July 2020 Thoughts and Insights

Michelle Trouvé |

Our Process

Over the past several years I have talked about how the market has evolved from a technology standpoint and that over 80% of the trades are now machine driven versus traders in colorful jackets on the floors of the exchanges. As such, at DTIM we have improved our investment analysis to include more robust technical analysis (the study of price/volume/volatility) in addition to fundamental analysis (revenues/profits/earning). 

As many of you know, I am a Chartered Financial Analyst (CFA) and have been a member of the board of the CFA KC Society for many years. This professional venue has given me access to some of the top investment research firms. Two years ago, I started subscribing to a research firm from Connecticut named Hedgeye Risk Management. The company’s founders are Canadian and started their careers working for some of the largest hedge funds on Wall Street after studying math and economics at Yale. As a side note, they were also varsity hockey and football players, so they bring a real spirit of hard work, grit, and a straightforward attitude to their research. Their company now employs 40 analysts covering macroeconomics, individual industries, demographics, and government policy.

This past March with the trifecta of Covid-19, an oil war between Russia and Saudi Arabia, and a fixed income market seize, I was reading everything available to make sense of it all to figure out how to position our money in the best possible way.  With 40 million Americans unemployed, GDP declines near 30% and US deficits larger than ever before, we need to be smarter now more than ever and have significantly increased our research budget to incorporate more of Hedgeye’s analysis into our investment process.

Hedgeye’s analysis is math based and focuses primarily on the rate of change of growth and inflation to provide a framework for what investments work well given the current economic cycle. In addition, they overlay the technical side studying the rate of change of price, volume, and most importantly, volatility. 

They also provide us many insights as to how the big banks function, how the banks interact with the Treasury and the Federal Reserve, and a behind the scenes look at who/or what trades are moving the markets.

Below you will find charts that show the VIX – the CBOE Volatility Index over the past 30 years and this year. The shaded areas represent recessions.  The green line is VIX 16 and the red line is VIX 26. When the VIX measures below 16, the markets are considered stable. Indexing strategies are sufficient and “buy and hold” strategies are profitable.  When the range is between 16-26, the markets are choppier.  When the VIX is above 26, the markets are considered “un-investable” and subject to violent swings in both directions. This regime necessitates active management, diligent security selection and quicker trades. (The details may be too small to read, but a visual of the lines should provide the gist.)

VIX 30-Year Chart                                                                 VIX 1-Year Chart

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Additionally, our investing world changed when trades became free. We are no longer charged a transaction fee when we buy or sell securities (except mutual funds and individual bonds.)

With all the above in mind, we believe that it is important to evolve and adapt to new environments, so our investment process is changing as we trade more actively and move in/out of sectors and even individual stocks. 

 

Our Outlook

Prior to March we were already at the end of an economic cycle with slowing growth, profits, and earnings. Many economists believe that stocks were over-bought due to corporate stock buybacks (buyers driving up prices.) The companies raised capital for the purchases by issuing debt since interest rates were so low. Corporate debt is now at an all-time high and we have a double bubble of expensive equity prices and over-extended companies facing reduced sales, increased costs and lower margins due to the Covid-19 shock to the economy.

The government issued stimulus (PPP, CARES, etc.) allowed the markets to rebound and many of our investments have recovered.  However, we believe the second half of 2020 may see large declines when companies report Q2 earnings quantifying the extent of the losses from the shutdown.  Earning season starts the second week of July. 

By the end of July, the stimulus programs are slated to expire. Mortgage forbearance, auto loans, credit cards, student loans, and enhanced unemployment benefits will end, and repayment will be demanded.  The White House talks of another round of stimulus, but sadly, it is estimated that one-third to one-half of the 40 million jobs lost may not be recovered. The Fed may be able to print money, but they cannot print jobs nor profits.

The massive amount of US debt issued will ultimately weaken the US dollar and we will find ourselves in an environment of slowing growth and rising inflation. This type of scenario is stagflation and it is not only extremely hard on people as the cost of living goes up but is also a very difficult investing environment.  

Although the outlook is daunting, we do have an investment plan. Over the past few months, we have increased our position in physical gold and added gold miners. Gold is considered a currency and holds its value when the dollar declines. Commodities also do well, and we have taken a position in a grain exchange traded fund that owns corn, wheat, soybeans, sugar, and coffee (ticker DBA) and we will continue to increase ownership. We bought Costco and Conagra stocks, which both are plays on consumer staples and can pass rising costs through. We added TIPs (Treasury Inflation Protected bonds) to our fixed income as well as more treasuries in general. Typically, REITs and Utilities do well as they can pass along rising costs so we will continue to hold these positions. Our emerging market consumer fund (ticker EMQQ) is also well positioned as we invest in economies outside of the US.

The profit cycle typically takes 7-12 months to correct so even though the current outlook may not be “puppy dogs and rainbows” right now, we have the tools, desire, and ability to adapt as the market changes.  I am very confident in the research and processes we have in place and would love to set up calls to talk in greater detail.

As always, we remain dedicated to serving your investment needs according to your goals. We are back working in the office and available for in-person meetings, phone calls, or video conferences.  We wish you and your families a safe and healthy summer!

 

Michelle