Dinosaur: 4th Quarter 2021 Commentary

Dinosaur

Each Friday I send my four children an email that contains a few so-called “Dad Jokes.” I usually follow that up with a text, reminding them to check their email, something their generation apparently rarely does. I guess I should learn to Snapchat to be sure they get the message. They rarely respond to tell me how hilarious my jokes are but I just know they love them. For example:

• Are monsters good at math? Not unless you Count Dracula.
• I saw a squirrel who just couldn’t make up his mind. He was on the fence all day.
• What’s the difference between a hippo and a zippo? One is really heavy and the other is a little lighter.

See? Fantastic, aren’t they? I know my kids aged 21, 20, 18 and 14 are just too cool to admit they like my jokes. When the older three are home from college and all four of them are together, I frequently bring up my emailed jokes. I ask, “Did you get my dad joke email?” I then brace myself for groans, eye rolling and a chorus of unpleasantries. “Dad, those jokes are NOT funny. Why do you send them? A first grader could think of better jokes. I can’t believe you think they are funny.”

That is always my cue to reel off a few I know they’ll just love. Such as:

• I didn’t think orthopedic shoes would help. But now I stand corrected.
• What do you call a dog serving on a submarine? A subwoofer.

The chorus from the kids continues, but louder. “Stop! Enough with the corny jokes! Those are not funny! Dad, you are such a DINOSAUR!”

Sigh. A dinosaur. I guess I am. Boring old Dad. But deep down I know they like my emails and even my jokes. Someday they’ll admit it.

Speaking of boring, life has been anything but boring of late. It is truly remarkable what we have experienced in the last few years: The Trump presidency, the virus, the lock-downs, an instantaneous and severe economic recession, working from home, unprecedented government and central bank stimulus, a record-fast economic recovery, racial strife, divisive politics on steroids, the 2020 election, the vaccines, the Delta variant, masks, a doubling of stock prices, surging cryptocurrencies and meme stocks, an economic boom, the great migration and resulting housing shortage, supply chain issues and resulting shortages, inflation, and the Omicron variant.

It seems that life is coming at us at a pace for which we are not prepared. The revenue model that drives social media and the news outlets results in everything in our shrinking world being in our faces 24/7 and sadly, turns everything into a crisis and somehow divisive.

As an investor, one could be forgiven for getting caught up in the idea that things are changing fast and therefore one’s portfolio should be changing fast too. Back in March of 2020, when we endured stock market declines like those shown in the Ten Worst Days of 2020 table, it was hard to get excited about staying in the market.

In the midst of those dark days, it was easy to become convinced the economy was heading for a second Great Depression and that the market would continue to drop. Instead, the market went straight up.

As the clouds cleared a bit during the summer of 2020 and we knew we would be locked down at home, it seemed obvious that we should load up on stocks that would prosper in that environment, so-called “stay-at-home stocks,” like Peloton, Zoom, DocuSign and Amazon. While these stocks did see an initial surge early in the pandemic, they have actually trailed the S&P 500 for the 21 months ending 12/31/2021.

When the Democrats swept the 2020 elections, it seemed like the perfect time to sell our energy stocks and short oil. Obviously, the new administration would favor alternative energy and we should load up on those stocks. Returns show that this would have been a bad trade.

Watching first-time investors pile into Bitcoin and other cryptocurrencies and hearing CNBC commentators gushing about this new phenomenon was hard to ignore in 2021. I won’t go into digital assets here today but I will refer you to an earlier newsletter—Donkeys for Sale—which includes comments on cryptocurrencies and blockchain, and this newsletter—Cowboys on Wall Street—from way back in 2014, which deals with Wall Street and the investment industry selling investors what they want to buy.

Also hard to miss in 2021 was the intense focus on meme stocks, so named because they became popular on social media sites. The most notable examples include GameStop, AMC Entertainment and Blackberry, each of which became the focus of viral online conversations and then saw its stock price explode upward before dramatically declining. The Meme Stocks table showcases the downside of buying into something about which everyone is talking.

And finally, surely hedging inflation by buying gold would have worked last year wouldn’t it?  According to Deutsche Bank, Google searches for inflation in 2021 reached their highest levels since 2010. Remarkably, buying gold was a money-losing trade last year.

Perhaps some of the trendy investments mentioned above crossed your mind over the last two years. You are not alone. As you likely know, it is not our approach at Bragg to make short-term tactical moves, to attempt to time the market, to rotate among sectors, to engage in theme investing or to take big bets on sectors or individual companies. We think the most important tenet of our investment philosophy is our humility; we do not have a crystal ball. Instead we build a diversified, low-cost, tax-efficient portfolio that we can own for many years. Beyond this, we rebalance with discipline and we trust the market.

Last week my father sent me a link to a YouTube recording of a wonderful speech by Warren Buffett to a group of business school students. Buffett told the students they were highly likely to have great success in business if they were focused and if they worked extremely hard at delighting their customers. The YouTube video of Buffett’s speech was interrupted by several advertisements, one of which ironically was for a book about getting rich quick through investing in “digital real estate.” The book by Jeff Lerner was entitled Millionaire Shortcut and I learned that if I submitted my email address, I would soon be on the path to riches. Something tells me Warren Buffett would not approve.

We don’t either. Boring is better. And boring works. Speaking of Buffett, I wonder if my children would consider him a dinosaur?

Above, I mentioned that at Bragg, we admit that we don’t have a crystal ball and that we trust the market. By this I mean that we look to market prices to tell us what is likely to happen in the future. Said another way, we think it makes sense to “get our news from the market.” There is tremendous information embedded in market prices. The market price represents the research and opinions of hundreds or even thousands of investors on a given day. These are people betting real money; some are buying and some are selling, but both buyer and seller agree to transact at the equilibrium price. In general, we trust that the market price is right. This concept is referred to as market efficiency. The market is powerfully efficient at going out and discovering all information about a company or asset and factoring that information into the price. Some talking head on CNBC’s FastMoney can go on and on about higher interest rates in our future, but actual bond prices tell us what investors betting with real money think about future interest rates. We would rather trust the market price than the special guest on FastMoney.

So, Benton, if the market price contains so much information, what is the market telling us will happen in 2022? To answer this question, first I should point out that US stocks (as measured by the S&P 500) are trading just a smidge below an all-time high, that short-term interest rates (1–2 year), while extremely low, have risen slightly over the last six months and finally, that long-term interest rates have also remained remarkably low. A 10-year Treasury bond yielded 1.5% at year end. Here is our interpretation of what these prices are telling us:

COVID-19: The market is looking past the Omicron variant, recognizing that while highly transmissible, the variant’s symptoms are far milder, especially for those who are vaccinated. Cases have soared but hospitalizations and deaths, relative to the number of cases, have not. The market has cheered President Biden’s backing away from the idea of new federally-mandated social distancing restrictions or lockdowns. It seems reasonable to conclude that the market expects Omicron infections plus the increasing number who are vaccinated will bring herd immunity so that the virus becomes endemic and is no longer a pandemic.

Economic Growth: The economy is still booming and this should continue into the first half of 2022. On December 23rd, the Atlanta Fed GDPNow model projected fourth quarter 2021 GDP growth at a whopping 7.6% (seasonally adjusted annual rate), driven by robust growth in consumer spending and private investment. Much of the demand driving the economy is still being fueled by the enormous liquidity provided by the numerous COVID relief bills and central bank stimulus that pumped trillions into the economy. Measures of liquidity indicate that more than $3 trillion of excess cash remains unspent and available in consumer and corporate bank accounts. The punch bowl remains full.

Inflation: According to the Bureau of Labor Statistics, for the 12 months ending November 2021, the consumer price index rose 6.8%, the largest 12-month increase since the period ending June 1982. But inflation may have peaked according to extensive regional surveys conducted by five of the twelve Federal Reserve Banks. These surveys measure things like delivery times, unfilled orders, prices paid and prices received and they indicate that bottlenecks appear to be easing and that inflationary pressure may have peaked during the third quarter. In addition, food and energy, the more volatile components of the CPI, are not expected to continue their upward momentum moving forward. At any rate, shortages and inflationary pressures do not seem to be impacting earnings or the confidence of consumers or corporate CEOs.

Interest Rates and Fed Action: According to Yardeni Research, the comments of Fed Chair Jerome Powell as well as actual bond futures prices indicate that the Fed will end the current round of bond buying (quantitative easing) in March of 2022 and will then raise the Fed funds target from zero to 75 basis points during the second half of 2022. While this represents a change of course for the Fed, from easing to tightening, the target level for rates remains low by historical standards and the market seems to be taking it in stride. Importantly, long-term bond prices do not imply that investors expect rates to rise significantly or to remain high. That investors are betting that rates will remain relatively low reinforces the idea that inflation pressures may ease in 2022.

Earnings and Valuations: Corporate earnings are at all-time highs and current lofty valuations indicate that investors believe earnings can continue to move higher in 2022. The aforementioned observation that tremendous liquidity remains on the sidelines supports the idea that companies will be able to further increase earnings in the months ahead. This is especially true if we continue to see progress with the supply chain and inflationary pressures.

There you have it. That is our interpretation of what the market is telling us. Of course the market could be wrong. COVID could deal us a bad hand, inflation could worsen, interest rates could spike much higher and of course, a myriad of other unforeseen things could knock the economy and market off course. We think it makes sense to enter the new year with low expectations. We do not expect another year of stock returns like those we have enjoyed over the last three years. As usual we are maintaining discipline and rebalancing portfolios. And that’s nothing to joke about.

Thank you for trusting Bragg with your investing and planning. Happy New Year!