains as demand for storage containers for shipping skyrockets along some routes and remains muted in others. Strong pent-up demand in the USA for various consumer goods is leaving major US retailers struggling. Even the trade in food has not been spared- Bloomberg has a concise and excellent summary of the situation here. 

The Keystone XL Pipeline has been canceled – again?

In years past, the Keystone XL Pipeline had the misfortune to become a popular political football, kicked between opposing sides of a debate over the environmental role (ie as an enabler of fossil fuel) the pipeline plays until President Trump’s administration approved a permit for the pipeline in 2017. Focus is again on the pipeline in 2021 when President Biden signed an executive order revoking that permit. While this does fulfill a campaign trail promise, the fickle (stop-go-no go) nature of US officials over the years has made Canada unhappy and the US court system may now have the final word on the pipeline. A quick summary of a US appeals court ruling against Dakota access pipeline permit can be seen at Reuters.

The time of the SPAC is upon us! But what’s a SPAC, and is the playing field fair?

SPAC stands for “Special Purpose Acquisition Vehicle” and is basically a shell company that has been created to help business go public outside of the standard IPO process. The concept has been around since at least the 1990s, popping up with some small degree of popularity from time to time until becoming all the rage in 2020. Indeed, with 2021 now upon us, investor enthusiasm for SPACs continues to show no sign of abating. With a SPAC, a group of investors come together and fund a company with the express purpose of finding and then acquiring a favorable candidate in a reverse-merger-type transaction. In purely speculative plays, The Ignorant Investor has personally seen some sizable gains in 2020 through several SPACs and watched others with passing interest from afar. Keep in mind that the initial SPAC investor will typically make decent returns regardless of whether the resulting company is any good, so retail investors still need to do their homework and be aware that even after due diligence they can still get burned (*cough* Nikola *cough*). The Wall Street Journal has a great article on how early SPAC investors get “steady returns with little risk.” 

The Gamestop Saga: A Tale of David and Goliath vs another Goliath

In the one corner, we have the smug and stoic hedge funds and other institutional investors, waving their fact sheets and touting their models, convinced that Gamestop is overvalued and will over time prove to be in irreversible secular decline (okay, The Ignorant Investor is using artistic license with this prose, but you get the point). Nothing unusual here, merely standard operating procedure for retail companies eventually destined for the dustbin in a similar vein to Blockbuster or Circuit City. In the other corner, you have the upstart retail investors - mainly millennials too young for lessons learned from the dotcom boom and bust - recently liberated from high trading fees and newly enabled to execute trades in a burst of confetti by merely touching their smart phones (*cough* Robinhood *cough*). Retail investors roared; their combined power unleashed as they turned their attention from Bitcoin and began a coordinated buying spree using a subreddit of the popular WallStreetBets thread. Institutional investors were unprepared and never knew what hit them as losses snowballed (at least this remained the popular narrative for a time).

When the dust settled, it became clear that investors had managed to execute a spectacular short squeeze using a combined strategy of buying shares, options, and in some cases calling their brokers to disallow loaning out their existing Gamestop shares to short sellers. The strategy worked remarkably well, and the power of the retail investor – backed by powerful, strategic trades of Wall Street institutional investors looking to make a quick buck – suddenly became less ethereal and very real. Hey, we already knew some of that from Tesla and other names popular with millennials, but still, this latest activity in and of itself deserves at least a golf clap followed by a moment of silence for the initial shorts forced to cover their positions.