Fall Commentary – 2021
By Contessa Archuleta on November 1, 2021
*This transcript is from our client tea held on September 22, 2021*
Kyle: It has been an interesting week because although the market is facing pressures and a little volatility this week, it has still been very favorable throughout the first nine months of the year. The S&P 500 is now up 17% year to date. The Nasdaq is up just over 15.5%. The Russell 2000, which is the small cap index, is up 12.5%. The Dow Jones Industrial is up 10.3% to start the year on a total return basis. The Dow is the largest 30 companies in the U.S. Europe is up 16% this year, even without any assistance from the U.K. markets. The U.K. markets are up 9% this year, so performing very well, but a drag on Europe overall.
Something we’re likely to talk about some today is natural gas which is up approximately 90% year to date. Natural gas has fallen for several years, but it is still a significant move relative to where it’s been in the past. Crude oil is up 45% this year. Oil is trading around $79, so up considerably this year. The S&P 500 Real Estate Index is up 27%. Technology is up 17%. When we look at the lower performing areas of the market, gold is down over 6%. Gold closed at $1,776, which as noted is a very patriotic number, but still down for this year. Emerging markets have been pushed down a bit as they are affected by some of the troubles in China. We see emerging markets down about 2.3% to start the year. That’s the markets as a whole. Are there any areas of interest for you, Rob?
Rob: A lot of people are interested in Bitcoin’s volatility and price movements.
Kyle: Bitcoin is currently trading at $43,495 and is a very volatile asset. Bitcoin is up 40% year to date. Owners of Bitcoin that were able to hold through the volatility have been rewarded. It has traded as high as $60,000 and then as low as $29,000 this year so far, so we’ve seen some pretty big movements in Bitcoin. There’s a similar coin called Ethereum. It’s the second largest cryptocurrency. Ethereum trades around $3,000 today, which is up about 300% year to date.
Housing has performed exceptionally well, although we’re starting to see some slowing in terms of sale numbers and sale prices. Housing starts improved this last month with about a 10% increase in new construction. One reason is the pullback in the price of lumber. Lumber ran up at an incredibly fast pace at the start of the year and then had a subsequent pullback. We also see housing prices starting to taper off from their peak levels. Inflation this last month was 0.3%, and if we go back 12 months, that takes us to 5.4% inflation for the year. Forecasters are projecting out 0.3% per month for the next 12 months. This would mean we are at 3.6% inflation for the next 12 months, which is much higher than the Fed estimate of 2%. Unemployment is at 5.2%. We are at the point where we have considerably more job openings than we have unemployed, which gives a lot of choice to those unemployed to choose which job openings they want. There’s over a two million gap between open jobs and current unemployment.
Rob: We will talk about how this inflation might impact interest rates, which drives much of the pricing for different asset classes such as stocks, bonds, and real estate. As usual, there’s debate about the prospect for continued high inflation. Another development to discuss is the impact of events in China, particularly the Evergrande company meltdown on our markets. Let’s start with inflation and talk about what’s happened in the last year and a half with the very brief but intense economic slowdown resulting from COVID, and then we had an acute recovery. This drove many prices high. The supply chain shortages and other COVID related difficulties persist today, one example being semiconductors used in cars. We have seen these chip shortages have had a large impact on number of major industries. At the same time, aggregate demand came back strongly, and so inflationary pressures persist.
The availability of raw materials, industrial supplies, and consumer goods in some areas has been severely constrained. We continue to see inflation in the price of commodities. The U.S. and Canada have their own domestic supplies of many commodities but things like steel, semiconductors, and precious metals, which are used in electronics, are primarily sourced overseas. That continues to be a driver of inflation. Another driver of inflation, as Kyle mentioned, are starting salaries and other wage levels. Companies are competing for workers and this has highly accelerated wage levels and has started to impact consumer prices as well. Unfortunately, many people who are getting those wage increases are seeing those benefits get cancelled out in terms of purchasing power by inflation. People who are on the lower end of the wage scale are not necessarily better off today than they were before because of inflation.
Kyle: It becomes a question of if there will be long-term inflation. We have temporary higher prices due to a mismatch of supply and demand and short-term global issues in the supply chain. It is unclear if inflation is here to stay.
Rob: One impact of the current round of inflation has been the beginnings of discussion at the Fed of “tapering off,” i.e., reducing the level of extreme monetary support that the Fed has supplied the economy since the beginning of the pandemic. The volume of money that was injected into the system over the last year and a half was 67% more than the amount of money that was injected during the Great Financial Crisis of 2007-2008. Within the first four months of the COVID shutdown, the volume of money that was created and put in the system equaled the full extent of government support that occurred during that financial crisis. The extent and the speed in which the central bank responded to the economic slowdown has been unprecedented and the markets responded accordingly.
Kyle: The question now is, was this an overreaction or just necessary as a follow-up to what occurred in 2008?
Rob: Second guessing the Fed is not an efficacious activity. Certainly, the fear existed that there would be a huge consumer spending retrenchment. The central bank utilized everything that they could. It worked, because before the emergence of the Delta variant and with the positive impact of vaccines, there was hope that the economy would succeed in opening up. This was especially important in places like New York, which was hard hit and continue to be hit in a severe recession in the hospitality and tourism industries. The Fed now really has little breathing room, it must talk about reining back the government’s support for the economy. This will pose a challenge in 2023 as it is also an election year. The challenge we face as investors is what happens with our trades and investment asset classes if this sort of tapering off of government support takes place. It might be a good thing in the long term but probably involves short term shifts in the performance of various asset classes.
Kyle: Chairman Powell said the earliest they would expect to start tapering is in November. Then, interest rate hikes wouldn’t be something they would consider until mid to late 2022. They said that the earliest they would expect to see any tapering would be in November.
Rob: He’s also lobbying for his job at the same time. It’s been a very long time, 20 years or so, since they’ve successfully attempted to reduce government support for the market. When we say government support, we are referring to when the government buys its own bonds in the market, which assures that interest rates stay low. It’s like being your own best customer and supplier so that you can drive prices down. This is the mechanism by which the government has made sure that the interest paid on the ballooning national debt remains manageable. Kyle what do you see going on with the economy in China?
Kyle: I think there’s a lot of short-term risk to the markets in China. The Chinese government is trying to clamp down on excesses in the economy and institute greater control over everything. You’re seeing a lot of clampdowns everywhere from real estate to gambling and video games. We saw a big pullback in many Chinese gambling stocks. There’s a lot of worry in Macao as to whether or not China is going to institute much greater control over those areas and industries. I’d say it’s really about government control and how the market reacts to game changing dictations of the government.
Rob: If you read the newspapers, Chairman Xi has embarked on a program to reassert control with the stated goal of “equalizing wealth” in China. Clearly, the Chinese government has a great deal more power over their economy than the U.S. government does over ours. In terms of their second largest real estate company, Evergrande, the Chinese government can absorb, manage, and control the extent of Evergrande’s losses without serious financial repercussions.
It’s worth talking a bit about the culture of real estate investing in China. Most Chinese look at real estate as a reservoir of value, much like people here think of stocks. Because Chinese People have such a short history of private ownership, and they’re restricted from owning gold, real estate is the preferred means of saving. The Chinese preference is for owning physical assets. It’s not dependent on the cash flow from having property rented. They believe that real estate does not go down in price. If you own two or three apartments and they’re vacant, it doesn’t matter because property is a form of currency. It’s why the Chinese development companies can build cities that are vacant and keep selling the apartments even though the people aren’t there to fill them up. What the government is challenged to do is to try and change people’s attitude about savings and promote a domestic driven economy that does not rely on exports to the U.S. and Europe. This is a huge experiment, essentially dialing back what they have promoted for 30 years. A tremendous number of people were lifted out of poverty in China through exports. They do not want to risk social dislocation. Their primary goal is to maintain social stability and to somehow rein in the deeply ingrained assumption that property prices always go up. We have not been big direct investors in Chinese stocks because the government will go through a phase where they’ll promote stock ownership, and then they will reverse and dial it back.
Kyle: There is a great chart that shows the illusive growth of the Chinese stock market because it has remained relatively flat over the past 20 years. Compare this to the growth of the Chinese economy, which going almost straight up. There’s been a real separation between those two and that’s where the institutional control piece comes. They allow it to rise and then they force a pullback.
Rob: The question is, does China impact our economy? I think that there is only a moderate impact. Many Chinese have companies issued junk bonds in the same way that riskier U.S. and European companies issue massive amounts of junk bonds when investors are foolish enough to chase yields. A junk bond is the debt of a company that doesn’t have strong finances, right? They still can go out and borrow money. How much interest do junk bonds pay in the U.S.?
Kyle: The differences in interest rates between government bonds and junk bonds are very thin. What you get paid for taking the risk of low quality is only minimal.
Rob: The bottom line is where can you put your money that does not put it at risk of principal default? How much interest can you earn? People have been driven into high yield junk bonds because the interest rates on U.S. government bonds are so low. In China, the property companies that issued junk bonds, like Evergrande, could default and go bankrupt tomorrow. If you invest in international junk bond funds as a U.S. investor, beware because some of those mutual funds have Chinese bonds inside of them. That’s the crossover between the domestic Chinese and U.S. economy. I think what the Chinese government wants to do is to make sure that the Chinese public doesn’t worry and try to dump all their real estate at once which would create a general panic.
Kyle: We’re seeing a lot of calls now to remove China from emerging market funds and classify China as its own “middle market” that’s separate from non-related emerging markets. If there are going to be ongoing issues with the Chinese junk bonds, it would move the entire international indices as it represents too large a piece of the emerging market classification now. People don’t tend to think about defaults until there’s a disruption like the one just seen in Chinese real estate. People wonder if China is actually any different than Indonesia and Brazil and all the other truly emerging markets. It is hard to say.
Question: How do you manage portfolios in the face of rising inflation?
Kyle: We are not buying long government bonds that pay 1.25%. That would be the first place we don’t want to go because on a real return basis, we would be in the negative there. Generally, areas that perform best under rising inflation are commodities, energy, and precious metals. We are seeing an inverse relation with gold this year, which is very unique, as well as in real estate. The stock market is another place where people typically go to combat inflation. We use hard assets or assets whose prices rise with inflation. Real estate is a big one, especially with interest rates super low. As we move forward, current fixed costs of borrowing make real estate more affordable; inflation goes up, but interest rates stay low. Some investors buy emerging market bonds to combat inflation, but this is somewhere we don’t normally invest.
Rob: Our long-term strategy is to diversify and own some commodities like gold and real estate. Our long-term strategy has always been to have mostly short-term bonds that adjust to higher interest rates. We’re not particularly worried about inflation in terms of the effect on our portfolios. Interest rates are a different matter entirely. Can we have persistent inflation and still have ultra-low interest rates? I think that it’s possible only short term because the impact of higher interest rates would be so profound on government debt markets. The U.S. government is the largest single debtor by far with no plan or viable way to pay all debts off.
Kyle: Twenty-four trillion in debt, currently.
Rob: It is something that looms large in the background. It is impossible to conceive of what it would mean if there’s a major disruption in the U.S. government debt market. There hasn’t ever been one and there is no game plan for dealing with it.
Let’s talk about the impact of cryptocurrencies. I think it’s quite likely that many governments will issue their own formal crypto currency and simultaneously outlaw others or bring the independents under the thumb of their regulatory authorities. India and China have already begun. With control over e-currency, the governments can keep interest rates lower than zero. By exerting more control over crypto currency, the Feds may gain more tools to lower interest rates even into negative territory. This is mind boggling, how can you have negative interest rates? Who in their right mind would buy a bond that they lose money on? It makes no sense to an individual, but on a macro scale, you can see the advantage if you are twenty-four trillion dollars in debt. It would be nice to be able to make some money by being a debtor! That’s not inconceivable in a cryptocurrency world; in a world where the government can control cash movements around the world. It’s quite likely that will benefit the stock market and the real estate market going forward because the lower the interest rates, the more valuable some assets become. There’s a direct, inverse correlation between lower interest rates and higher prices. It’s called the capitalization rate.
Kyle: For those of you who may not have been watching, there’s a disagreement in Congress over the debt ceiling. Interesting statistic here, there’s been 78 raises in the debt ceiling since 1960. On average, we raise our debt ceiling every nine months, 49 of those increases have been under Republicans and 29 have been under Democratic presidents.
Rob: The debt ceiling may be tied in with the new Biden bill and the proposed infrastructure bill. Then there is the budget reconciliation bill, so clearly the debt ceiling will always be raised.
Kyle: If the federal government shuts down, it affects all of the other levels of government. We’ve seen it happen before, but it’s only a very temporary occurrence.
Rob: What is the likelihood of taxes going up, given that it does not seem to matter what the U.S. debt is?
Keren: It’s hard to say whether or not taxes will increase at this point. We’ve been looking at the topic over the last six months or so, and nobody expects that the Biden bill as initially presented will come through.
Rob: The most likely tax increases to take effect will be moderate on top income earners, and a surtax on people making $5 million or more. One possible main change is in the estate tax provisions.
Keren: I think the capital gains tax may be another. Raising that to 25%. There is talk of decreasing the lifetime exemption for passing an estate to a spouse. There are several things on the table that could impact estates.
Rob: The provision in place now is that in 2025, the amount being able to be passed free of estate taxes is slated to go back down from 11 or 12 million to five or six million per person. They are talking about accelerating that schedule to the end of this year.
Kyle: They would move it back to the previous level at an inflation adjusted amount. The current exemption per individual is 11.7 million. I think that if we were to revert back, it would be around 6.3 million per person. There was talk previously of eliminating the “step-up in basis” at death but that doesn’t appear in the current bill. It’s something that was part of the original Biden proposal that they’ve backed away from.
Keren: There’s also a proposal to close the cryptocurrency loophole and to treat it the same as other securities for wash sales and for taxing capital gains.
Rob: Kyle and I believe the chances of the current budget proposal going through are small. Efforts to tack the infrastructure bill onto the budget/social program reconciliation in its current form is unlikely to happen. The markets tend to like inaction on the part of government. As Kyle noted, the performance of the markets has been strong this year, mostly concentrated in the early months of the year. We don’t see any major upsets to the market based on Congress’ activity or lack of thereof. The Federal Reserve Bank is another factor entirely.
Keren: The last few times that we have heard Chairman Powell speak about reducing support, the market has come under selling pressure. We hope people are getting comfortable with the Fed’s plan.
Kyle: I think we are seeing them continue what they call the “dovish” tone, where they say they’re going to taper, but not yet. They want to raise rates, but they really want to do it in the future. There’s a continuance of strategy of moving things down the road and not dealing with anything now.
Question: As we see supply shortages across the nation in many different industries, what can we expect as far as the market? Do you foresee that changing anytime soon?
Rob: Going into a supermarket, some things are missing from the shelves. Go into the lumber store and a lot of supplies just are not there. The prognosis is not good for the alleviation of these conditions. The timing of when these shortages will be alleviated is unknown. These are very important issues for the costs of most businesses and especially the production of new housing units. It is very difficult to build anything with a six to twelve month time delay for getting supplies. It’s not reflected yet in the price of stocks or real estate but it’s definitely going to have an impact.
Kyle: There are pieces of the supply chain that aren’t going to be fixed due to vacancies that are unfilled in certain job areas. A lot of our goods come from foreign countries and they come from a lot of countries that have not had the capabilities to vaccinate their populations or control the spread of COVID. We’re seeing continued disruption along the supply chain. In the U.S., people aren’t going back to work and this further disrupts the movement of goods. There are political pressures and geopolitical risk as well when we look at tariffs and the interaction of our government with the rest of the world.
Rob: China is definitely a major factor in that equation. China is moving into Africa and trying to control more of the world’s natural resources. For two decades, increased trade with China was a major help to the U.S. economy due to the lower cost of goods from China and the ready availability. That has gone away and likely will remain gone for a while. The Biden administration is well aware of the long-term stakes as strategic industries come under supply chain pressure.
Question: How do you view the prospects of investing in electric vehicles (EV)? Are you investing in EV, and if so how?
Kyle: We spend a lot of time reviewing prospective investments in electric vehicles. The hardest part about investing in new technologies is understanding which companies are going to be the winners and which companies are still at an appropriate valuation. It’s basically questioning, does a company’s valuation make sense for long-term investors. Often these companies that were big winners last year are less attractive this year. The move over time is going to be toward electric vehicles and greener technologies but it’s just a matter of getting into stocks at the right price. We spend a lot of time evaluating tangentially related products: companies that are part suppliers to the electric vehicles, manufacturers that might be making a power train or a computer chip. Semiconductor companies that are related to the electric vehicle trade at more reasonable levels because they’re talked about less than the actual car manufacturers themselves. We spend a lot of time looking at pockets in the market that might present some opportunity.
Rob: The Chinese made a concerted push towards electric vehicles and now that sector is in real trouble because they have misallocated resources. The companies that have been successful from a volume perspective have not been profitable because in China, it’s not a market driven economy. Electric fuel cell technology in our country, like solar power, has been challenged to find long-term profitable companies because of the price cutting practices of Chinese manufacturers. The fact that size of a market looks like it is going to expand dramatically does not necessarily mean that it presents a good stock buying value. This is true for nuclear power as well. There are 10 companies working on smaller nuclear power plants and fusion. One out of 10 will be huge successes.
Kyle: When we talk about solar cells, we have seen a race to the bottom as to who can produce the cheapest solar cell. China has been pushing prices down and the U.S. has been trying to keep up using subsidies, so we look to find a company that makes power inverters that takes the energy from the solar cells to your house. Here you have a more secure market and it’s a specialized product where you don’t face that race to the bottom in profits. There are still opportunities in each of these silos. It is a question of finding the right price and time.
Question: We see turmoil both in the Chinese real estate market and in various markets around the world. Would we expect to still see dollar flows into the U.S. real estate market?
Kyle: In years past, we have seen a lot of external investment in U.S. real estate markets that are caused by things like the Evergrande crisis in China.
Rob: That clearly has been the case and is likely going to continue to be the case. Look at the New York City real estate market, which was decimated by COVID. The seeming exodus of people out of large cities made NY prices fall further than people thought they ever would, especially in Manhattan. It is an important point for real estate investors to consider. Will people be moving back from the suburbs? When might that happen?
Kyle: I pulled up the Case-Shiller home price index before this and L.A. actually is currently the most expensive market in the U.S. We have seen a real pullback in New York as it sits right between Phoenix and Las Vegas on the home price index. It’s a factor of earnings as well, but you’ve really seen that fall. The top markets are all West Coast markets. It’s L.A., San Diego, and Seattle right now.
Rob: Notably, San Francisco is not, which traditionally was up there with New York City. There’s quality of life issues and questions about the changes in the work from home structure, the quality of services and education, the dangers of physical congregation from COVID, and the perceived risk of people in urban environments like New York, where public transportation is key to the operation of the city. All of that is unknown. Real estate prices continue to go up in many places due to low interest rates. I think that’s the key to always remember, is that both stock prices and real estate prices are highly dependent on the level of interest rates.
Kyle: What we are seeing is 17 to 20 % of all purchases are from real estate investors right now. You basically have one fifth of the market that’s being eaten up just through people that are buying properties for investment purposes.
Rob: There is a housing shortage in this country because the growth in housing units is not keeping pace with demand. The rate of first-time home purchases for new families was very low for an extended period of time. The salary level that someone needs to be at in order to afford a new home is not within the range of entry level professional positions. I think the demand for new housing continues to grow. The supply is constrained by the factors that we were talking about in terms of materials, supply chain, labor, etc.
Kyle: It is another place that presents a strong investment opportunity, particularly when working against inflation.
Question: Regarding the shortages you had discussed, are there any companies that are beginning to elect for moving some production back to the United States given the supply shortages and labor shortages in the countries we receive those goods from? This kind of shortage is killing companies because they simply do not have the ability to produce goods to meet demand. Is there a widespread understanding that we need to start making things here?
Rob: The commodity shortage is complicated. We talked about the tariffs, and the supply chain. If you look at statistics regarding the cargo ships with containers that are waiting to unload in Long Beach, California, there’s tens of thousands of containers with goods in them that cannot unload because the port’s capacity is diminished, whether it’s due to the work rules, truck transportation, infrastructure, etc. That’s one of the focal points of the infrastructure bill in front of Congress; to improve the port capacity of the country, which doesn’t happen overnight. If your question is will the U.S. start to produce things domestically, there are challenges. Let’s use plastics as an example, the production of resins; really anything made out of plastic is now super expensive and the wait time is long. That constrains U.S. industrial activity. Is the demand for plastic enough to bring expanded manufacturing plants back to the U.S.? There are many hurdles to overcome in building a plastic plant so the fact that there’s an undeniable need for it and the possibility of it happening are divergent. There are environmental, skilled labor, and political impediments to increasing domestic production of plastics, steel, and now we see that with energy. There was a huge rush to develop domestic production of oil and natural gas. Ten years ago, we were dependent on overseas sources for energy and now we’re an exporter of oil and gas. I don’t know whether it’s possible with to resuscitate manufacturing in the U.S.
Kyle: I think it’s a mix. Part of the purpose of the tariffs was to bring certain production back into the U.S. We’re in a scenario where we want things to be less expensive. We’re worried about inflation. We have a mismatch between job openings and the number of unemployed people. There are limits to what the system can actually take in terms of domestic production. We’ve largely moved into being a more high-tech economy and a service economy. The difficulties of bringing manufacturers back to the U.S. are more related to systematic issues rather than concerns about building new factories. Even when we look at oil and gas production, they came largely through technological advances.
Question: Do you think with the government tapering down, that this job’s market will be affected? Will this mismatch, in terms of jobs available and people willing to work, improve? When might the influx of employment occur and what will it affect?
Kyle: The good part is that there are job openings now. If everyone were to decide to go back to work at the same point in time, we would have a very competitive space. It would be likely to drive wages downward. However, people have chosen not to. It is important to note that 1.3 trillion of the stimulus has yet to be spent. Many people have banked a large portion of their stimulus check, and that gives them time and leniency to choose what job to take their own terms.
Rob: The Fed tapering has to do with monetary stimulus. It is not spending on social programs. That issue is what’s up for debate now in Congress. It’s possible the Fed could reduce monetary stimulus, but Congress could vote to increase the fiscal spending on social programs. That is what the 3.5 trillion-dollar program called the budget reconciliation is about. There is little real concern with how to pay for those programs. New taxes are a smoke screen. If the amount of money that’s injected, the continued bond buying, is curtailed after two years of being increased to get consumers and the economy over the COVID shock, they could really affect each other. All that is up in the air and will be decided by Congress and the new Fed chairman. This is why there is so much attention being paid to whether Powell gets re-nominated or someone else comes in who’s more or less accommodative, which means more likely to inject government money into the system to support continued low interest rates and eventually expanded social programs. That’s the political realm and not a direct investment issue.
Question: You’re saying that it won’t affect the markets?
Rob: It hasn’t in the past. Look back at the last 10 years of market action. The deficit has grown, public spending has grown, the market has gone up and inflation has been very muted. We have had this best of all investing worlds where everyone has benefited other than savers and future generations. Retirees on fixed income, people who rely on conservative investments such as bonds, have found it impossible to make an income. That is a change from the past when you could make a decent return, not a great return, but a worthwhile return to invest your money as a lender to corporations and the government. Today, you cannot do that. We are in unchartered territory.
Kyle: This last week, Nizhoni Redmond, our newest team member who we see on the call here, passed the Series 65 exam. That is the initial test to start working towards becoming a financial advisor. We are very excited for her and it’s a great accomplishment. Please, anyone that has questions, feel free to send us an email and we’re happy to follow with you.
The Markets – What we are watching:
Kyle Burns – Alternative Credit: The yield on the benchmark 10-year U.S. Treasury has increased over 50 percent this year, but even with the increase, bond yields remain near all-time lows. The persistence of low yields makes it difficult for investors seeking income to find opportunities that help them meet their income needs. Advisors are constantly seeking out new opportunities that will provide sufficient income for their clients as we remain in a low yielding environment. The Rikoon Group has traditionally supplemented their bond portfolios with real estate to meet the income needs of clients. We are now looking at additional places to seek out income as real estate prices have increased and with yields remaining low. One of the places I have found interesting is in an area called alternative credit.
Alternative credit is financing provided to corporations or real estate developers that is outside of the traditional public financing markets. The terms of the loans or borrowing are typically non-standard or customized to the specific needs of a situation or borrower. Alternative credit investments are often less liquid than the standard fixed income investments that clients hold in their accounts today and should be looked at through a long-term investing lens. The tradeoff of liquidity allows investors to receive yields that can be much higher than those of traditional bonds or other fixed income products. There is of course an additional risk component that needs to be considered when looking at alternative credit and the investments are not a fit for all portfolios. For certain clients, alternative credit presents a good opportunity to improve diversification and income in an account.
Jeff Sand – Active Versus Passive Investing: There is a debate sometimes between active and passive investing and which approach is better. Active investing takes a hands-on approach with the goal of outperforming the market averages whereas, passive investing uses broad based index funds, and the goal is to match the performance of the overall markets.
Active managers attempt to “beat the market” by using research and analysis to enter and exit the markets at favorable times. They monitor market trends, the economy, and the political climate as a part of their research. Actively managed portfolios tend to have higher fees than passive portfolios to pay for the expertise of the professional managers to make the investments and monitor the portfolios. Active managers often perform best during times of volatility and in certain specific niche markets.
In the area of passive investing, two of the better-known advocates for this approach are John Bogle and Burton Malkiel. Bogle was the late founder and CEO of the Vanguard Group. He pioneered and popularized investing in low-cost index funds. Malkiel is an economics professor at Princeton University, and he wrote the classic book “A Random Walk Down Wall Street.” He believes that stock prices are unpredictable in the short-term and therefore mostly random. He recommends investing in indexes for the long-term and not jumping in and out of the markets.
We think that active versus passive management doesn’t have to be an either/or choice for investors. In fact, we like to combine the two approaches because that can provide the benefit of further diversifying a portfolio to help manage the overall risk and it can also improve the portfolio performance sometimes.
Contessa Archuleta – Finding Yield in Value: Crude oil prices rebounded from historic lows at the beginning of 2020 to the highest level we have seen in over seven years. Despite this recovery, the stock prices of energy companies are now just reaching pre-pandemic levels with what appears to be additional opportunity for growth. We are currently seeing broad increases in energy prices from crude oil to natural gas with energy shortages occurring worldwide creating increasing pressure on prices. Natural gas is commonly used to power homes and businesses, and it is facing supply issues overseas which continues to push prices higher. The higher prices could lead to opportunity for growth in various energy sector stocks.
In addition to the potential for growth, many energy stocks pay a dividend above the market average. In the current low yield environment, there is an opportunity to add yield and growth to your portfolio by investing in this industry.
Keren James – Inflation: This year has seen an ongoing debate as to whether the current rate of inflation is transitory, and how investors should respond to the data. Many argue that the current rate is temporary and that it will decrease once the economy recovers and the jobless go back to work. Others point to wages, government debt, and the cost of housing, which continue to rise and could point to stickier inflation. While a decrease in purchasing power is a concern with investors and consumers, inflation is a healthy sign of expansion and economic recovery. Though the current business cycle may stretch out longer than what we have seen in the past, the ways for long term investors to protect against inflation remain the same. These tools include:
- Diversification
- Investing for the long-term, rather than trying to capture short-term trends
- Minimize risk with more frequent rebalancing to take profits while seeking undervalued positions
We continue to research opportunities in asset classes that perform better in times of inflation. Those that have traditionally outperformed when inflation has been above 3% include commodities, U.S. energy stocks, precious metals, infrastructure, and real estate. Please reach out to us to discuss how your portfolio is allocated, and which of these it might be appropriate in relation to your long-term goals.
Anthony Penner – The Bullwhip Effect: An economist term that describes how small changes in demand for certain goods can create large disruptions that ripple through a supply chain. And it’s not just a pandemic problem, economists have been exploring the consequences of the bullwhip effect since the 1960s. Over the past two years, the world has faced a series of shortages that in turn disrupted the supply of everything from cars to toilet paper to household appliances. Hundreds of industries were affected with an estimated loss of revenue between 2 trillion to 4 trillion dollars. And yet, bad news doesn’t seem to bother Wall Street these days, as the stock market quietly continued its remarkable year. Stock prices of companies whose profits are tied to it directly have been or are positioned to gain from the messy economic recovery, like metals manufacturers, energy companies and semiconductor makers. But as the bullwhip effect continues its upward stream, companies proceed to adapt and are pursuing a range of actions to mitigate the impacts of future disruptions. Including strengthening their relationships with existing suppliers, implementing permanent supply chain risk management teams and processes, increasing investments in digital technology, and integrating supply chain and procurement more closely with finance and IT.
Nizhoni Redmond -Tech Investing: After over a year of experiencing most of the world online, some are opting to spend less time in the digital universe while others have settled on using fewer digital tools with greatest benefit. Year to date, the Nasdaq has a total return around14 percent and the S&P 500 is up 16 percent. We are still seeing strong market returns, albeit with tech lagging behind other areas of the market. Now is a great time to remember why we often speak of diversification. I personally continue to have interest in tech investing as part of a long-term investment strategy even while it is lagging the broader market. From the start of the pandemic last year, we plunged into the world of tech much more quickly than could have been previously expected. It was a necessary push in order to keep the world moving. In that time, many of us witnessed all of the ways in which innovative tech can and likely will become indispensable to every single industry.
The returns from investment in tech may feel like they are slowing now, but after the performance last year this is likely a healthy adjustment. It is important to keep in mind that with the prospect of increasing interest rates, we may not see the same tremendous growth in the tech sector within the near-term. A slow down in the returns from technology companies will emphasize the importance of diversification to maintain steady investment returns while allowing tech returns to normalize at more consistent levels.
Staff Updates:
Rob: We enjoyed a bountiful summer in Santa Fe with above average precipitation yielding delicious white peaches and gargantuan tomato plants. Outside the office, the metal shop received a fair amount of attention as clients, friends and students all made appearances. With restrictions somewhat lifted, daughter Robyn’s Santa Fe Playhouse has sprung back to life with multiple productions and daughter Hannah began a new residency program specializing in women’s health and fertility treatment. Traveling back and forth to North Carolina isn’t getting any easier but is still part of my quarterly routine. Come by and visit if you are in the neighborhood!
Kyle: It was a great summer for me both professionally and personally. In July, I passed the CFP® examination and am now officially a CERTIFIED FINANCIAL PLANNER™ professional. It took a lot of work to get through the studies and test and it feels great to start to use the knowledge gained to support our clients in achieving their goals. Adding to the excitement, in August I was named one of Albuquerque Business First’s 2021 40 Under Forty honorees. It is a real honor to be selected among a group of professionals that share in professional achievements, contributions to the community and leadership skills. The boys started in person school again in August entering their first year of middle school. They are enjoying being back around their friends and really like getting to change classrooms throughout the day. I recently purchased my season pass for Ski Santa Fe and am looking forward to a snow filled season.
Gayle: I recently read that the term fall is likely a deviation from the old English feallan, which means to fall from a height. And of course, we’re also experiencing a fall from the light! And then there’s the market “October effect”; historically speaking September has had more down markets then October. So, we stick to our financial plans, turn off the TV, and enjoy the fall foliage. I’ve recently attended a few of my grangirlz’ soccer matches. What a hoot! Claire (7) is now a goalie; the gloves are almost bigger than she is. And Violet (4 and going on 18) is also a fierce competitor. Blessings, Gayle
Jeff: My wife and I took a road trip in August through parts of Colorado. From Santa Fe we drove north to Estes Park, CO and then we went west through the Rocky Mountain National Park. What a spectacular place it is with the beautiful scenery and wildlife. I marvel at the engineers and the workers that were able to design and build the roads to cross the Rocky Mountains. From there we meandered over to Steamboat Springs for a few days and then finally we went to Pagosa Springs which is one of our favorite spots. Our granddaughter, Ariah, is now 6 months old. She can sit up by herself and likes to sit on the couch and babble some conversations with us. What a treat she is.
Contessa: Fall is my favorite season in New Mexico – especially on those mornings when the air feels fresh and crisp, the trees start changing their colors and smell of green chile fills the air. I consider each day an incredible gift as I soak up the natural beauty of my surroundings. With Halloween around the corner, now is the time to start preparing ourselves for the upcoming holidays and hopefully spending time with family and friends. This fall I’m feeling particularly grateful that my kids are back in school and I am incredibly proud of their efforts to be good students. I’m also thankful for the support they receive from their teachers and school administrators who have done a fantastic job navigating a continuously changing environment. I am looking forward to holding events with our colleagues and clients as we finish the year and start anew in January. I wish everyone a healthy and prosperous close to the year.
Keren: The past few months have been a heady whirlwind spent at the opera, visiting family and beloved friends in California, and supporting my son in his first quarter at Santa Fe Prep. It was moving to walk into the theatre at the Opera, to take in the unparalleled view and sunsets, and to see familiar faces, or eyes, of friends and artists I have known for decades. My son and I attended a drive-in dress rehearsal, and it was fun to sit in the car with him and be able to hear his comments on the voices, composition, and costumes of an opera premiere. Having literally been exposed to opera since he was conceived, he has strong and sound opinions, and I loved sharing that experience with him. Our time in California was spent swimming, playing many competitive card games, and talking and laughing over delicious food and, yes, dim sum. He has successfully navigated his first quarter in the eighth grade at Prep and is adjusting to longer days and a more rigorous academic schedule. Most of all, I am enjoying my favorite season, the changing colors of the trees, the smell of home fires burning, and the aroma of chile roasting. Seeing snow on the mountain has been a particular treat, and I hope it is a sign of a proper winter to come. Here at The Rikoon Group, we have been enjoying the opportunity to safely host events and have more on the horizon over the coming months. I hope to see many of you in person or online.
Anthony: Goodbye Summer, your visit was all too short, but much appreciated. This year was very active as we were able to spend more time outdoors. I was able to get out on the golf course more this year which I was happy about. As I continue to take up bike riding, I was also able to work more with my daughter as she learns to ride without training wheels. We also managed to spend a lot of time out by the pool with friends and family, which was great as we are teaching our daughter to swim. My wife and I were excited for the return of Santa Fe Wine and Chile. We were able to participate in several events this year, everything from the kickoff party, to a champagne seminar, and wrapping up with the Grand Tasting event which always brings great food, plenty of wine, and a lot of familiar faces. Now it’s time to say hello Fall. We look forward to the kickoff of Balloon Fiestas, going back to McCall’s Pumpkin patch, drives to Hyde Park to see the change in foliage, trick or treating, and before you know it’s the Holliday season. With all the rain this past summer, more than I can remember in years past, I hope this winter is nothing more but memorable with plenty of moisture.
Nizhoni: This quarter has been quite a busy one for me as I both took and passed the Series 65, which is the exam which puts me on the path to becoming a financial advisor. Needless to say, it was my pleasure to spend a lot of my free time studying. However, I did get to enjoy the end of the Summer as well. I enjoyed a wonderful Indian Market assisting my family in volunteering for their booths and watching their musical performances. This brought me together with my parents, grandparents, and aunts as a group for the first time in nearly two years. I would say this was the highlight of my Summer. After the test I decided to take part in some of the fun early Fall activities that the area has to offer. For the very first time—after growing up in Santa Fe—I attended the Albuquerque International Balloon Fiesta. I look forward to the fall season and all it has to offer.
Upcoming Tea
Please join us for our quarterly virtual gathering to discuss economic and market related events on Wednesday, December 1, 2021, from 2:30-3:30. A Zoom invitation will follow.
The Rikoon Group 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. The Rikoon Group 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. The Rikoon Group 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.
Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.
