Date: August 11, 2021

***Q2 Client Update*** – Excerpts

Many people like to read my very brief quarterly client update which I select excerpts. If you’re one of them, please read on. If not, feel free to stop right now. Always happy to hear comments and questions.

It seemed like yesterday when every piece of news was dark and uncertain. People were acutely concerned about their survival and less about their finances. 2020 was a year where time almost stood still. 2021 could not have been any more the polar opposite. The economy is continuing to roar ahead. Most people are out, about and spending money at a rate not seen in decades. And the year is flying by at a pace I cannot ever recall.

During the second quarter I met with more clients on a percentage basis than in any quarter in my almost 33 years in the business. That continues a trend that began in the third quarter of 2020 as Zoom and Skype became widely accepted social and business modes of communication. While I do not have any plans to stop offering virtual meetings, many clients have expressed the desire to have lunch, go to basketball games, play golf, have drinks and even come back to the office for meetings. In short, I will leave it up to you to choose whichever medium is preferred.

As you know from early January, I thought the vaccines would be the single biggest economic stimulus of the modern era. And that has been playing out in the U.S. with the strongest economy since Ronald Reagan was our President. Doubters can look to Europe, Asia and the developing world for places with lower vaccination rates and economies struggling to recover. Add unprecedented spending by the Biden and Trump administrations along with unfathomable support by the Federal Reserve and it’s no surprise that the U.S. economy has roared back from printing -31% in Q2 2020.

Although the light at the end of the proverbial tunnel has been shining since late last year, it certainly got brighter in Q1 of 2021 as more and more Americans got vaccinated and the economy continued to reopen. That’s where I am going to begin. Although we have gotten used to society’s “new normal”, the first quarter of 2021 began to shed light on how life is going to look as we get to the other side of the pandemic.

First, we all know that there is epic pent up demand to get out, to visit with friends and family, to shop, to eat and to travel. That comes as a surprise to no one. While I started booking travel for 2021 almost a year ago to take advantage of rock bottom prices, I find myself doubling and tripling my scheduled trips for 2021 and 2022 as it feels like life is starting to normalize. Extrapolate that to more than 300 million people and it’s no stretch to say that the economy will continue to boom.

As I discussed in my 2021 Fearless Forecast, I thought the economy could see its strongest growth since Clinton or Reagan. That wasn’t hard to forecast after seeing the historic surge in Q3 2020 and the release of the vaccines in Q4 which I said was as or more important from an economic standpoint than the Fed’s tsunami of liquidity or Congress’ unfathomable response. Although we will not get a first look at Q1 GDP growth until after this is published, it is going to be very strong and north of 6%.

When we look at earnings from Q2 2020, they literally fell off the cliff. So, no one on earth will be surprised that Q2 2021 earnings are going to soar when compared. In my 32-year career, I do not believe there has ever been a year over year comparison like Q2 2020 to Q2 2021. And let’s hope and pray none of us see anything like it again. The big question that began towards the end of Q2 and will likely persist to year-end is have we seen peak acceleration in GDP and earnings growth, as if that is something that spells doom for the economy and markets.

I don’t have to go out on a limb to say that Q3 2020 GDP growth of 33% is certainly the peak in acceleration. On a year over year basis, it’s plausible and likely that peak growth in earnings will be Q2 2021. However, none of this means much going forward. The beginning of every recovery almost always sees peak growth early on. Just look at 2009-2010 and 2003-2004. That’s the nature of recoveries. All that pent-up demand gets unleashed as the economy turns.

When I look at the financial system, I see a Fed that has added roughly $4 trillion to its balance since March 2020 and that doesn’t include the several trillion in special programs to keep the wheels of the system greased. On top of that, Congress, Trump and Biden have spent another $6 trillion on various COVID relief and related programs. I may not have been a math major, but that adds up to unfathomable and unthinkable amount of money in the system. It is certainly easy to understand why the markets have surged, almost unabated and “everyone” seems to have money.

To give you an understanding of just how much money has been essentially created, M1 which is basically all the currency in the system plus checking deposits rose 316% over the past year. M2 which is M1 plus savings deposits, money markets and other time deposits rose 26% year over year. I believe that’s the highest since 1943. It’s just really hard to fathom all the money that is and has been in the system. And so much of that money has been invested which is why the rising tide has lifted all ships.

Many of the economics textbooks tell you to conclude this is all inflationary. Too much money chasing too few goods. That sounds great in theory, but that’s not how it works in practice. My apologies to my various economics professors at the University of Rochester. Although inflation has been a theme of mine since last summer it’s much more complex than just a huge surge in the money supply.

After all, look at the historic measures the Fed took at the end of 2008 and on. They begged and pleaded for inflation to kick up every year to 2020 with no success. The difference this time around was that the Fed and government acted swiftly and in unthinkable terms. They essentially undertook everything at once, rather than at a measured pace. You could see that most in the value of the U.S. dollar index which peaked in March 2020 as the stock market bottomed. The dollar then went straight down to the end of 2020 as commodity priced surged and soared right to the end of Q2 2021.

I think the best way to describe inflation for the average consumer is a loss of faith in the government and many times the currency. Inflation itself doesn’t lead to collapses everywhere; that’s more along the lines of hyperinflation. But when you look at history, domestic impatience, violence and uprisings typically occur when inflation soars. While inflation has been running very hot, I do not see hyperinflation as a possible scenario.

Inflation is everywhere. Watch the financial channels and it’s an ongoing theme. Everyone continues to talk about it and warn of dire consequences. On the surface, they are right. However, one of my favorite sayings is that it’s not what the actual news is, but rather, how markets react. The April and May inflation reports were white hot. No one on earth could argue that. However, a funny thing happened on the way to the pundits crying about hyperinflation. Markets behaved completely counterintuitively.

In May when the April report was released, we saw bond prices bottom and yields peak. Commodities peaked. Industrial, material and energy stocks found ceilings. Technology stocks found their floor. All of this was the exact opposite of what “should” have happened with the white-hot inflation that was seen in the report. I knew something did not look right, but it took me another month to see the big picture.

While the media and pundits continued to spread fear about a 1970s style return of systemic inflation, the markets were pricing in something very different. To me, it looked and still looks like the markets are saying that the white-hot reports will not get even hotter. Late Q2 or early Q3 may be peak inflation for 2021. While inflation could stay high, the markets are saying the worst case has been seen for 2021. The best case is that inflation acceleration peaked and will trend lower into 2021.

The most important takeaway and perhaps the most misunderstood feature of inflation is that prices must continue to rise for inflation to remain high. For example, gas goes from $2 a gallon to $4 a gallon. In order for inflation to continue, gas prices must go even higher and higher. If gas stays high at $4 over the coming quarter or year, that shows there is no inflation because prices did not continue higher. Many people think that inflation equals high prices. That’s not correct.

Staying on the topic of the economy, the April and May employment reports came in much less than expected, by several hundred thousand jobs. After April’s release, I thought for sure that it was some kind of seasonal anomaly and the May report would see a strong upward revision. But May wasn’t much better, confounding many. With back to back misses, I concluded that what I have been writing about and hearing about anecdotally was now widespread. The added unemployment benefits amounting to $900 per week had created a disincentive to work or at least work above the table.

Somehow, my conclusion became yet another partisan issue, not that I started it. 31 governors, all Republican, opted out of the additional benefits by the end of Q2 as they believed it was hampering new job creation and growth. With the additional benefits slated to expire on September 30, Q3 should certainly tell us if my conclusion was on target or a miss.

With so much of this report focused on the economy, it is time to turn to the heavy hand impacting the scale. That would be Jay Powell and the Fed which were very quiet during the quarter. In their eyes there wasn’t much to do. Their capital markets programs worked. Congress spent a clinically insane amount of money and the vaccines were the greatest economic stimulus in modern history. Mission more than accomplished.

It’s long past the time where Powell and his minions should be starting to exit, stage left. The Fed continues to buy $120 billion a month in Treasury and mortgage-backed bonds. I cannot find anyone on the planet who thinks the U.S. housing market is in need of crisis-level support. Yet, the Fed just keeps on buying and buying. The economy is creating more than 750,000 new jobs a month in 2021, but the Fed just keeps on buying Treasury bonds. Inflation is white hot for months and the Fed keeps stimulating. I think you get my drift. I gave the Powell and the Fed huge props and kudos last year for going unfathomably and unthinkably big and not hemming and hawing and going piecemeal. It was a job more than well done, but they are overdue in starting to taper their purchases and get out of the bond buying business.

Q2 2021 was not challenging in the financial markets. There still hasn’t been even a 5% pullback since October 2020. The Dow Industrials, S&P 500 and NASDAQ 100 all saw at least mid-single digit growth and the bond market returned more than 1.50%. Commodities and real estate continued to run hot. Three months ago, I thought the rallies would flatten out and let fundamentals catch up with prices. But the risk on appetite was too great and the markets remained full steam ahead.

The Initial Public Offering (IPO) market saw 213 issues priced during the first half of 2021. That’s what we normally see in an entire year. And while the average gain has been more than 20%, all of that has come on day one from the offering price to the opening price. There have been many high-profile IPOs this year and you have likely seen my criticisms of buying too early. No IPO had more hype and attention than Coinbase, the cryptocurrency exchange.

The stock was priced at $250, opened for trading at $381 and ran to a high of $430 on day one. Doesn’t that sound amazing for investors? The stock closed the day at $328 and proceeded to plummet to a low of $208 a month later. While I love the story and the economics, I waited until June before dipping my toe in for those in our Unloved Gems strategy. And that’s my IPO thinking in a nutshell. I would much rather wait until the volatility gets wrung out and the hot money leaves for greener pastures than to buy too early and watch the stock collapse. There are only a handful of companies that open higher and never look back. Google is the only one I can recall in my 32-year career and there are thousands that did not.

After easily eclipsing my long-standing target of 30,000, the stock market should see 36,000 achieved later this year, something I did not forecast to occur in 2021. All year long and right here three months ago, I wrote about a summer stock market peak with the largest decline since last October unfolding by fall 2021. Nothing has changed in that regard. The five major stock market indices are not all in sync. Leadership has been lacking from financials and transports. The high yield bond market rally seems to have stalled. And participation in the rally has narrowed. While none of these are the death knell for the bull market, there are only two scenarios for stocks. One is that there is a decline of some magnitude that resets the bull market. The second is that the market blasts off over the coming months and repairs most of the warning signs listed.

At this point in the report, I usually write about my barbell strategy to investing. If you picture a barbell from the gym, there is a long, thin bar with big weights on both ends. Think of those weights as our conservative strategies and aggressive ones, the exact proportions do not matter yet. In theory, your money would have higher weights to conservative and aggressive strategies, especially if you are in or very close to retirement, and lower allocations to the middle of the road strategies. This barbell approach has also worked very well with monies being transferred in from 401K and 403b plans as those pre-packaged plans rely heavily on bonds for the more conservative approach and do not account for interest rates rising. Additionally, their aggressive choices do not usually reward the risk taken.

Anyway, even though I did just write about it again, I have not moved client money into the barbell for over a year. That is because our middle of the barbell strategies have been performing at such a high level. I want to give them a chance to plateau before moving more money to the barbell. If you would like to learn more about the barbell approach, we can set up a call, Skype or Zoom.

Let’s discuss our strategies. Overall, it was a very strong quarter across the board, one of the better ones we have ever had. Equity strategies led the way with some returns being impressive for a whole year, let alone a single quarter. However, let’s remember that it can cut both ways and it has been an unusually strong five quarters in a row.

As I do at the end of each quarter, below you can see how our various strategies preliminarily performed for the quarter as well as year-to-date. I added a third column for the trailing 12 months since people seemed to like it after Q1. Please let me know your thoughts. As always, all returns are net of all fees and expenses.

Looking ahead to Q3 and the rest of the year, I see several crosscurrents. The odds favor a stock market pullback. However, until price, always the final arbiter, finally cracks, it’s too early to play meaningful defense if that becomes appropriate. On the flip side, there are several worthy studies that point to higher prices and buying any bout of weakness. When the S&P 500 finishes the first half of the year up by more than 12.50%, the second half of the year averages a 10% rally. 1987 and 1998 saw 20% declines first. When April, May and June are all up in a given year, the next 9 months have been higher 17 straight times although 1980, 1997, 2016 and 2018 all saw full-fledged 10%+ corrections during those 9 months.

Worries about the Fed beginning to talk about the possibility of discussing a taper will likely begin in earnest after their annual retreat in Jackson Hole in late August. Others will be concerned about peak earnings growth, inflation and new strains of COVID. Please always remember two important things. Price is always the final arbiter in the markets. And it’s not what the actual news is, but rather, how markets react. The masses wrongly disavowed the first 6 months of the new bull market last year because the stock market should not have been rallying so hard with a global pandemic and no vaccine. Never get caught up in a narrative. Markets discount news 3-9 months ahead.

Our strategies continue to perform remarkably well, something that I do not take granted and never forget more challenging times which ebb and flow throughout the years. I am so thankful for such a loyal and supportive client base. There are still many new clients to welcome and I always promise to never sacrifice the tenets and mission of this firm.

Although we briefly were able to meet in person without masks, it seems that is coming to an end as I type this. Hopefully, it is just a fleeting return to caution and not into 2022. Please continue to share your feedback, positive and negative. Investing is a marathon not a sprint and the long-term future continues to look very, very bright. We look forward to sharing that with you over the coming years. Again, here is the link to my calendar to schedule a meeting in the office, call, Zoom meeting or Skype.

Thank you for the privilege of serving as your investment adviser!


Heritage Capital, LLC

Paul Schatz

Here is the link to our disclosure documents including our privacy policy as well as our ADV Part 2A & 2B.

According to SEC and state regulations Heritage Capital, LLC will deliver Form ADV Part 2 to all clients within 60 days of its annual amendment filing date. Here is the link to our disclosure documents including our privacy policy as well as our ADV Part 2A & 2B. Additionally, we may engage unaffiliated investment advisers as sub advisers to assist us with management of client assets. Our services under the investment advisory contract do not include financial planning.

Past performance may not be indicative of future results. The above individual account performance information reflects the reinvestment of dividends, and is net of applicable transaction fees, Heritage Capital’s investment management fee (if debited directly from the account), and any other related account expenses. Account information has been compiled solely by Heritage Capital, has not been independently verified, and does not reflect the impact of taxes on non-qualified accounts. In preparing this report, Heritage Capital has relied upon information provided by the account custodian. Please refer to formal tax documents received from the account custodian for cost basis and tax reporting purposes. Please remember to contact Heritage Capital, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you want to impose, add, or modify any reasonable restrictions to our investment advisory services. Please Note: Unless you advise, in writing, to the contrary, we will assume that there are no restrictions on our services, other than to manage the account in accordance with your designated investment objective. Please Also Note: Please compare this statement with account statements received from the account custodian. The account custodian does not verify the accuracy of the advisory fee calculation. A copy of our current written disclosure statement discussing our advisory services and fees continues to remain available upon request.


Paul Schatz, President, Heritage Capital