Raising More Cash in Our US ETF Portfolios
In the first half of this year, we achieved the results that we anticipated we would achieve for the entire year. Actually, we exceeded them in many accounts. So, the question becomes, do you put some in the bank? In our view, the answer is yes. In addition, we see some changes in the world and in the financial scene which suggest that the easiest money in the bull market, which started with the COVID selloff in March and April of 2020, is now behind us.
We warn readers, clients, and their consultants that any change that we have made to date can be changed at any time without notice. On many of the issues that are influencing financial markets, interest rates, economic outlooks, forecasts, the safest and most honest answer is, “I don’t know” or “we don’t know.” Our position is to admit when we don’t know, to do risk assessments on issues to see whether or not they are likely to have portfolio impacts, and to act accordingly. Here are the considerations that support our decisions.
1) COVID is not over. We don’t have herd immunity. We don’t expect to see herd immunity. We can’t change the behavior of millions of people. Our job is portfolio management. MedPage’s Daily Roundup for June 7 announced a litany of unwelcome COVID-19 news:
“The Delta variant now comprises more than half of all coronavirus cases in the U.S., according to the CDC. (CNN)
“Including some of the cases that caused more than 125 church campers in Texas to get sick with COVID. (Houston Chronicle)
“As of about 8 a.m. ET, the estimated COVID-19 toll in the nation included 33,748,698 cases and 605,932 deaths, increases of 24,894 and 365, respectively, since this time a day ago.”
https://www.medpagetoday.com/infectiousdisease/covid19/93448
If that isn’t enough for you, let’s add that the rest of the world is still on fire with this virus, and in many places cases are rising, deaths are rising, hospitals are overrun, and some don’t have oxygen(1). As of this date, hospitalizations in the US are rising in 21 states.
We’re not going to debate vaccination versus no vaccination. That’s not up to us. We’re going to debate the outcomes. The statistics that support a vaccination policy versus no vaccination policy and a free for all are very clear. They are there to be read by anybody who wants to read them, and they are there to be seen from a money management, portfolio management, economic outlook point of view. We have almost a million excess dead in the United States(2), and the number is growing. We have 3.5 to 10 million long haul COVID sick in the United States, estimated as a percentage of confirmed cases, and the number is growing. And there is no prospect of a quick resolution tomorrow that stops this, and there is little likelihood that behaviors will change until they are forced to change.
2) The labor shortage in the United States is a shortage of people who are interested in, inclined to, and seeking work. We evidence that unemployment payments and supplements are a piece of the worker-shortage problem, but it’s not the whole problem. The rest of the problem is that there aren’t enough people to fill the jobs, or the people who can fill the jobs don’t have the skills, or the people who may want to try to fill the job are in the wrong place. The job is here; the people are there. It’s simple: There are mismatches in the labor force, and they are driving explosive and surprising payments being made to new hirees as employers try to outbid one another for the same limited number of people. That’s why a truck driver can get a $10,000 signing bonus(3), a nurse can get a $20,000 signing bonus(4) and a lifeguard can get $20 an hour and there still aren’t enough of them(5). For further discussion of this issue, see our June 30 commentary, “Wanna Job?” https://www.cumber.com/market-commentary/wanna-job.
3) The big debate over monetary policy centers on transitory versus strategic inflation. Which will it be? Nobody knows. Are wages, measured by most elements, rising now? Yes. Are they rising because of a demand shock, without the ability to fulfill the demand? Maybe. Is this a function of monetary policy? We don’t know. Nobody knows. We haven’t had a shock like this in a hundred years. What makes anybody think they know? So our view is this: The Federal Reserve is trying to wrestle with two problems at once. It wants the financial system and banking system to transition without shocks. It doesn’t want to disrupt the economic recovery process. To accomplish those goals, it is willing to tolerate higher inflation if it can get it. We’re not so sure it can. Maybe it will, maybe it won’t. But if you look at some of the data tracking the various measures of inflation, many of them (PCE-related) are telling you that an inflation bubble of the type we had in the 1970s is not looming in front of us; furthermore, the bond market and market-based pricing metrics are telling you that there’s a bigger worry about an economic slowdown from the growth rates that we had in the first half of 2021.
4) Let’s get to the economic growth rates. We think they are going to slow substantially. Whether the growth rate in the second half of this year will be 2%, 3%, or 4%, we don’t know. But it will certainly not be 6% or 7% or 8%. And the elements that would sustain the high growth rate we saw in the first half are not in place; they’re behind us, because we were recovering from the COVID shock. Furthermore, early warning signs are telling market agents that those elements are not in place. Everybody was hand-wringing when the lumber prices spiked. When they peaked in the middle of May, the hand-wringing stopped. Now that they have fallen since by 40–50%, depending on your futures pricing mechanism, suddenly all the Cassandras who were forecasting indefinite upward lumber prices have gone silent. What happens if the oil price spikes? Maybe the oil price will go to $75, $90, or $100. We don’t know. But the history of oil price cycles suggests that if it did, it wouldn’t stay there. And furthermore, the history pre-COVID of the oil price is that, with a little time, the world can rebalance supply and demand at prices lower than $75 or $80 a barrel, not higher. Energy prices tomorrow? We don’t know.
5) Lastly, there is a huge flow of funds going into the reverse repo structure, which is under the supervision of the Federal Reserve. It’s a massive flow of money, leaving bank deposits and excess reserves in banks and being redeployed into repo. The repo system is a substitution for an abundance of cash that has been created by monetary policy. It’s wrong to debate whether the abundance of cash and monetary easing were necessary. They either were or weren’t; but the fact is, during the COVID shock we didn’t have massive bank failures. We didn’t repeat the financial crisis of 2007–2009. Neither did much of the rest of the world. That’s why credit spreads are so tight. Credit spreads have been telling us for over a year that the success of the central bank is in the lack of a disaster in financial terms. To have no default experience of substance and narrowing credit spreads, you have to have excess liquidity provided by the central bank. And the markets have to believe that the central bank will continue to provide it and avoid a repetition of the Great Financial Crisis. Markets believed it, so that’s the way it worked.
Now what? Now the Fed has to remove one piece at a time, gingerly, without triggering what we used to call a “taper tantrum.” And without causing those credit spreads to widen rapidly. That is a huge challenge for a central bank. The central banker has to decide how to implement this. Do they do it all at once? I hope not. That’s a recipe for disaster. Or do they do it one piece at a time, as they are already doing? If I had my druthers, I’d like to see the Federal Reserve raise the corridor interest rate, which is currently 5 bps to 30 bps and was 0 to 25 bps. I would like the Fed to raise interest rates again 5 bps next month and 5 bps the month after that and 5 bps the month after that. Maybe at the end of this year or in the early part of next year the lower bound would be 25 bps or 30 bps or 35 bps, and the higher bound of the corridor in which monetary policy is made would be 55 bps or 60 bps or 65 bps or something like that. Baby steps. What would that approach do? It would give market agents comfort that adjustments are going to be made gingerly, softly, and gradually. Market agents would be able to realign portfolios; business would be able to realign its investment structure; investors and savers would be able to say, oh, I can look forward to earning something beyond 1 bps on my cash, although it will come slowly. I can see that the Fed is sensitive and does not want to surprise anybody. It wants to conduct monetary policy thoughtfully, carefully, and transparently.
We don’t know whether points 1-5 will happen. And we also don’t know what will happen with China’s behavior, which to us seems to have gone through a transition. We now see headlines that China is ramping up its capacity for conscription, recalling seasoned military veterans, and doing the kinds of things you do at an early stage when you want to advance your ability to make war or threaten war(6). Whether China will threaten war or not, whether it will actually engage in war or not, we don’t know. What we do know is, China is preparing.
We also see a new Chinese policy that is specifically oriented towards those Chinese companies that have accessed or plan to access the American financial markets. Alibaba and Ant were not a one-off, singular event of retribution by the Chinese oligarchs against Jack Ma. The activity with the Didi IPO confirms that. The list of other companies that have an American capital market presence confirms that. China is using the capital market as an instrument of competition, of belligerence, vis-à-vis the United States. The old notion of Hong Kong as a stable, separate system of finance and economics in the world is over. It’s over. “One country, two systems” is over. It was supposed to last 50 years from July 1, 1997, when the Sino-British Joint Declaration of 1984 went into effect(7). It didn’t make it. The agreement got about halfway through the 50 years, and China is upending it. China has a new policy toward financial markets, toward its use of its economic power as the second-largest economy in the world, and towards its finance and banking system and regulation. And it is a direct competitor and an adversary of the United States. If I were to add China as the sixth item in the list above, it would qualify. It doesn’t apply so much to our US ETF portfolios; however, it does indirectly impact Chinese companies that have a lot of exposure in the US. For example, does a Chinese electric vehicle competitor to Tesla threaten Tesla’s market penetration worldwide? Will that tension reveal itself in an adjustment in Tesla’s stock price? And Tesla is a component of the NASDAQ Index. All these issues are still question marks. Answers? We don’t know yet.
So, what have we done at Cumberland? We’ve realigned some portfolios; we’ve raised cash; we’ve banked profits from positions that were successful; we’ve made an adjustment to our risk profile. We are happy to put the first-half returns into the accounts, and we hope that the outcomes in the world will be very positive. Nothing would please us more than to see peace break out, to see a Henry Kissinger in modern form develop a discussion and formulate an embracing policy between the West and China. Do we expect it to happen? No. Nothing would please us more than to see a pill, a sugar cube for COVID, with 8 billion of them distributed around the world. It happened in the past. The big breakthrough, comparable to the new MRNA vaccines from Pfizer and Moderna, was Jonas Salk’s polio vaccine. It was a miracle. And heavy resistance to polio vaccination existed then, just as resistance to COVID vaccination is a problem now. That’s the way it is. That’s the way it was and probably, given human behavior, always will be. Back then, Sabin improved on Salk by creating an oral vaccine. Several companies are working on one for COVID right now. It would be wonderful to see it. It hasn’t arrived yet. So, at Cumberland we’ve raised cash. We’re a little more defensive. We’re redeploying carefully. We would like to see the optimistic outcomes, but we think the risk profile in the world is rising. And we don’t think human behavior changes easily until it’s forced to do so by events beyond the individual’s control.
David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio
SOURCES:
(1) “Global COVID-19 deaths hit 4 million amid rush to vaccinate,” https://apnews.com/article/coronavirus-pandemic-government-and-politics-health-8869272b1347540a2a19fbf56afbd6c9
(2) http://www.healthdata.org/news-release/covid-19-has-caused-69-million-deaths-globally-more-double-what-official-reports-show
(3) “Roehl to offer $10,000 sign-on/stay bonus,” https://www.trucker.com/business/article/21746602/roehl-to-offer-10000-signonstay-bonus.
(4) “Florida, Georgia health systems offering nurse sign-on bonuses,” https://www.beckershospitalreview.com/compensation-issues/florida-georgia-health-systems-offering-nurse-sign-on-bonuses.html.
(5) “These 2 Jersey Shore towns couldn’t hire lifeguards, so they hiked pay to $20 an hour,” https://www.nj.com/cape-may-county/2021/05/these-2-jersey-shore-towns-couldnt-hire-lifeguards-so-they-hiked-pay-to-20-an-hour.html).
(6) “China spells out wartime conscription plans for first time,” https://www.scmp.com/news/china/military/article/3140064/china-spells-out-wartime-conscription-plans-first-time
(7) https://en.wikipedia.org/wiki/Handover_of_Hong_Kong
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