Major Strategy Change

Growth is Accelerating

The federal government is attempting to stimulate growth as much as it can by massive spending, pushing debt to a level relative to the size of the economy that surpasses even WWII. I think you know how I feel about that. This is not WWIII, not even remotely close.
The Federal Reserve is also, and the bond market traders are becoming concerned about this, keeping record low interest rates in spite of rising inflation, especially in housing prices.

As more people get vaccinated and the economy continues to reopen, consumer spending will continue to increase, probably by quite a bit. I suspect we will get more growth than the DC crowd bargained for and inflation ought to be a very real worry.

King Kong vs. Godzilla

The Fed has it badly wrong here and I have a lot of good company in that opinion. I think low rates have more to do with keeping interest paid on the exploding debt from becoming a huge budget item than they do stimulating a weak economy. But, that risk of mounting interest payments ought to make the Fed, Congress and the White House stop and think about whether exploding the debt is a good idea. If they did, the thought passed quickly.
Already concerned bond market pros are selling more bonds than the Fed is buying, counteracting the Fed and pushing Treasury and mortgage rates higher. That takes an enormous amount of selling because the Fed is in the bond markets as a King Kong-size buyer, buying bonds and mortgages in staggering amounts in order to try to keep their prices up and thus their effective interest rates low. Remember that when you pay more than face value for a bond with a fixed interest rate you lower your overall return because the principal you lose when you get face value back at maturity offsets some of the interest earned. So, higher bond prices = lower effective interest rates.

This seems to me to be a King Kong vs. Godzilla showdown between a government set on stimulus at any cost and people in the bond market with concern for the value of their holdings as inflation begins to eat away at them reacting fearfully and selling bonds in a big way. You may have seen mortgage rates move up ¼% in the last week or so and I think that has a lot more to go. That means higher costs for home-buyers but it also means principal losses for bond owners. Thus, I am steering clear of this bad movie. See below.

Bond Strategy Change

Bonds have not been my favorite investment over the past two or three years and we don’t have a lot there, preferring the income and growth of alternative investments. But what we do have there, needs to be shifted into those bond funds less susceptible to losses as rates rise. That generally means floating rate or high yield bonds and I am replacing our few existing funds along those lines.

Stock Strategy – Out with the Old, In with the New
Stocks are changing too. Over the last few years, large growth stocks have completely dominated. Kind of like 1999, if you weren’t in them, you weren’t making much money most likely. We were and we did.

Over the last 12 months, for those more aggressive accounts that do individual stocks, we were pretty well-positioned with an emphasis on stocks that were beaten down, and with one exception that few people held, we did extremely well.

Recently, say the last six months, the big tech stocks that have been the darlings of Wall St. and Main St. for several years have flattened out or declined. In their place, small stocks and yes, value stocks have taken their place. We need to shift with this, in fact, we are probably overdue, and you will see a change there too. Large growth has gotten to where almost everyone had some and when that happens, sellers at some point begin to outnumber new fans and things move elsewhere.

With the recovering economy and value stocks having been out of favor for years, many stocks are underpriced. Small stocks have had a terrific start to 2021 but they probably have additional catching up to do. So, you will see most of your big growth funds replaced with value funds, focusing more on midcap and small stocks.

Just FYI, this tilting the portfolio toward the trend, not frequently, but as major changes occur has significantly helped performance. I don’t change often because I have learned through studying my past performance that less frequent changes are associated with higher returns. But, changes at major turning points are important. I have been doing this since 1998 and it has proven to work much better than the old broadly diversified, a fund in every style box approach that I used to use and which is still used by many other investment advisors.

Tax Consequences

Fortunately, 95% of the accounts I manage are in tax-deferred vehicles like IRAs and 401(k)s so in those accounts there is no tax. In the few taxable accounts, I think it is well worth paying the capital gains tax which for now is 15% of gains for most clients, plus state tax. Unless a position is a very long-term one, I try not to let taxes dictate investment decisions.

For those clients with taxable accounts, I will be calling to talk about this move. For nontaxable accounts with discretion, I plan to put this into action over the remainder of the week.
Let me know if you have any questions or concerns.