In this essay we intend to convey that external and internal dynamics of the economy, global and local politics, the stock market, and the labor market continue to be in violent flux. At times it may seem like we are in an airplane that hits an air pocket (up and down on the y-axis) while the wings toggle (back and forth on the x-axis), i.e., very unsettling. When many people feel this way, they don’t always have the bandwidth to fully consider the valuation or fundamentals of stocks and will sell them down to extreme bargain prices. Furthermore, the five- and ten-year returns in your portfolio are often driven by outsized returns in a small number of holdings, and bear markets are a good place to buy (or buy more of) the stocks that can drive the longer-term performance of the portfolio.
Our essay at the beginning of the year described a confluence of economic and market confluences, which prompted us to anticipate very high levels of (opportunity creating) volatility. Since then, complex geopolitical and military confluences have surfaced which are further perturbing an already chaotic and volatile market environment. According to Deutsche Bank, with only eight trading days to go before the end of the first half of 2022, the S&P 500 was on pace to have the worst first half of the year since 1932, and it sure feels like it. Their note further describes how the S&P 500 tended to rebound quite strongly in the second half of the year when the first half was dismal. Time will tell how the back half of 2022 plays out for the stock market, but we are highly confident there will continue to be unsettling volatility in the stock market.
Source: Email from Alex.Brown, A Division of Raymond James sourcing Deutsche Bank (whose US private client services unit was acquired by Raymond James.) 6/21/2022. (H1 = First Half)
The stock and bond markets are not the only places showing a great degree of being unsettled, as the 2021 “Great Resignation” in labor markets has continued into 2022. So far in 2022, nearly four times as many people quit their job than were laid off. 2.9% of the labor force has been quitting each month and this extrapolates to 34% of the labor force for the year, which is slightly higher than the quit rate in the 2021 Great Resignation when 48 million or approximately 30% of the labor force quit.(1),(2) Comparing 2021 to 2012, the number of people who quit their jobs in 2021 is approximately double the number in 2012, approximately 30% fewer people were laid off in 2021 vs. 2012, and this has occurred while the number of job openings has approximately tripled.(3)
Unfortunately for employees and employers, 40% of people who recently switched jobs are already looking to change jobs again, according to a study from Grant Thornton.(4) The greatest employee turnover has occurred in the “Accommodation and Food Service” segment which has seen annual quit rates of approximately 70%, consistent with the quit rates in 2021.(1) Employee turnover is noticeable to most people and, in our opinion, adds to the overall tenor of being less settled as a population and an increasing awareness of just how easy it is to perturb our systems. Whether the labor volatility is spilling over into the stock market or the stock market volatility is spilling into the labor market, the bottom line is there is a considerable degree of being unsettled. Perhaps the job and stock markets are reflective of the changes in the way news and media are delivered. The one thing that is for sure is that these will continue to be volatile times.
The investment inference is that there is a tremendous opportunity for employees, managers, technologies, and services which ease the challenges of a less settled culture. The value of being steady, reliable, and stability-promoting keeps increasing in this environment. We feel that companies in your portfolio absorb and extinguish external chaos and make life better for all involved. Overwhelmingly, we believe companies in your portfolio operate with financial discipline such that they are not put in a strapped position and have to make harsh decisions or be dependent on the kindness of strangers to offer needed capital on undemanding terms.
Several of the companies in your portfolio provide products and services that ultimately reduce the need for human labor. A common holding in accounts that do not have an income generation priority, makes software and apps used by restaurants to make life much easier on the restauranteurs and managers and provide more predictable experiences for patrons. Ordering online or via an app, picking up dinner at a full service restaurant, QR Code menus, placing orders on touch screens, loyalty programs, new payment systems et. al. is becoming much more commonplace. The area of a restaurant with perhaps the most obvious potential for transformation through technology is the in the kitchen, and this company is working towards leading the advancement. The company is primarily run by software engineers and a business partner who founded an impressive restaurant chain, and we have confidence in that line up. Revenue at this company has been growing at a remarkable clip for several years, and we do not see signs of this changing for many years to come.
The stock of this company has not fared well, and this is in part due to the potential impacts that food inflation that we have all experienced, and employment challenges noted above. When it comes to inflation, the best antidote to inflation is usually more inflation; as some say, “price cures price.” Prices can increase to levels that cause demand to drop like a rock, and so long as more money is not pumped into the system, (California should not pass the $18 billion inflation relief package - a type of move which led to the debasement of many third world country currencies); the prices will follow demand down until an equilibrium is set. Housing prices have continued to be hot in most areas, and it seems too hot considering the rapidly rising interest rates. Wells Fargo is the largest mortgage lender in the U.S. and recently the CEO said, “We’re seeing a huge decline in terms of just mortgage applications. Our mortgage revenues will be down 50% from the first quarter to the second quarter.”(5) At least for the moment price is in the process of curing price in the housing market.
Price is also curing price in several commodity markets. Below are the year-to-date charts for copper, corn, and lumber. If geopolitical and military situations stop getting worse or possibly improve, inflation is likely to moderate so long as large amounts of money are not pumped into the system.
Source: FactSet 7/5/2022
Source: FactSet 7/5/2022
Source: FactSet 7/5/2022
Overwhelmingly the companies in your portfolios were selected in part based on their ability to benefit from gradual inflation. Inflation is the largest factor in the erosion of the future purchasing power of a dollar today, and we want your purchasing power to improve over long periods of time. We have previously written about how the equity of such companies can be viewed as inflation protection securities. We believe the management teams know how to deal with inflation, and we are confident in their abilities. But when large amounts of inflation come on quickly, it may take time for the company to adjust. Again, we believe you overwhelmingly own companies that do good things well and treat people well. However, in the process of responsibly adjusting to the recent burst of inflation, it would not surprise us if there were an earnings recession at many companies during which earnings were a little lower than for the same period last year. Until we have more visibility as to when and how inflationary trends are likely to subside, stocks seem to be lacking the tailwind to break out of the current trading ranges. While this period has been and will continue to leave us all a bit unsettled, this is the time to keep our pencils sharp. If we find only one or two classic growing companies to buy (or buy more of) at bargain prices, we expect it will have been worth going through these unsettling times for the significantly positive impact on your portfolio.
1Table 4. Quits levels and rates by industry and region, seasonally adjusted - 2022 M04 Results (bls.gov)
2Table 5. Layoffs and discharges levels and rates by industry and region, seasonally adjusted - 2022 M04 Results (bls.gov) 3https://data.bls.gov/cgi-bin/surveymost (Bureau of Labor Statistics Databases, Tables & Calculators by Subject. Calculation available by request.)
5Wells Fargo CEO Charles Scharf: ‘Real-estate values moderating in the long term are a good thing’ (msn.com)
Redmond Asset Management, LLC July 2022
The opinions contained in the preceding commentary reflect those of Redmond Asset Management, LLC. The stated opinions are for general information only and are not meant to be predictions or an offer of individual or personalized investment advice. They also are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Redmond Asset Management, LLC does not assume liability for any loss which may result from the reliance by any person upon any such information or opinions.
Redmond Asset Management, LLC (RAM) is an independent, SEC registered investment management firm located in Richmond, VA and is not affiliated with any parent organization. RAM was founded in 2005 and registered with the SEC on 22 Dec 2005. The company offers investment management services for equity, balanced and fixed income portfolios to corporate, institutional, and individual investors