THe K Shaped Recovery
For those of you who remember Count Dracula from Sesame Street with the number of the day, we can officially say we have a letter of the Year. That letter is K due to its shape. The “K” shape depicts many things that our society and economy are experiencing this year since the outbreak of Covid -19.
The pandemic has changed the landscape for everyone. Human behavior has been forced to change due to the challenges presented to our way of life. Businesses have had to adapt as well. There have been winners and losers both personally and professionally. Financial markets have recovered and recently made new all time high but underneath the surface its been a tale of two cities. There are companies that have prospered and others that have been devastated form the effects of the pandemic. Business models have been tested and only the nimble and liquid will make it through. This dichotomy has created huge opportunities for investors. Some of the recent trends will be long lasting and there will other patterns that will revert back to normal cycles. Most investors can use common sense to extrapolate certain paths for businesses and industries but its not as simple to declare “haves” and “have nots” as the economy improves and the market broadens out to cyclical and value oriented sectors. We have already seen a rotation out of some growth areas like large cap technology into more cyclical or economically sensitive names like basic materials such as steel and chemicals and financials. From an investment standpoint, your portfolio should not stay stagnant in this environment. Growth has been the clear winner over the last decade but there is a place for balance and value. ESG asset management prefers the barbell approach in general but we are willing to be very lopsided at times and concentrated in leading sectors and companies. We continue to believe that secular growth will be the most predictable path to long term financial success, however, there should be more of a balance in you portfolio over the next 4 to 6 quarters. We are active managers that make long term investments but remain mentally flexible when there are significant changes to some underlying themes.
The risk/reward for equities is favorable due to the low interest rate environment and the unfavorable set up for fixed income. Valuations will remain elevated especially because growth names have become a bigger proportion of the market and they are expensive on many metrics so naturally, the overall market will be more expensive. Growth is scarce and higher valuations are justified up until the markets decides there are alternatives. With the potential for significant rotation in to more cyclical sectors, we can see some big moves within certain areas of the market. Our portfolios are currently rebalancing and trimming some of our outsized positions in large cap technology and big winners that prospered during the pandemic. The other dynamic to think about has been the decline of the dollar. Growth has slowed and our deficits have been growing at an alarming rate. It seems as though the dollar is entering a different phase while it will continue to be the worlds reserve currency for the foreseeable future. There has been significant changes to the buying patterns of the dollar over the last few years. Other sovereign countries have been buying baskets of currencies that includes the dollar but there has been an increased allocation to the Chinese yuan and the euro and other currencies. This is significant because a longer term trend of a declining dollar will have an impact of foreign holders of our financial assets as they are priced in dollars. One of the ways for hedge that outcome is an allocation to gold and Bitcoin. ESG will discuss these positions in another blog but they serve as a buffer to some of the potential outcomes of the dollar.
We anticipate the K shaped recovery will morph into another letter as we currently know the “ups and the downs” of this market. Perhaps economists will be talking about “W” if we see a dip early next year due to a disappointing first quarter as the vaccine doesn’t get disseminated as quickly as the market perceives. There could be new tax laws that can also lower the earnings projection for companies and individuals. Looking through some of those risks we continue to see huge opportunities in many areas with long term secular tail winds.