Be Bullish with Alex Ely - Q2 Markets and Volatility

Alex addresses equity markets and Ukraine-related volatility as the new quarter begins, with an eye on long-term opportunity.

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Transcript

Hello and welcome to another edition of the Be Bullish podcast. I'm Alex Ely. Thank you for listening in. Here to give you an update on what we're seeing in the markets, in the equity market, specifically, the good, the bad, what matters when it comes to investing. So thanks again for listening in. 

Well, a lot has happened since the last time we talked to you, and we've been through some volatile times in the markets, for sure. Things seem to be better as of late, and I'll explain why we're thinking that's the case. First off, we have the invasion of Ukraine that has occurred by Russia. Obviously, this is a humanitarian crisis that we feel deeply disturbed by in respect to what's happening to the people that are there and what they're having to go through. This does cloud visibility for the markets when it comes to investing. In essence, there's questions about certain kinds of commodities, there's questions in regards to global trade, and most importantly, for an investor, it's how long does the conflict last, and does it get bigger or smaller or what happens? We hope for peace. We hope that there's a ceasefire, that they can come to some sort of an agreement, that Ukraine remains independent, and that we can get to a point where this matters less for investment. So we're hoping that the visibility that has been clouded for the equity markets by the conflict will dissipate throughout the year. So that's one thing facing the markets that's created volatility. We're hopeful that that's the case as we go through to the end of 2022.

The other biggest issues that have been facing the markets has been inflation and the Fed and what's happening with rates. We've seen a significant move since the last time we talked in respect to rates. The 10-year treasury bonds go on from about 1.9% all the way up to about 2.45%. So a significant move. That affects mortgages, which of course, affect, in essence, the buying power that consumers will have. If they need to go borrow money to buy a house or something like that, that house will cost more because that mortgage costs more. So it does affect the cyclicality of the overall economy, which is why people worry about this so much. Now, rates go up because of inflation issues. And to us, we think inflation issues will dissipate throughout the year. And the reason that we do is that-- Is really a host of reasons. First off, some of the inflation is transitory. As an example, used car prices are up 40% year on year. That's correct, 40%. So that's unlikely to sustain itself. Sure, used car prices can remain high, but in terms of them increasing in price 40% each year, that seems unlikely. The second part that I think will help with inflation is the hope that I have that the pandemic is coming to an end. Typically, this is how pandemics end. Viruses morph into different kinds of variants that are more infectious but less deadly. That's what we saw with Omicron. We're certainly hopeful that's the case here. And if so, there's a couple different things that would make the end of the pandemic deflationary.

First off, the supply chain should improve. We're still seeing factory closures today in areas like Shanghai and other areas of China. If the pandemic were to wind down, you'll see less factory closures. That will improve the supply chain. You also see an opening of borders. People are able to cross from one country to another more easily. That helps to smooth the supply chain as well. Another area that could be deflationary would be labor. We lost millions of people, according to the Bureau of Labor Statistics, during the pandemic from the workforce. We should see some of those people return as they're getting less government subsidies. Extra unemployment rolled off. The childcare tax credit rolled off. The suspension on evictions rolled off. There aren't any stimulus checks planned for this year. So in essence, people will need to get back to more-- work more than they used to. And also we should see an improvement in terms of the ability for people to get childcare, them being less worried about the overall virus itself. All of those things mean that the labor market, which is very tight today, should loosen up. And that would be a positive in terms of inflation because you would start to see labors go up less quickly than they have. In fact, looking at inflation in general, the average economist is expecting inflation to go down from the 7.8% that we're at today to somewhere in the 3 to 4 percent zone. So if that's the case, inflation concerns should also diminish throughout the year. That too would improve visibility for the equity markets and improve the world for growth, which has been hit the most when it comes to inflation. And that gets to the part of where we are and what we do.

We invest in a lot of innovation. Some of it is speculative. We saw a terrific move in growth in 2020. In essence, growth was in a unique spot. Many growth industries were able to not skip a beat. They were able to continue on with their businesses. In fact, many growth industries accelerated as a result of the pandemic. Things like e-commerce, mobile banking, virtual healthcare, software to, in essence, enable remote working. All of those things accelerated as opposed to slowing down like many other Industries. Meanwhile, during that time in 2020, many value industries went into depression. Travel and leisure, of course, that uses up a lot of energy. So that hits the energy markets. Deep cyclical industrials, many banks. You didn't know how many bankruptcies there would be of individuals and small businesses, so they were difficult to value during those times as well. All of that resulted in it being a spectacular year for growth. And as we as pure growth managers, we benefited. Then what we saw was a macro shift. The macro shift started when vaccines were approved for emergency use at the end of 2020. And with that visibility and a reopening happened and we saw value types of names, like I just mentioned, start to do quite well. In fact, it was the biggest rotation from growth to value in a generation, so just dramatic. It didn't really surprise us. We expected value would do better after getting hit so hard in 2020. I have friends that run value funds. I don't have any-- we don't begrudge it at all. So it wasn't really unexpected for us. What was unexpected though is we did see also the greatest movement from smaller-cap companies to larger-cap companies, particularly the mega-cap companies like Apple and Microsoft and Amazon, as they were perceived to be safe havens within a volatile market. So greatest rotation out of smaller names, greatest rotation growth to value, really putting what we do, small and mid-cap growth stocks in a style that was clearly out of favor as we went into 2021.

Going through the year, though, it wasn't so bad. We were hanging in in general, but things really turned for the worst back in mid-November when Federal Reserve Chairman Powell started to change his language in respect to inflation. Started to talk about it not being transitory, but more sticky. This made people think that the Fed was behind the curve. And as a result, that was the beginning of a correction that we got in not just growth stocks, but across the board. The Nasdaq was down over 20%. The S&P went down well over 10%. Almost all the major indices got hit on concerns that the Fed was out of position. And this was the narrative to start off 2022 and continued to be so all the way up until the middle of March when the Fed finally raised rates. And when they raised rates, they didn't just raise them by 25 basis points. They talked about doing six or seven different rate increases in 2022, and they also talked about doing 50-point rate increases instead of 25-point rate increases. And it seems like the perception of the Fed is that they're now finally getting around to dealing with inflation, that they're now treating it in a hawkish enough way to actually deal with it. And that has changed or created a shift within the markets. Since that period happened, we've seen smaller-cap names start to outperform significantly, we've seen growth outperform value with some significance, and you've seen funds like ours, which are invested in future trends and in future innovations start to outperform with significance as well. So it's an exciting time for us. For us, we always do this. We always just focus on the most dynamic, most exciting trends and disruptions within the economy. We always try to own the leaders of those trends and the leaders of those disruptions. It's been a long 15 months, as we've seen rotations to value, rotations to larger-cap companies. That's something that we never try to do. We just try to stay pure to our style. We don't try and switch into that kind of-- or try and capture the trade of the day. That's not what we would do in terms of a rotation.

Similarly, we don't try to call corrections. I'm quite sure that our team would not be able to correctly call the top and call the bottom of every equity market and get us in and get us out in an elegant way. I just don't think that we'd be able to do it. So we don't try to call corrections either. That said, it has been tough for what we do. Speculative names did take it very hard after being overly pumped up in 2020, I believe, and then overly hit over the last 15 months in our mind. And we believe that the change in basically the market's behavior and the acceptance that some of these names can start to go higher is beginning to happen. And so it makes us quite optimistic. At the end of the day, the reason that we feel overall positive and bullish about the markets is our economy is not extended, not the way that it was in 2008. Banks are not leveraged the same way. They've been stress tested. They've been regulated endlessly in the 2010s. As a result, they were much tougher in terms of their lending practices to consumers. As a result, consumers aren't extended. In fact, just the opposite. Their homes are worth more. Their stock portfolios are worth more. Their wages have likely gone up. They're in a better position as well. And if the economy isn't extended, that means that we're unlikely in our minds to see a severe recession or a severe bear market. We think that what the ending result is is that it's macro noise that we have to be working through. And that's what we see. We see again, inflation diminishing throughout the year and we see hopefully the war in Ukraine start to diminish in importance throughout the year as we reach some sort of ceasefire or it gets isolated more and more in whatever way it can be. As I said, we're rooting for peace when it comes to Ukraine.

The other part of all this is that we are in one of the most exciting environments when it comes to investing in history in our mind. What we've reached in terms of connectivity, efficiencies that are realized, productivity gains that are realized are extremely exciting for investment for us when it comes to growth. We love it when we see these trends run deep, whether it be digital payments or mobile banking, whether it be streaming media and everything that's happening in content in a variety of different venues, whether it's all of our medicines being individualized, all of our food improving and becoming higher quality food in our grocery stores and in our restaurants. Really just super exciting things. Oh, and finally, software as a service improving the productivity and business models in almost every industry as technological adoption rates continue to accelerate. So you can see the backdrop for us is that the economy is sound, that we're in a very exciting time for an investment, that we're in an area that's been out of style pretty much since the end of 2020, and hopefully our style will come back and be favored within the markets. We think it should be over the long run and that's where we're looking at things. So be bullish. I'm Alex Ely, again, CIO of the US Growth Equity Team. I appreciate you listening in. Have a great day.

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