Commentary

April 2, 2022

After two years of pestilence, we are now facing war and perhaps famine in certain parts of the world. The often cited “Wall of Worry” appears to be building up to the sky these days. So, what is an investor to do?

 “Turn Out the Lights”: This is happening quite literally in Ukraine. Initially, the consensus opinion was that Ukraine would fold quickly under Russian aggression and the world would adjust and carry on. That has not yet happened. So, we watch the horror unfold daily with a mix of shock at the devastation, pride in the Ukrainian spirit and grief at the human toll. We knew about Europe’s reliance on Russian gas. What has come as a surprise is Ukraine’s impact on global supplies of wheat, corn, seed oil and iron ore to name the top four. The longer the war lasts in Europe’s “breadbasket”, the more likely it is for shortages to hit Ukraine’s main customers, Europe, China, and North Africa. Demand from abroad will inevitably raise costs in the U.S., further fueling inflation here. While Ukraine appears to be beating back the Russians, there is a prevailing fear that Russia, in a desperate attempt to “win”, will resort to chemical or biological weapons (or worse). Crossing the line this way raises the odds that NATO will get directly involved. Investors are justifiably anxious, as evidenced by the daily gyrations of the markets responding to the most recent news on the war. 

“All Good Things Must End”: Federal Reserve Chair Powell raised rates on March 16, officially ending its easing policy and signaled its willingness to continue to raise rates aggressively until inflation is brought to its knees. The bond market answered in kind with the Bloomberg Aggregate Bond Index dropping 7.7%, worse than the S&P500 stock index which dropped 4.9% year to date through March 31. 

Is a Recession in the Cards?: An “inverted yield curve” that results from short term U.S. treasury rates getting higher than long term rates, is often considered a foreshadowing of a recession. In the past few days, the yield curve has flirted with inversion, causing much handwringing among market watchers. The caveat here is that while every recession is preceded by an inverted yield curve, an inverted yield curve does not always precede a recession. So “‘while the candles flicker and dim”, they are not out yet. 

 “Just Let it Go”? With bonds no longer cushioning the drop in stocks, it is tempting to sell and stay in cash until the coast is clear. Historically, this strategy has never worked, particularly for long-term investors. Cash cannot safeguard against the ravages of inflation, particularly when it is as high as it is now, above 7%. Investors seldom get back into the market in time to benefit entirely from the it’s rebound. In 2020, the S&P 500 dropped 34% in March from its all-time high in February. The rebound was sharp and steep, returning the S&P to its previous high in a mere six months, despite a pandemic-related shut down of most economic activity. While the situation was very different then, it is typical that investors who try to time the market often sell low in despair and end up buying only when the market has already rebounded and appears to be “safe” enough to get back in.

 Green Shoots: March unemployment of 3.6% is almost back to the pre-Covid rate of 3.5%. This was on top of higher labor participation rates and job growth over 400,000 for 11 straight months, the longest run since 1939. Foreign investors are paying attention, increasing their investment in the U.S., a haven from the turmoil in Europe, and new Covid restrictions in China. U.S. companies with strong management and “fortress” balance sheets, have demonstrated their ability to adjust to new challenges. Still flush with cash from the liquidity pumped into the economy over the last two years, these companies are rewarding loyal investors by increasing their dividends. Some are also taking advantage of current market weakness to buy back their own stock, boding well for their future earnings per share.  

We expect further market volatility as companies report first quarter earnings, if recent reports are any indicator. If companies are cautious on their outlook, we expect they will be punished regardless of reported results. However, we remain positive on the second half of the year, as the U.S. is in post-Covid recovery mode now, and consumers are raring to travel, shop, and be entertained. While high gas and food prices will put a dent in their Covid era savings, the statement “Never underestimate the propensity of the U.S. Consumer to spend” is still valid. With money market funds yielding under 1% and bonds experiencing loss of value as rates rise, T.I.N.A. (There Is No Alternative) holds true for long-term investors of U.S. stocks. 

Bottom Line: Jason Zweig put it best in his column in the Wall Street Journal of March 12-13, 2022: “...investors need not only courage to act, but the courage not to act – the courage to resist”. At Fern Capital, we see it as our responsibility to keep our clients invested, even when everything and everyone is screaming “sell!”. History has proven that this is the prudent thing to do over the long haul.

 * Lines taken variously from lyrics by Willie Nelson, Billy May, and Finneas Baird O’Connell

January 2, 2022 

Despite widespread handwringing, the Santa Rally came in as expected, ending the year on a high note, slightly shy of all-time highs. This is as good a time as any to evaluate how financial markets will respond to the expected end of the pandemic-related stimulus programs in 2022. 

The Economy: After the sharp two-month recession in early 2020 caused by the Covid shut down, the economy has been steadily steaming ahead. Even though Covid has been stubbornly present, 2021 U.S. GDP is expected to rise by over 5%, despite the much-discussed supply-chain disruptions. With the stimulus ending in 2022, GDP is expected to drop to about the mid-3% next year. Inflation topped 6.8% year over year in November 2021. The magnitude of the rise could not be ignored, particularly by the Fed. While initially brushing off signs of inflation as “transitory”, Fed Chair Powell in effect conceded that it could linger at higher than their tolerance of 2.5% and for longer than anticipated. Accordingly, he announced plans to reduce their bond purchase program and end it entirely by March 2022. There is also an expectation that the Fed will raise short term interest rates later in 2022 if inflation persists and employment stays robust. 

“Don’t Fight the Fed” is a well-worn maxim on Wall Street. The expected rise in rates while tamping down inflation, is not as good for both bonds and stocks as the “easy money” policies of the past. This is because bond prices are inversely related to interest rates. As interest rates are also used to discount the future earnings of companies, their stock prices also respond inversely to changes in rates. 

So, is Cash King? In a word, no. Anyone who has seen their bank savings accounts recently knows that cash earns almost nothing currently. While short term rates will rise in response to Fed action, the derivatives market is implying the Fed Funds rate (currently 0-.25%) to peak at 1.5% over three years. With inflation currently running north of 6%, consumers face a significant erosion of purchasing power if they stay in cash even if inflation moderates. 

Impact on Bonds: While the stock market draws all the attention, the bond market has enjoyed a little noticed long bull market of its own. This run ended in a whimper in 2021. The path will be rockier in 2022, particularly for investors who have strayed to low-quality bonds in the search for higher yields. While investment grade bonds are not immune from a drop in price, they should be able to deliver their face value upon maturity. For most investors, this relative certainty acts as a hedge against the volatility of the stock market. 

Impact on Stocks: Now, more than ever, it will pay to be selective. With cheap money evaporating, investors have started to abandon many of the darlings of the last two years. The spurt of new companies that offer little more than a concept have already had their comeuppance. Companies now need to have real earnings, not just sales projected 2 or 3 years into the future. While the price to sales is still used as a metric for companies with no earnings, investors are now starting to revert to traditional measures of profitability. This realization is already sinking in as seen from the recent disappointing performance of SPACs (Special Purpose Acquisition Companies) and IPOs.

All is not gloom and doom in 2022, however. Interest sensitive stocks for example, banks will be obvious beneficiaries of higher rates, as will companies that have the pricing power, cash flow and pristine balance sheets to deliver earnings regardless of the economy. The Omicron variant is known to be less damaging, and its rapid spread could provide herd immunity. That probability will release the all-mighty American consumer with cash left to spend on travel, restaurants, and entertainment. 

Bottom Line: It is going to be tougher delivering returns in 2022 and few expect anything close to what 2021 returned. Market consensus is that 2022 will still generate single digit stock returns as companies wean themselves off cheap money. At Fern Capital, we have already taken steps to get back to targets and trim positions, so we are poised to take advantage of opportunities as they arise. Stocks are still the asset of choice to battle the erosion of inflation. While bonds will be a challenge, laddered portfolios allow for the reinvestment of proceeds at higher yields as rates rise. In summarizing its past 100 years covering the investment world, Barron’s mentioned a startling fact: Despite market crashes, wars and pandemics, the Dow Jones Industrial Average climbed 9% on average over the past 100 years. The tag line for the article read: “Lesson of the Century: The U.S. Economy is Nothing if Not Resilient”. Amen.

October 3, 2021  

“There is a season”: The increasing chill we feel is not just fall settling in, but the markets reminding us that there is indeed some risk we bear in exchange for the bountiful harvest of gains the market has delivered so far this year. Despite the downdraft of -4.65% in September, the S&P 500 eked out a gain of 0.58% for the quarter and 15.92% year to date for 2021. The September swoon has investors everywhere wondering whether this is “a time to reap” and harvest some of those gains, or “a time to plant”, invest more, to take advantage of the weakness.

“A time to break down”: One of the reasons for the weakness was Fed Chair Powell intimating that come November, the Fed would likely begin to reduce its bond-buying program. This was a tool the Fed started using in early 2020 to inject additional liquidity into the financial system. At that time companies stressed by the Covid shut-down were able to get cheap financing, preventing them from going under. With the economy now more stable and expected to get back to normal soon, there is no question that the Fed would begin to taper this stimulus. What took investors by surprise was the extent and speed of the rise in the yield of treasury bonds with the resulting drop in bond prices. This weakness carried over to the stock market as investors realized that Fed support was beginning to wane. 

Chair Powell had justified his past dovish stance on rates in the face of the rise in inflation above the Fed’s target, by describing the inflation as “transitory”. Certainly, the log jam at the ports will ease, and workers will return after Covid induced reluctance subsides. But many believe he is wrong, citing the traditional stickiness of wage gains and China’s hostility to the West which may infect other Asian countries in the supply chain. The current immigration policy has reduced the pool of workers willing to take jobs at the bottom rung of the ladder. The impact on the restaurant and farming sectors is the greatest. 

“A time to refrain from embracing”:  Despite all the weapons we have amassed against it, the Covid virus is badly injured but not yet vanquished. There are signs that the Delta variant is weakening, but there are still fears that a new variant may appear that is resistant to the vaccines. We got good news of an oral treatment that promised a 50% reduction in the chance of death if taken soon after testing positive for Covid. This, and the expectation of a vaccine for children under 12, were cited as reasons for the stock market’s rise on October 1. This is good news for parents and workers afraid to carry the virus home to loved ones. Also good for stocks that benefit from the reopening of the economy here and abroad. Until this happens, elbow and fist bumps will remain de rigueur. 

“A time to gain, a time to lose”: October promises to be as volatile as September, maybe more so, with third quarter earnings being announced. Good year over year comparisons will be welcomed by a yawn, while weaker outlooks will be punished severely. The negatives are well known, a labor shortage, supply bottlenecks, and higher energy prices. A wild card is the brinkmanship in Washington which could have serious ramifications to the full faith and credit of the U.S. and the dollar, if not resolved by the hard deadlines.

On the positive end, corporate America is healthier than ever, and optimistic of the ability of its workers to get back on the job safely as Covid diminishes.  Another plus is that the all-mighty U.S. consumer is a coiled spring, with plenty of cash on hand to spend in the upcoming holiday season and on travel abroad as countries also open up. The upcoming quarter will be a test of how well companies are able adjust. To the victors go the spoils.

Bottom Line: It is clear that the Fed will no longer be the wind beneath the wings of the financial markets. Going forward, stocks and bonds will have to generate performance the old-fashioned way, earning it in a less benign environment. Now, more than ever, it pays to be highly selective. As active managers, we at Fern Capital believe that our attention to companies with robust earnings and cash flow and solid balance sheets will help us choose the winners in what promises to be a tumultuous period ahead. In preparation, we have been trimming over-weight positions to generate the dry powder we need to be able to take advantage of opportunities ahead. We “swear it’s not too late”!

 * With thanks to Ecclesiastes (3:1-8) and Peter Seeger, quoted freely in this article 

June 29, 2021

Market watchers cringe every time they hear the phrase “This time it’s different”. It is invariably followed by a breathless justification for an action taken in response to a market move or situations that vary from the norm. However, this year the chorus of “This time it is really different” is growing louder as we adjust to the post-Covid world, with a nervous eye on the progress of new variants abroad and here. Some are citing the profound changes expected in how we live and work after the collective trauma our society has experienced. We address the impact of some of these changes on business and investments here. 

Inflation: The dreaded “I” word is rearing up constantly as businesses struggle to reopen faced with supply and labor shortages. The annualized inflation rate in May was 5%, the largest since 2008. While no one is expecting the double-digit inflation levels last seen in the 1970-1980s, there is increasing anxiety expressed in the financial press. In his public comments at a hearing on Capitol Hill, Fed Chair Powell acknowledged the rate was higher than expected but underscored his opinion that the surge in inflation was transitory and likely to subside after reopening stresses have abated. We have enjoyed inflation averaging 1.6% annually since 2011, so this sharp rise is understandably worrisome. Will it be different this time, or will Chair Powell stick the landing perfectly? 

Fed (In)Action: Given this inflation spike, many are questioning the Fed’s determination to keep interest rates low until the labor market has reached “maximum employment”. The irony is that, although the U.S. is still 8 million jobs short from pre-Covid levels, there are about 9 million job openings left unfilled. Understandably, there are many theories given for this conundrum. Meanwhile, Fed Governors have begun discussions on whether to start tapering their purchase of bonds to allow for a gradual reduction of stimulus as a first step before raising short term rates. The Fed also announced the timeline of raising rates was moved up to 2023. The market’s reaction to this announcement was relatively muted, unlike the “taper tantrum” in 2013. Investors are paying attention, adjusting their portfolios accordingly. 

Working from Home (WFH): We learned to adapt to working from home during the pandemic by necessity. Some employees have embraced WFH whole-heartedly and are reluctant to return to the nine-to-five grind with the hassle of stressful commutes. The Wall Street Journal Written June 29, 2021 2 of June 28 has called WFH the “new signing bonus”, as many employers are being forced to offer remote work and flexible work schedules to retain and attract talent. There are some who posit that we have entered a new phase where employees have more power than in the past and are not afraid to wield it. Whether this lasts beyond the year is up for debate. 

Flight from Cities: The ability to work from anywhere has cemented the flight away from urban areas. Initially caused by the need to get away from crowds during the pandemic, employees are reluctant to move again to get closer to work. The spectacular rise (14.6% for the year ended April) in housing prices in the suburbs, ex-burbs, and even remote areas is the result of increased demand chasing limited housing supply. This demand has had a ripple effect on the home improvement, furniture, and retail stocks as consumers have continued the “nesting” process begun last year. With the supply of raw materials, particularly lumber, clogged up in the supply chain, housing prices have been robust, fueling inflation short term. 

A Brave New World of Drug Development: The urgent need to arrest the progress of the pandemic had an unexpected benefit. The messenger-RNA technology used to develop Covid vaccines can also be used to develop drugs for other chronic diseases more expeditiously. For example, just this week there was an announcement of positive preliminary results of gene editing done directly within the human body to treat a hereditary disorder in part, using RNA. Another benefit of the need to move quickly on the vaccines is that the FDA now has a template for managing the drug approval process more efficiently. 

Just in Time? Not! : The pandemic uncovered the glaring downside of expecting supplies to arrive from across oceans to refresh inventories “just in time”. From shortages in necessities like drugs and PPE to computer chips for all our devices, we now realize how reliant we are on the global supply chain. Will companies maintain a higher inventory now? Will there be impetus to build factories here to supply the essentials? Will consumers be willing to pay up for the privilege of having goods available when they want them? 

Bottom Line: It may well be different this time. What is not different is that companies with strong management will make the necessary adjustments to prevail, regardless of the challenges, however extreme. Businesses that were flexible enough to adapt were able to survive and even thrive. Of course, they also had the prudence to set aside reserves in good years to enable them to sustain their businesses last year without government aid. This is precisely why our focus at Fern Capital is on companies with good balance sheets, cash flow, and earnings. There is a temptation to buy into the fledgling hot dots that shoot for the moon, only to find them flaming out as they reenter earth’s orbit. Much better to wait it out for the leaders with a proven record and the scars to show for it. is a long form text area designed for your content that you can fill up with as many words as your heart desires.