Asset Management Letter Archive

1st Quarter 2021 AM Newsletter.

April 16, 2021   ·   By   ·   Comments Off on 1st Quarter 2021 AM Newsletter.   ·   Posted in Asset Management Letter Archive

“Scattered, Smothered, Covered, Chunked, Capped, Diced, Topped and Peppered”

One of our portfolio managers recently stopped at a Waffle House with his family after a weekend getaway and couldn’t help but think we need a Waffle House Economic Index. The Yogi Berra quote “Nobody goes there anymore. It’s too crowded” came to mind as he saddled his way to the counter with one of his kids and dispatched the rest of the family to an open booth. If Waffle Houses in Georgia are any indicator, then we are returning to normalcy. Of course, the true indicator of normalcy will be when they remove the lone seat by the register that is reserved to preserve social distancing. Oh, how far we have come since this time last year.

Why do we drift to Waffle House as a backdrop for our letter this quarter, you might ask? Are we trying to distract you with sweet memories of buttered waffles and sizzling bacon? All temptations aside, we simply felt the need to emphasize normalcy and what it means. As the economy starts to thaw from its “dark winter” to borrow a phrase, what are we seeing? To our credit, a lot of what we hoped for is coming to fruition. The early cycle winners such as financials, energy, value, and small cap are doing very well. Through the first quarter, energy was up 30.83%, financials +16.02%, small cap value +16.84% and large cap value +10.99% whereas large cap, middle cap and small cap growth were up at best 2.56% and at worst 1.25%. To say we knew for certain the reopening trade would play out this positively would be a hubristic statement, one not welcomed at the Waffle House counter since hubris is not something you can scatter, smother, or dice on your hash browns. However, we did feel the upside optionality was so significant in the “value” and smaller capitalization sector versus mega cap and growth stocks, that if we just trended towards normal levels then we should see a significant spike in value as the price differential dissipated. The natural question from here, is if this “value” trade can last and, if history is any indicator, then it certainly can. Of course, growth has outperformed for the ten years before the recent cycle, so it could continue but there have also been significant time periods in the past when value has outperformed (2000-2010 for a short cycle, and 1926 to present for a longer cycle).   

Another area we drifted into last quarter was the inflation discussion. If you remember correctly last quarter, we alluded to the market and Federal Reserve almost inviting inflation at all costs. Well, as the saying goes, be careful what you wish for, as inflation reared its head in the first quarter. Thus, our call to keep duration short on our fixed income was prescient. Staying humble, though, it is not too hard to predict rising inflation when monetary stimulus is at levels not seen since WWII and debt levels reside over 100% of GDP before an infrastructure bill even gets passed. That being said, there are probably many investors who, unlike our clients, are unhappy with their -3.37% performance in their Bloomberg’s Barclays Aggregate Bond Index or worse than that if they held a long term bond fund like Vanguard Long Term Bond Index fund that was down 9.30% for the quarter. Our actively managed bond funds didn’t sniff levels like that with only one being down for the quarter and that one, Pimco Total Return, more than made up for it by being up 8.88% the previous year. Conversely, though, our gold investment didn’t work for the first quarter with gold being down 8.25% for the quarter. As we mentioned when we put this trade on last year, gold is more volatile than fixed income, but given the level of global monetary stimulus we felt this was a long term hedge against government malfeasance with a fiat currency and the resultant consequences. Gold has a far longer history as a currency than fiat currency and cryptocurrency. In addition, the majority of gold is not mined in China, like cryptocurrencies are. Thus, we continue to feel comfortable holding gold as a small percentage in client accounts.

Truly, the level of debt creation and government intervention makes one want to run back to Waffle House for a side of normalcy. Hopefully, once we work through vaccines, viruses and votes, the order of the day will not be so scrambled we can’t find our way forward. Of course, it’s our belief that we can always find a way to improve our lot in life and it usually starts with a good foundation whether it be eggs, bacon, or waffles. To that end, we will keep scrambling to find opportunities for you while keeping an eye on the tab (Trust us, if inflation starts creeping into the price of eggs and bacon, we will notice it). 

P.S. – There actually is a Waffle House Index but it is used by FEMA. It is an informal metric used to determine the effect of a storm and the likely scale of assistance required for disaster recovery. The index is based on the reputation of Waffle House for having good disaster preparedness and staying open during extreme weather, or reopening quickly afterwards. As Craig Fugate, former head of FEMA, said about a disaster area “If you get there and the Waffle House is closed. That’s really bad…”

P.P.S – For those intrigued by the type of hash brown toppings listed at the beginning of the letter we have included them below. Admittedly, we were not aware of them all either and are considering stepping up our “hash brown” game next time we visit Waffle House. Scattered is the standard, smothered is sauteed with onions, covered is with melted cheese, chunked is with ham, diced is with tomatoes, peppered is with jalapeno peppers, capped is with mushrooms, and topped is with chili.

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