January 2021 Thoughts and Insights
January 2021 Thoughts and Insights
Despite the many trials and tribulations that 2020 brought us, we do believe that our investment process has emerged stronger, more focused, and smarter. Our commitment to your investment needs and goals remain our top priority.
Lessons from 2020
- Our view on how important it is to have an investment process that is driven by math and not politics nor headlines was confirmed.
- We learned that the investment cycle is based on the rate of change of growth and inflation. When we know what “quadrant” we are in, we know how to identify the appropriate investments for the given outlook. For your reference, the quadrant definitions we reviewed in our October newsletter are also shown at the end of this newsletter.
- We learned how to adapt to extended periods of volatility and how to integrate the VIX into our investment process.
- We took advantage of zero cost transactions and traded more frequently, dollar cost averaging in and out of positions and taking profits (or mitigating losses when trades did not work).
And as we head into 2021, our challenge is managing our investments when the markets are clearly disconnected from the economy and trading at all-time highs.
Some of our successful ETF investments for 2020 include gold, energy, commodities, and emerging markets. For individual company investments, Costco and Conagra were our leaders.
For our fixed income portfolio, we have reduced most of our exposure to long-dated maturities and are keeping our focus on high income generating investments. We added back our exposure to Emerging Market debt as not only does it do well as the dollar declines but also pays higher coupons.
Our biggest regret for 2020 is selling out of our Amazon position. The company was not making profits (still is not), faced (still faces) regulatory threats, and discretionary spending during the lock downs had dried up. Ultimately, though, COVID-19 was a tremendous accelerator for this company. We are looking to add back our position at the next significant opportunity.
Our number one goal has always been to preserve and protect our capital. This strategy allows us to never lose as much when a market declines, but consequently, performance to the upside may be reduced.
Q1 2021 Outlook
We ended our October note taking a defensive position as growth was declining, inflation was accelerating, and the VIX was above 26 headed into the election. As the VIX declined post-election we have been steadily deploying our cash back into equities.
We are focused on three macro themes that we believe will drive markets over the coming months: 1) strong equity markets, 2) weaker US Dollar, and 3) rising inflation expectations.
First, aided by easy money from the Fed and generous fiscal support from Congress, the US economy is in Quad 2 with both growth and inflation accelerating. Remember that markets move based on rate of change, meaning that comparisons that are “better” or “worse” are more important than “good” versus “bad”. As we close in on March 2021, a full year since the markets began to decline, rate of change comparisons will be massive compared to last year’s -30% decline in GDP. The top 20% of households in the US account for 40% of spending. Over the past year, this demographic’s savings rate and disposable income have significantly increased resulting in pent up demand for purchases of both goods and services. Technology, consumer discretionary, industrials and materials are the sectors we are currently adding to. We are also currently rotating out of REITS and Utilities.
Second, the “cheap money + fiscal support + easy comps = Quad 2” equation outlined above is not just a US phenomenon but also applies to global markets in both developed and emerging economies. This setup is explicitly bearish for the US dollar and bullish for global assets priced in US dollars. We will continue to hold our emerging market ETFs and commodities for this reason.
Lastly, even though the Fed has no plans to tighten monetary policy anytime soon, we anticipate that institutional investors around the world will sell their longer dated maturities causing rates to increase (and prices to decline) accelerating inflation. Commodities and shorter fixed income maturities do well in this environment, so we will continue to hold these positions.
Thoughts on the Election Outcome
The economic outlook is clearly Quad 2 without any consideration of politics. However, with a Democrat controlled government, Congress will vote for additional stimulus (fiscal policy) and the Treasury will continue to print more money through additional monetary policy. Furthermore, Biden’s pick of Janet Yellen as the new head of Treasury and Cecile Rouse as the chair of the Council of Economic Advisors adds further support. Both women are labor economists whose doctrine is to “fix society” and support policies designed to stimulate wages and labor.
This combination is supportive of equity markets, even at all-time highs. However, this combination will also lead to a devaluation of the dollar and increased inflation expectations.
Politics aside, given the easy comparisons to last year, markets will continue to drive higher over the next several quarters. Comparisons will slow in the second half of 2021; at which time we will shift again as growth slows and we will keep a keen eye on the VIX if it accelerates again.
As always, we remain dedicated to serving your investment needs according to your goals. Please feel free to call or write with any questions or concerns you may have. We are so very grateful for your trust in us.