What’s Going On

The broad indexes moved higher this week, led by the technology sector that has a woeful year, to say the least. But coming off yesterday’s release of CPI inflation data (Consumer Price Index) the reaction was for the indexes to move sharply higher, and the interpretation of that data is at the root. Our favorite Algochums obviously found the data proof that inflation has peaked and is going lower. The Pindudes jumped in to cover open, and derivative, shorts, but maintained some composure. And lastly the investor, such as myself, sat tight, maintained higher cash and continued the search for opportunities that are still present. Why? Because yesterday’s new data point was a welcome treat, but also, just one data point that is still telling us inflation is still too high. So, what’s going on?

 The strategy this year has been to maintain an allocation that favors less volatility when economic cycles are shifting lower, as they are now. Inflation has brought the Fed into aggressive mode with the explicit intent to slow the economy down and everything that goes with that, such as job losses. Maintaining investments in sectors that are less impacted by changes in the economic cycle and hold favorable fundamentals are the first place to start. These investments are focused on the products and services that are less likely to see the same pullback from the consumer. For example, makeup, fragrance and hair care product company Este Lauder (EL), or, global warehouse style retailer Costco (COST), a beverage and convenient food company Pepsi (PEP), are all companies that bring to the consumer, what the consumer always needs. Other sectors providing more calm include the healthcare, pharmaceutical companies such as Abbvie (ABBV) and service healthcare companies such as UnitedHealth Group (UNH). Most of the companies in these sectors have strong balance sheets, and also share their profits with investors in the form of dividend payments, a procedure that is less important and therefore less followed by our growth investments because they are focused on reinvesting excess free cash back into the company. And that can only be realized if inflation and the economy begin to look better than it does now. What about our growth investments?

 It is always, in my opinion, in the best interest of long term growth to maintain sector diversification in portfolios, to better capture the overall changes in the markets and economic cycles that will always ensue. But this year while favorites such as Apple (APPL), which has eked out a much better year (-9.4%) than say Amazon (AMZN) or semiconductor company NVIDIA Corp (NVDA) both down -46.9% and -53.9% for the year respectively. So why stick with them? Well, yesterday’s softer inflation data tells us just how that sector of technology companies will perform when the economy and inflation begin to normalize. And as the markets have moved lower, I’ve not shied away from investing in the sector as normalization may not be with us, but the sector only needs hope and certainty to recover, and that will eventually happen. And it’s those new investments that have focused on the technological changes that have impacted many different sectors. These investments are the other side of fundamental consideration, they include what I refer to as Event conditions as well. An event condition has always been the strategy of investors looking for companies that will be acquired or perhaps go out of business, but for my strategy the focus is on events that will have genuine impact on the economy and culture and therefore the companies as well. For example, industry cloud-based software solutions for the global healthcare industry Veeva Systems (VEEV) has done more to organize the data heavy healthcare industry by allowing providers wider access patient data instantaneously. A software and services company PTC Corp (PTC) is providing a new technology called Digital Twin that is impacting sectors such as Industrials and Energy to help focus on better servicing of processes such as warehouse machinery and refining facilities through virtual technology. This isn’t new, older tech companies such as General Electric (GE) are engaged, and the expansion of its impact is definitely an event in the making.

 As we come into the last six weeks of this year another casualty of the portfolios has been fixed income. On the lighter side, our exposure to the asset class has been comparatively light since 2003, when yields first reached historic lows and bonds became less interesting, and useful, all which pointed to greater risk. Much of that risk has been realized this year, enough to impact portfolios. But just as cycles effect the stock market, those same cycles can impact the fixed income markets as well. In my opinion, the aggressive moves by the Fed to increase interest rates has made the fixed income asset class more interesting than I’ve witnessed in the last 20 years. That isn’t to suggest the Fed is finished, but the higher yields go, the better the intermediate term advantage they will play in portfolios. In the meantime, the seasonal factors and the softer inflation data could be negatively divergent on Tuesday when the Producer Price Index (PPI) is released. If not, the markets could stay positive into the end of the year, but that isn’t a good reason not to be cautious. Recession is coming sometime over the next twelve months, and the Fed has promised to remain aggressive in the interim, both good reasons to continue looking for opportunities, and to maintain the current strategy as well.