Large Cap Value – 1Q21 Insights & Outlook

Transcript:

Where are we in the cycle?

We’re definitely early in a new economic cycle. Obviously, the COVID recession was not a normal recession. It was not brought about by business conditions being unsustainable. It was brought about by a global health development. But nonetheless, it was a recession. We’re emerging from it. I think it’s important to understand that going into 2020, we had had two consecutive years of decreases in global trade and a lot of reductions in industrial activity. You know, a lot of that was a consequence of political noise from Trump and tariffs and uncertainties related to that. But nonetheless, you already had some quasi recessionary activity. So I do think the new economic cycle and probably long economic cycle assessment is correct.

Lower quality/higher beta names tend to lead over a recovery.  Has the portfolio changed given we are in a post-recovery world?

Generally speaking, for the last 10 years, going into the COVID recession, you’ve seen lower quality, asset-heavy, utilization rate driven businesses perform poorly when the economic velocity deteriorates and perform relatively better when economic velocity improves. And that all make sense at a basic level because they are very sensitive to the economy, to and to utilization rates. So now, we’re going from one extreme to the other, from a lack of utilization completely to there being not enough capacity in a variety of industries as we try to turn things on.

We haven’t changed our positioning radically. Where we think investors and investment professionals need to apply some thought and not be overly dogmatic is a basic question. Are we transitioning into a new era of higher economic philosophy, of higher interest rates, of higher rates of inflation? Or is this just a gigantic one-off that really won’t be through the system until we get well into 2022?

Right now, we don’t know. We think there are good arguments going both ways, and we are in effect straddling the issue with respect to our portfolio allocations for really most of our strategies that we manage. And we think that’s the correct posture. What’s my bias? It’s a bit more that slow-flation is durable and likely to win out over the new era of inflation and rates thesis. But I want to hedge my bets to be clear.

What are some near-term and eventually unavoidable risks facing U.S. equities?

The biggest risk in my opinion that is anticipated is a policy error of some kind by the Fed or by the Federal government. So the Fed policy error possibility is a larger one. Fed Chairman Jay Powell was indicated that they plan to simply look through short-term elevated inflation readings. They plan to not taper asset purchases for a long time. They plan to not even think about raising interest rates for a very long time, despite some very, very strong evidence of overheating in a number of parts of the overall economy. He made a comment at a meeting in the first quarter that the main risk to that outlook as he saw it was if inflation expectations became “unanchored.”

And at that point, the Fed would need to do something. Well, the way I look at it is it is a pretty good way to cause inflation expectations to become unanchored, which is to tell everybody that you’re going to blow off short term and medium-term economic data, because you have some preconceived notion of how this is all going to go. I don’t think you’re going to want to wake up and walk into the office and look at your screen the day that inflation expectations truly become unanchored. There there’s a flip side to this, which is that by being so accommodative, by using such aggressive monetary policy, you are in effect creating an asset bubble. You’re creating a lot of moral hazard behind that asset bubble, and that has its own form of dangers.

In your 1Q21 Market Outlook podcast you discuss the ‘era of digital currency”.  How is portfolio positioning changed to address this potentially massive change?

It’s becoming increasingly clear that some form of digital currency is coming to wallets far and wide in the very near future. We think that things like Bitcoin and some of the other cryptocurrencies are sort of a very loud first gunshot in this development. It’s hard to say exactly what this will look like. If we’ll use digital dollars, just the same way as we use traditional physical dollars. And there’s just a different payment and clearing system. What we’ve tried to do is have some exposures to businesses that we think are potential beneficiaries of a move to digitalization in a need for technology in terms of how money moves around. And we’ve added a couple of positions to our portfolio in the last several months and aim to continue to be active in this regard.

Now, this is one of these areas where growth and value investors may identify potential winners and losers a bit differently. There are some interesting stocks, PayPal and Square jump to mind, that are very interesting. They’ve done a good job, but the valuations are just awfully demanding to participate. We’ve approached this with owning traditional credit card rails in MasterCard and American Express, as well as financial technology company, Fiserv.