2Q21 Letter: “What a Difference a Year Makes”
Business Update
Since its inception in September 2020, Evolve Investing has grown meaningfully. We are now partnering with over twenty clients to help them attain their financial goals and invest consciously in companies focused on business practices that heal our planet, improve our health, and promote equality.
As we look forward to the second half of and beyond, there are a number of developments on the horizon:
We are rolling out a new approach to assessing our clients’ values and the investment causes that they care most about.
We are enhancing our reporting of investment performance, with respect to both financial returns and impact metrics.
We are taking meaningful steps toward B Corp Certification, which measures a company’s entire social and environmental performance.
We are making it easier for our clients to source, diligence new deals, and angel invest into early-stage, impact-focused companies and funds.
We are exploring more innovative ways to help our clients vote on shareholder matters in full alignment with their values.
Given our growth expectations, Evolve Investing is looking to add new members to our team in the near-term. We welcome any introductions to early-stage founders, impact investors, financial analysts, certified financial planners, and accounting and tax professionals aligned with our mission to create a regenerative, more just, and healthier world.
Economic & Market Update
At this time in 2020, we were facing an uncertain global economic recovery. Daily new COVID cases were far from stabilizing, with the U.S. entering its second wave. A vaccine announcement was more than six months away. And while the U.S. stock market was ascending, the economic outlook was unclear – even in light of the largest central bank intervention of all time. During the second quarter of 2020, U.S. GDP (economic output) contracted by -31.4 % on an annualized basis.
Today, our perspective is much different. Vaccination campaigns are well underway, and in some cases accelerating in most developed economies across the globe. Governments in these markets have eased COVID-related mobility restrictions, and previously lagging sectors of the economy – such as transportation, leisure, and hospitality – are seeing a resurgence in demand. Leading economic indicators, such as purchasing managers’ index (PMI) business surveys, have reached levels not seen in decades. For the second quarter of 2021, U.S. GDP is expected to jump +9.4% y/y, following first quarter growth of +6.4%.
However, this rapid rebound in demand and economic activity introduces a new risk: inflation. In May 2021, the US consumer price index (CPI) increased by 5.0% y/y, a 13-year high. Some of underlying data suggests that some of these price increases are temporary, with certain categories such as used cars and trucks, vehicle rentals, and airfares posting outsized gains.
Whether or not inflation is transitory is a question at the forefront of most investors’ minds, as well as that of Federal Reserve officials. Following its most recent policy meeting, the Fed has become slightly more hawkish, suggesting a move toward policy normalization which could come in the form of tapering its $120 billion per month pace of purchases of Treasuries and mortgage-backed securities (MBS), and/or an increase in its target effective Federal Funds rate.
I share the Fed’s perspective that this inflation increase is transitory in nature, and due largely to base effects (large year-over-year comparisons due to the economy being at a standstill at this time last year), as well as supply chain disruptions resulting from a resurgence in demand. The impact from base effects should normalize over 1-2 quarters, and while I expect raw materials costs to moderate, I’m closely watching lead times to help determine the direction of certain commodity prices.
The Federal Reserve remains squarely focused on the U.S. jobs market. While initial jobless claims have consistently tracked lower since peaking last year, they remain well above pre-pandemic levels. In the June monthly jobs report released last week, the unemployment rate edged up as people voluntarily left their jobs, and companies continued to encounter challenges in filling open positions due to enhanced unemployment benefits, limited childcare options, early retirements, and ongoing virus concerns. It could take several months for job gains to accelerate again.
With that in mind, I expect monetary policy to remain accommodative until we see a full recovery in employment to pre-pandemic levels. Furthermore, I believe that the market is largely pricing in the Fed’s hawkish stance, as eleven of eighteen Federal Reserve officials are now projecting two rate hikes sometime in 2023, up from no rate hikes just three months ago.
Given these policy expectations, as well as my positive outlook with respect to near-term economic growth and earnings growth, I was not surprised to see major equity indices hit new highs during the second quarter. While I acknowledge the risks of inflation to the U.S. economy, as well as relatively high equity market valuations, I believe that conditions remain supportive for U.S. financial markets.
As I look to the second half of 2021, I am increasingly focused on corporate earnings to provide fundamental support for additional stock market gains. The consensus expectation for 2Q21 S&P 500 earnings growth now sits at +62% y/y, declining to +24% in 3Q21 and +16% in 4Q21. As earnings growth outpaces overall equity market gains (the S&P 500 was up 6.9% in the second quarter of 2021), I expect the risks surrounding overall equity market valuations to subside.