Summary of Market Thoughts
We believe the #1 question right now for investors is how the stock market will react as the Fed starts to taper probably in November. In 2011, 2015, 2018, and 2020, the stock market fell 10-20% over 1- 5 months during periods when monetary stimulus was flat to down. And the current daily amount of stimulus is roughly 10x what it was pre-pandemic given there was $3.2 trillion of stimulus over 11 ½ years following the GFC versus $4.3 trillion in just 1 ½ years since the pandemic. This would not matter nearly as much if 1) most valuation metrics were not at record levels, 2) inflation was also at decade highs, and 3) growth forecasts were getting cut due to the delta variant, cost pressures and supply chain issues.

Details
The year the pandemic started, the S&P500 was up 16% in 2020 on a price basis and so far it is up another 19% in 2021 despite the pandemic being ongoing. The annual historical price return for the S&P is 6% since inception so either the Pandemic is 3-4x better for the world than a normal environment or something else is driving returns.

What the past couple of years have proven is tremendous stimulus, like a powerful drug, can overwhelm the normal reaction to a cataclysmic event like a global pandemic but eventually a price will have to be paid. In this case we think the price will be persistently high levels of inflation. And the resultant necessary withdrawal of that stimulus causing the inflation will cause some powerful withdrawal symptoms. Our portfolio construction is driven from this thesis on both the long and short side.

All good things must come to an end and rising persistent inflation after 13 years of easy money policy since the GFC, marks that end. 
 
Inflation continues to be strong and at decade highs in many cases. Headline CPI of 5.3% and core CPI of 4.0% are at their highest levels in over a decade. We view inflation as more persistent rather than “transitory.” Wage increases and rental costs should continue to drive high levels of inflation despite some commodity prices retreating from their highs during the pandemic.

June home prices were up 19% y/y, surpassing the housing bubble peak, and is the highest on record since 2000. Home prices typically lead owners' equivalent rent (OER) by a year which is already up 2.6% y/y and is 30-40% of most inflation metrics and larger than food and energy combined for the consumer. 

Wage increases (average hourly earnings up 4.3% y/y) are being driven by the strong improvement in the employment picture with 10.9M job openings versus 8.4M unemployed. As a result, the unemployment rate is down to 5.2% versus a 70 year average of 5.8%.

The employment picture seems to meet the Fed’s “substantial progress” hurdle and as a result we expect the Fed to taper in November and raise rates multiple times in 2022 to deal with inflation that is more persistent than “transitory.” 

Given the market cap divided by GDP of the stock market is at 2.0x versus a peak during the Tech Bubble of 1.4x and 50 year average of 0.8x, we feel the downside risk is large. Despite 50% earnings growth from 1972 to 1974, the stock market declined by ~50% driven by persistently high inflation and slowing growth crushing market multiples (despite this also being called a “transitional period of cost-push inflation” at the time by then Fed Chairman Arthur Burns).

The longest serving Fed Chairman, William McChesney once said "the role of the Federal Reserve is to remove the punch bowl just as the party gets going." After $3.2T in stimulus over the last 11 ½ years following the Global Financial Crisis, the Fed increased the daily alcohol content by 10x and added $4.3T in stimulus over the past 1 ½ years since the pandemic. But all good things must eventually come to an end and tapering followed by rate hikes in 2022 will force investors to sober up. 

Portfolio Positioning
We are trying to maintain as many shorts as longs in the portfolio. 

Our favorite theme into year-end is sports betting as represented by the $BETZ ETF. Over 2 dozen states have legalized sports betting, but only 15 states have legalized online sports betting with more coming. In game advertising is being allowed by the NFL for the first time this season for sports betting operators. We believe this is one of the last big markets to go online. This space should grow revenues at over 30% a year for at least the next 5+ years.

We also recently bought $ATVI (one of our top 5 picks last year) given the decline of their stock driven in large part around their legal issues with the stock now down 20% YTD. We believe momentum is strong in the video game space as more people that were acquired during the pandemic are staying to play than expected. While the workplace legal issues are certainly serious, we do not expect it to affect consumer buying habits of video games. Given the lack of next generation consoles available in the holiday quarter last year due to the supply chain issues caused by Covid, we believe video game sales will hold up better than other sectors like streaming or e-commerce this holiday season. People should finally be able to get their hands on the new Xbox and PS5’s that were so hard to get during the peak of the pandemic. A bigger base of consoles will drive more video game purchases this holiday season. We think that online gaming is becoming another big entertainment source for the younger generation of consumers in addition to streaming content and social media.

Our favorite sectors in technology include legacy enterprise tech names that were hurt during the pandemic but should benefit as people go back to work such as Oracle, Cisco and recently added Dell. We added Dell post the sell-off  following their quarterly results in anticipation of the VMware spinoff. These names all trade at valuation levels well below the S&P multiple and both $ORCL and $CSCO have solid dividends with a dividend coming from $DELL post the VMW spinoff. They were all hurt by the pandemic last year as businesses cut back spending while their employees ramped up their spending and worked from home. These trends are reversing as economies slowly re-open.

We recently added to Viacom ($VIAC) at a 10x PE given strong momentum in their streaming business which is in sharp contrast to slowing at Disney ($DIS) and Netflix ($NFLX) both at ~50X PEs. Viacom’s streaming revenues were up over 90% in their June quarter to nearly $1B and momentum is expected to remain strong into next year given they are expanding internationally and ARPU should go up. For now, investors still think of them as a traditional media company, but we believe that will change and the difference in results among the relevant players during the upcoming earnings season may help that process along.

In mega-cap technology, our favorite name remains Google ($GOOGL.) They will benefit as economies re-open given 10-15% of their revenues are in the travel and leisure vertical. Revenues are expected to grow 38% this year and even grew 14% last year despite the recession. A 24x PE is inexpensive compared to the S&P at 22x for this type of growth.

We also like the financial sector (best represented by $XLF.) This sector should benefit from being able to lend at higher interest rates given our view that 10-year treasury yields should reach 2% by year end due to high inflation and Fed tapering.

We also own energy names (best represented by $XLE.) Oil prices have held in better than we would have expected despite the cuts to global growth forecasts due in part to the delta variant and supply chain issues. Oil demand should continue to improve as economies continue to reopen.

Against these positions, we are short a basket of names sitting near all-time record highs weighted towards the tech sector and names that benefitted from the pandemic.

We have reversed our Apple position from being one of our larger long positions in August to being one of our larger short positions currently.  We see upcoming iPhone 13 launch as being evolutionary with some slight changes to the notch size, battery life and camera. This follows the revolutionary 5G launch last year.  Also iPhone launch prices will likely go up relative to last year from inflation in the underlying components like semiconductors.  As a result, we believe sales in the second half of the year are likely to be disappointing as consumers retrench from pandemic driven sales last year.

Apple has been a big beneficiary from work/learn from home trends since the pandemic.  Both Mac & iPad sales were down year over year in the December quarter of 2019 before covid but were up over 70% in CQ1 of this year driven by learning from home.  iPhone sales were down in 4 of the 5 quarters prior to Covid but were up 66% in CQ1 of 2021 driven by work from home and the launch of 5G phones.

iPhone revs in FY2020 (September FY end) were 11% below FY2015 levels given incremental improvements led to lengthening replacement cycles.  As a reminder, global smartphone units were down for 4 years in a row prior to 2021. Global penetration of smartphones is high at ~50% at nearly 4B users versus an installed base of 1.5B PCs for comparison.  Meanwhile smartphone replacement cycles were lengthening prior to Covid as changes were incremental driving this decline in units.  In addition, we expect pressure on Apple’s App Store revenues given the recent EPIC lawsuit results and regulatory pressures globally on App Store commissions.
​
Technically, investors have also had a tendency to “buy the rumor and sell the news” when it comes to Apple product launches.  Looking at data going back nearly 20 years, from a technical basis, Apple is typically up about 3/4ths of the time in the month leading up to their product launches but is down 3/4ths of the time the day of the event.  The stock also is roughly flat for the two weeks following the product launch before starting to climb again.