ALINE Market Roadmap: April 2021

By Aline Wealth Management on April 28, 2021

Over the years, whenever I needed to have a “discussion” with one of my kids that I knew would lead to arguing and hence an ineffective outcome I turned to pen and paper and I wrote them a note. This allowed me to explain my reasoning for something that they surely would not like without having to hear their screams of disdain and the drama that ensued (i.e. door slamming, crying, tantrums). By writing I was able to put my thoughts down—cohesively—and in a manner that was thoughtful and efficient.

I have turned to the pen, from time to time, in professional discussions as well—discussing why we did this or why doing that is not a good idea, etc. Again, writing, I believe, allows for more definitive and effective communication. That being said, given the state that the markets are now in and the critical importance of our work in protecting our client’s assets (and the strong returns as of late) I thought to return to the “pen.” So, this month—unlike the prior installments of our Market Roadmaps—we’ve changed the modality and as such, you can expect increased verbosity So, curl up on the couch, grab a large glass of your favorite libation and enjoy…

I bet many of you are scratching your heads lately trying to figure out what the heck is going on Wall Street. The speculation, the carefree attitude towards risk (amid a pandemic no less), the valuations of cash flows going out more than 2 years are being used to “rationalize” current prices. I can go on and on but to what end? My goal is not to frighten you—to have you run to the “safety” of treasury securities with their negative real yields—but rather to explain the work of our profession.

Being an investment advisor carries great responsibilities. You have other people’s money resting on your shoulders—their aspirations, retirements, education for their kids and grandkids, their legacies—and the professional advisor MUST remain aware of those responsibilities and the risks that are present that can derail them. This is the business we have chosen and at ALINE Wealth we take it very seriously. Ours is not an exercise in making our clients the greatest return but to match their stated objectives and risk tolerances to achieve the magic of compounding over a longer period so that their goals are met.

Join me for a walk around Wall Street to see for yourselves what we and other fiduciaries who must “suffer the numbers” must contend with:

• Let’s begin with people—investors—who have, many for the first time, turned to the stock market as their new past-time; a digital vice akin to sports betting, online dating/swiping, and video games. I sat at a lunch counter the other day (separated from my fellow patrons with a glass shield and ample space) and watched a fellow set up his iPad and phone—he was “investing” (at least he thought he was). I overheard him tell the wait staff how he bought this and that and now he expects a sell-off but “will be back buying late this afternoon”. Folks, lest you think that is fun or profitable, allow me to enlighten you. It is neither. It is simply a form of diversion and gambling and it will likely end badly. Investing takes time, professional knowledge and tools, and a hefty dose of humility and skepticism—especially when you are doing it for others. As the chart below shows, “everyone is already invested” (and with many borrowed dollars!), and that folks is a “YBLOC”—yellow blinking light of caution (there are more – just wait). Come on you know this—when everyone is invested no matter how much you want to “send it in” and “load the boat” you know you should not do so—that the outcomes are dangerous to your financial health. That’s investing 101—something that these newbies are likely to learn in short order. The third chart is from data compiled as of 4/9/21 and its implications are sobering—more capital has flowed into the global equity markets in the past 5 months than the prior 12 years combined.

• The Fed and its Balance sheet—debt and more debt and the printing presses are still on overdrive around the world—and you should not fear a shock to the system? Really?! From our friends at Knowledge Leaders Capital:

The Federal Reserve’s balance sheet has increased by about 16% of GDP in the last 14 months. At the same time, government debt as a percent of GDP increased by 22%. To put this in context, the Fed’s balance sheet increased more in the last 18 months than it did in the entire post-Great Financial Crisis era and US government debt increased by more in the last 14 months than the previous 9 years combined. Combined fiscal and monetary stimulus equal about 38% of GDP in the last 14 months

Who’s going to pay off all this debt? How will it be retired/eliminated? Increased taxes? Heightened inflation? Both?

• Inflation—an insidious killer of compounding growth. Economic activity (proxied by ISM data in below charts) suggests that inflation is around the corner and when present is likely to be more severe and last longer than current market expectations. Additional data points (Citi Surprise Index and Michigan Inflation expectations) are showing a similar glide path for inflation expectations. We believe that the CPI, given its substitutions and its outdated basket of goods, is an ineffectual measurement of inflation. Once the genie is out of the bottle, we suspect the Fed will have a difficult time taming the beast that has been hibernating and frankly building, for the last 2 decades.

Source: Factset

Source: Factset

Source: Factset

Sectors to allocate capital to in an increasing inflation environment are companies/sectors that can pass along their increased costs to consumers (i.e. utilities, staples, real assets, materials, and commodities) and those sectors that do well in an increasing rate environment (i.e. financials). Value style, long the goat of the growth bias since 2008, has begun to re-assert itself. Also, International exposure is favored given the probability of decreasing dollar, more attractive valuations, and, in the emerging markets, stronger demographics and growth trajectories.

How about the darlings of Wall Street over the last decade-plus? The tech sector? With multiples going out to as far as the eye can see they are at the most risk given that they are a “long duration” asset (much of their valuation is dependent upon a terminal value way out into the future) and therefore most susceptible to higher rates impacting their valuations. The chart below gives you a sense of just how whacky things have gotten—when more than a third of the companies in the sector are losing money (38% vs the 36% that represented the peak in March 2000) …

• Valuations. Well, you knew this was coming. What can I say? As a fiduciary and as someone keenly aware of what can happen when one overpays for an investment, I must “suffer the numbers.” We strongly believe that valuation matters. So, take heed dear reader, it is for your own financial well-being. All of these are off-the-charts YBLOCs.

• As I have often said, Price-to-Sales is one of the most mean-reverting valuation statistics we have to work with and yet they are literally off the charts.

• So, what is one to do? Can’t just stay in cash, right? Wrong! Why not have some cash on the sidelines—some dry powder? I am confident it will come in handy when prices go on sales and everyone else is getting margin calls. Of course, we can have some cash/dry powder but given that it is not providing a return we don’t want to have too much. So, where else can we shop for opportunities? We already mentioned some sectors/asset classes above that are beneficiaries of our expected increasing inflation call. We see opportunities in Japan small caps and gold miners.

Ok, so we are coming to a close and I assume your glass is nearly dry, but I hope your mind is fully engaged. These are very interesting times and we at ALINE Wealth are quite mindful of the importance of navigating the capital markets correctly for our clients. Again, NOT to make them the greatest returns but to PROTECT them, their capital, and their objectives.

To summarize our “take”:

• Pre-COVID the global economy was chugging along on all cylinders. This was partly if not majority fueled by lower corporate taxes and reduced regulations in the Trump administration.
• The pandemic changed that resulting in stimulus to the rescue. So much stimulus and free money (think Bernanke’s helicopter money).
• Debt levels are through the roof and no end in sight for a change in that appetite.
• Vaccines and recovery are taking hold. As the world opens up more pent-up spending will occur (but there likely to be some impact on income statements given higher expenses in this new post-COVID world as well as increased taxes).
• Sure, this is good from a GDP perspective, but it also pushes inflation higher, and given the unprecedented amount of stimulus, there is the fear that the Fed will stay accommodative for longer.
• Inflation! It is way overdue, and the Fed is behind the (tightening) curve—probably concerned about the interest expense on that huge amount of Fed debt as well as the expected market reaction. Mr. Powell, you are not in the business of providing a moral hazard to investors. So, yes, Virginia the Fed can make a policy error! They are not infallible. And I think we are seeing the setup of that in real-time.
• Then enter the bond vigilantes who have been in hibernation since Rubin and Clinton era and watch rates go higher and then the ball game is essentially over—at least for the high multiple stocks.
• We enter a period of stagflation due to the huge debt—prospective returns on bonds and stocks are below the last 20-year trend—but commodities awaken from their slumber (down nearly double digits annually since the Great Financial Crisis and the beginning of this monetary experiment) and begin to be the winners as well as international equities and good old fashioned value stocks/sectors.

ALINE Wealth is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. ALINE Wealth and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. ALINE Wealth and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.