November Newsletter – 2021

It’s the Second Mouse That Gets the Cheese

There are always crosscurrents in financial markets, but today they seem particularly strong. A few cases in point: We’re seeing massive strength in corporate profits while economic growth decelerates. Demand for both goods and labor are outstripping supply, yet developed market sovereign bond yields imply a very tepid economic backdrop. And investor demand for risky assets is at multidecade highs, yet the cost of insurance is unusually elevated as a fair number of investors hedge their portfolios.

When things get complicated, it can be helpful to try and simplify them. In its simplest form, investing is an exchange of capital for a stream of future cash flows. The cost of capital is set by its providers based on the riskiness of the investment and the probability of realizing promised cash flows. What makes investing difficult, of course, is that the future is unknowable. Investors can only theorize about a project’s potential for success or failure in terms of a range of potential outcomes.

Is investing more difficult today?

Technology has democratized information, and society is more informed than ever before. We have infinite and instantaneous access to news. However, we question whether that has improved investors’ ability to price risk. As John Naisbitt writes in Megatrends, “We are drowning in information but starved for knowledge.”

While an economic or political headline may be newsworthy and important, it’s often irrelevant to the long-term health of a particular company and its cash flow stream. For instance, are the effects of a central bank reducing its current pace of asset purchases really material to the five- or 10-year profit outlook of a global hotel operator? Or will the prolonged suppression of a country’s risk-free rate save an uncompetitive brick and mortar retailer from the growing threat of e-commerce?

Deciding what matters and what doesn’t has gotten a lot harder. In our view, successful long-term investors have the ability to distinguish meaningful information from market noise. To be clear, reaction time to a data point is not a differentiator. The differentiator is the ability to disregard what isn’t material and incorporate what is. If after careful consideration new information is seen as altering the most probable profit path, then action is warranted.

Where are we now?

Given the number of crosscurrents and the level of noise today, a simple review of how we got here might clarify the picture.

  • In response to the 2020 cash crisis caused by the lockdown, companies eliminated nonessential costs.
  • When credit markets thawed after extraordinary central bank interventions, corporate leverage and balance sheets exploded.
  • Well into 2021, the combination of direct payments to consumers, pent-up demand, vaccines and economic re-openings catalyzed a step-function increase in worldwide corporate revenues.
  • The convergence of depressed corporate expenses, higher financial leverage and massive revenue gains resulted in a near-doubling of global corporate profits. Margins are back to their pre-COVID heights, and profits have soared well beyond late-2019 peaks.
  • Financial markets began to discount the profit explosion in mid-2020, and risk premia, the investment return an asset is expected to yield in excess of the risk-free rate of return, steadily declined to the historic lows we see today.

What’s ahead?

Profits are a function of revenues versus costs, and in our view, revenue growth is vulnerable while costs are likely to rise.

We think revenue growth rates will decelerate as the current economic sugar high fades. But the market, which is like the smartest person in the room, already knows that. To us, the uncertainty is not over the direction of revenues for each company but the magnitude of the deceleration. Understanding which companies are the most likely to see the sharpest decline in revenue growth and which are the most likely to be resilient will be key.

In an inflationary period, such as the one we have experienced over the past year, almost all companies have been able to raise prices, driving impressive revenue growth. But that isn’t pricing power. It’s simply a step that must be taken to keep up with rising costs. These days everyone is raising prices, and consumers have an easier time accepting them psychologically in large measure because they have extra cash in their pockets because of the policy response to the pandemic. And that makes it harder for investors to distinguish between companies that are taking advantage of cyclical forces and those that can command higher prices due to high levels of demand for products or services that their customers find superior and are willing to pay for.

In other words, markets become less efficient in times like these. What investors ultimately care about, the true free cash flow growth differential, is only learned after the fact. Markets become volatile when forced to correct for faulty cash flow projections. Today, investors face the significant risk of owning financial assets where cash flow growth proves illusory because their recent profit strength was stimulus-driven rather than something more durable.

An underwhelming outlook

We are not suggesting a bear market or correction is on the horizon. However, looking ahead, we expect high-priced financial assets that deliver underwhelming fundamental performance to be repriced. When valuations are high, the market’s tolerance for disappointing data (even if the miss is small) is low. Conversely, stocks and bonds of companies that meet expectations may be in short supply and outperform by earning a scarcity premium. Combined with the poor risk/reward tradeoff in many financial assets today, discretion has the potential to be worth more than it has in a very long time. It’s a time for patient, skilled investors.

After all, as the saying goes, it’s the second mouse that gets the cheese.


2022 Social Security Increases

People who collect Social Security are about to see bigger checks. The cost-of-living adjustment in 2022 will be 5.9%. The bump, which will help beneficiaries keep up with rising costs due to inflation, is the largest increase in about 40 years. The adjustment will mean larger checks for more than 70 million Americans. The roughly 8 million Americans on Supplemental Security Income, or SSI, will see the change come Dec. 30, while about 64 million getting Social Security will see the increase in January. The 2022 cost-of-living adjustment will add roughly $92 a month to an average retirement benefit of $1,565 a month, according to some estimates.

Here’s what beneficiaries need to know about this year’s COLA.

What actions do you need to take?

None. People already getting Social Security do not need to do anything to get the increase — checks will be automatically adjusted.

Inflation, Medicare will erode most of the adjustment

To be sure, people getting Social Security should understand that the COLA isn’t meant for them to necessarily be able to spend more or have a bigger budget — it’s to keep their cost of living the same as prices rise due to inflation.

Right now, prices on things such as rent, gas, utilities and food have increased due to inflation.

In addition, those who are on Medicare or Medicaid will also likely not see a full 5.9% bump because of premiums associated with health care. Premium hikes for Medicare Part B, for example, are due in November. The latest Medicare trustees report estimates a $10 increase to Part B, raising the monthly rate to $158.50 for 2022 from $148.50.

Those payments are generally taken out of Social Security and may eat into the adjustment. However, a special rule called the hold harmless provision protects people from getting smaller Social Security checks because of Medicaid and Medicare.

There may not be another big adjustment for some time

Just because there’s a record adjustment this year doesn’t mean that people on Social Security should count on getting similar increases in the future.

In fact, the big jump in 2022 may signal that there won’t be large adjustments in the coming years. The last time there was a similar bump, of 5.8% in 2009, there were no adjustments for the next two years.



Did You Know?


-An estimated 20% of workers in the hotel and restaurant business globally have permanently exited the industry during the pandemic, electing instead to seek employment within industries that may provide greater job stability going forward (source: Tony Capuano, Marriott CEO).


– An estimated $3.3 trillion of additional cash has been accumulated in bank accounts by American households since the beginning of the pandemic, i.e., cash that would have previously been spent (and not saved) if the pandemic had not occurred (source: Longview Economics).


– Inflation as of 9/30/21, using the Consumer Price Index, will be reported this Wednesday 10/13/21. For the trailing 12 months ending 8/31/21, inflation was up +5.3%, a level not seen over the course of a calendar year in 31 years (source: Department of Labor).



“You may not control all the events that happen to you, but you can decide not to be reduced by them.” -Maya Angelou

“Character consists of what you do on the third and fourth tries.” ― James A. Michener

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