June 16, 2020 - Monthly Update

Dear all,

This week, Western New York entered phase 3 reopening. It will feel good to see restaurants and store fronts with “open” signs on them and people getting back to the streets, while hopefully respecting the social distancing rules in place to keep us all safe. I certainly am excited at the prospect of seeing friends in-person and share a drink with them, even if it’s 6 feet apart. It felt renewed to get a fresh hair cut and a dental cleaning appointment last week. Getting back to some sense of normalcy is very important. This is not just because isolation causes depression in people, but also because prolonged shut-downs create an environment where the expectations of the participants in the economy changes, causing further issues to the economic recovery. Behavioral economics greatly impact the direction and the magnitude of economic growth. With a return to the life-as-it-should-be, by incorporating adjustments necessary to help keep the virus at bay until an effective vaccine is found, and advocating for controlled growth towards a full recovery, confidence in our system and our ability to overcome the issues caused by the novel Coronavirus continues to grow.

As it stands, we are in an economic recession. The data has confirmed it. The unemployment numbers are high, but still, a little better than the worst-case scenarios that were predicted. Consumer confidence is down, but the consumer is still spending. The fresh retail sales numbers are confirming that the month of May has provided a rebound to retailers. The key investment markets are functioning properly and liquidity is available. All of this, has caused a fast rebound in the stock market indexes. The Nasdaq even hit new a high, since the crisis bottom on March 23rd. Moderate growth and growth allocations have turned positive for the year.

The magnitude of the move up in the stock markets since the March bottom has left many wondering for a week or two whether this was a resumption of a 10-year old bull market, or a typical and expected bear market rally. Last week’s negative days started pointing towards the latter. It is interesting that with the recession here and officially declared as one approximately 10 days ago, some think the old bull will just continue. The outperformance of the US stock market in this last bull part of the cycle was due to the rise of six companies without which our market would be only slightly better off than the World-ex-US index. These tech giants grew more and faster than any other company. The sheer size of these entities, and the influence they have over society, are becoming their biggest threat. While owning these companies is important, we continue to value full diversification. On the other hand, we believe they are now better protected from the pandemic than most others. Similarity between the last bull market and this recovery is that the same companies are leading the way. In truth, value of all assets is on its way up, but full rebound will likely take some time and it may have multiple confidence checks with negative days or negative weeks ahead of us.

We believe that the creation of the bottom and opening of the opportunities for investors started with the resolute Fed policy. Determination to provide liquidity needed and protect the system from the shock and possibility of depression, gave confidence to market participants who got awarded for being brave and patient. Some famous investors missed this completely. Since a lack of rebound exposure is not at issue here, there is no need to rehash what has passed. I am focused on the future in short and the long-term, and one issue seems to come up more than others. Inflation is becoming a concern, so let’s take this issue apart.

In principle, equities are a good hedge against inflation. Revenues for business grow with consumer prices, and investors’ shares are basically claims on those revenues. Even though the link between inflation and stock market is not completely straight forward, stocks provide a decent inflation protection over the long run. In some cases, real estate and stocks could be the only available hedge. For example, Iran had one of the hottest stock markets recently. With serious sanctions making it dangerous to keep money offshore and the pandemic and sanctions in pair causing both supply side pressure and loose monetary policy, locals have sought protection from inflation in the only available place – the Iranian stock market. With us having most of our investments in the developed markets, our problems are different than the ones faced by Iranians. The immediate outlook for inflation is to stay low. In previous notes I pointed out that we have to first avoid negative interest rates and deflation, and then, later on, start worrying and fighting inflation.

Scenarios of inflation coming back and rising in future are plausible. Reasons are obvious. Fiscal stimulus is in favor of inflation. The higher the government debt becomes, the higher the temptation to just inflate it away. Money-creation can often result with too much money chasing too few goods and services. All the more now, since the pandemic has constrained production and delivery of services, at least temporarily. We believe globalization is a key reason for the prolonged secular decline in inflation. This process is now reversing. Big companies could very likely emerge bigger and with much more pricing power after this crisis is over. The rise of populism in developed world is hard to square with globalism and stimulus-for-power will be even more in favor.

Even though stocks performance beats inflation in the long-run, over shorter horizon there is an inverse relationship, where a rising inflation is associated with falling stock prices. This is what some investment firms, hedge fund managers and a group of monetarist economist are getting vocal about. Similar forecasts were around after the financial crisis ended in 2009. The scenarios predicted then did not play out. Inflation stayed annoyingly low. And, even with most of the newly created money now ending up in personal accounts and consumer pockets, as opposed to ending up on bank balance sheets like last time, creating rising inflation will be hard. The immediate risk is not in too much inflation, but too little. I am more afraid of the policy makers losing their cool and folding under pressure, consequentially losing the faith of the markets. Staying the course to get the economy growing and directing the savings into the investments should be the priority.

The time to worry about inflation will come further down the road. When that time comes, policymakers and the Fed should resist the politics and start tightening. We will review moving some funds away from technology and luxury goods and services that do well in disinflationary environment, and place them into real estate, commodities and banking, the businesses doing better under rising inflation that were lagging behind for the last 10 years. Until that time, we will follow economic data closely and aim to stay diversified with the overweight to technology, health care, and financials (due to low valuations, good stream of income and stable balance sheets). Going forward, we see main indexes staying range bound for a few months until more data and direction on earnings and economy is available (declaring that a safe and effective vaccine is found would quite possibly change this view for the better). We would advise here that only truly long-term money should be added to investment portfolios in the mentioned period.

Even though we are all now working from the office again here at CWM, we are going to continue to follow rules of social distancing and keep unnecessary exposure to a minimum. We continue to keep all our meetings via videoconferencing and utilizing expedited carrier services for documents needing signatures. Office remains open for emergency cases from 9 AM to 3:15 PM, however the office hours continue to be 8:30 AM to 5 PM.

I hope you all start to enjoy your summer. Please continue to be safe and don’t hesitate to contact us for any questions you may have.


Emir Culov

Partner, Portfolio Management Director