Importance of Leadership

The most crucial analysis we make, as investors, is assessing an organization's leadership team, understanding their objectives and strategy so that we can measure their ability to deliver results against them.

We are living through unparalleled times, and that calls for a higher caliber of leadership. We need leaders who can create focused attention on shared objectives. The efficacy of the leadership team determines results. They can make or break an organization, regardless of industry. The proof is extensive. Look at what new, competent management did for Google, Microsoft, AMD, UPS and Ford, to name a few.?

The financial markets continue to rise on a wall of worry, with market leadership changing along the way. It is a complex environment. We all recognize that the key to future growth is getting our arms around the virus, increasing capacity in critical areas to end shortages, and resolving supply line bottlenecks.??Liquidity trends remain extremely favorable, with many trillions in the system along with continued accommodative fiscal and monetary policies everywhere in the world. We recognize that corrections can occur anytime, but we are far from a market top which happens only well after liquidity trends turn negative, which won't begin until the end of 2022 when inventories can finally be rebuilt, loan demand increases, and the demand for funds exceeds supply.?

Corporate America has done a great job navigating through the pandemic, shortages, and supply line bottlenecks.?Third-quarter reports have been outstanding, with over 85% exceedingly forecasts!??Our long-term thesis of higher operating margins despite all the headwinds is proving true.?We continue to forecast S&P earnings reaching over $210/share in 2021 with an operating margin of 13.1% vs. $163/share in 2019, pre-pandemic, and an operating margin of 11.5%. We see further gains in earnings and margins ahead, reaching $240/ share and 13.8%, respectively, in 2023. Not too bad.?

We also have not altered our view that the Fed will begin tapering before year-end, finish tapering by the end of summer 2022, and finally increase the Federal Funds' rate early in 2023. Again, tapering is NOT tightening, and the "real' funds rate will not be negative for years, which is not restrictive. Nevertheless, we expect the curve to continue to steepen as the economy improves and inflation stays elevated as long as shortages and supply line bottlenecks exist, at least until the summer of 2022. We expect the ECB and BOJ to remain overly accommodative well into 2023 too. Finally, we expect the PBOC to ease further too to stimulate China's economy.

Negotiations in Washington on the social infrastructure bill have been a joke. Each day a new trial balloon goes up as to what may be included in the bill, which now appears to be around $1.75 trillion funded with tax surcharges on multi-millionaires and billionaires and a corporate minimum tax of 15% and a 1% tax on buybacks. Most of Trump's tax cuts which Biden targeted, will not be touched. We expect a deal to be reached soon on the social infrastructure bill, which will permit passage of the $1 trillion infrastructure bill shortly and be on Biden's desk in weeks. It is interesting to note that investors have given up on our government passing anything, so if this does come to fruition as we expect, those sectors that benefit will lift. We are there.?

Progress continues to be made with the Delta variant. The number of cases and deaths is falling domestically and worldwide on a 14-day trailing basis. More than 6.91 billion doses have been administered worldwide across 184 countries at a rate of 27.7 million per day. Four hundred fifteen million doses have been given at an average current rate of 822,893 doses per day. Enough doses have now been administered such that 45% of the global population has been vaccinated. It will take another three months to fully vaccinate the U.S population and six months to vaccinate 75% of the world population at current rates. Fortunately, we expect sufficient doses to be available next to vaccinate everyone, including children and a third booster shot. We continue to expect a combination vaccine will become available in 2022 to protect against the coronavirus and flu. All good news!

We expect the Fed will announce next week at its monthly meeting that tapering at $15 billion per month will begin in December and end by the summer of 2022 data-dependent. Chairman Powell will reiterate that tapering is not tightening, and potential rate hikes are an independent decision. We still do NOT see the first federal funds rate hike until 2023, and when it occurs, it will not be restrictive as the "real" rate will remain negative. Powell will discuss at the conference call that inflation is likely to run hot longer than initially envisioned as it will take more time for shortages and supply line bottleneck problems to lessen. Still, he remains confident that inflation will fall back later in 2022 into 2023. It is worthwhile to note that Microsoft CEO Nadella commented on their earnings conference call last week that "digital technology is a deflationary force in an inflationary economy. Business-small and large- can improve productivity and the affordability of their products and services by building tech intensity." He concluded that Microsoft helps companies manage inflation while boosting productivity and reducing waste. Our government should show more support for our great tech companies as they continue to innovate, improving our lives every day. We support Powell's reappointment as Chairman of the Federal Reserve as we have confidence in his leadership.?

It appears that the framework for a $1.75 trillion social infrastructure deal is close? The plan includes a one-year extension of the expanded child tax credit through 2022 plus a provision making the break permanently available to low-income families that don't pay income taxes; it funds six years of universal prekindergarten; six years of child care subsidies; $150 billion to support long-term healthcare for elderly and disabled Americans; $555 billion for climate-related provisions including $320 billion in 10-year expanded tax credits for utility-scale and residential renewable energy, transmission, electric vehicles and clean energy manufacturing. It will be paid for by introducing a 15% minimum corporate tax($325 billion); a 1% surcharge tax on stock buybacks($125 billion); a 15% country by country global minimum tax($350 billion); a millionaires surtax on incomes above $10 and $25 million($230 billion); expanded Medicare tax on the wealthy(($250 billion); a provision to limit excess business losses for partnerships, limited liability companies and pass-through entities($170 billion); IRS stricter enforcement($400 billion); and prescription drug savings($145 billion). Once there is general acceptance by all factions of the Democratic Party, the House will vote on the $1 trillion-dollar traditional infrastructure bill soon thereafter and have it ready for Biden to sign when he returns from the G-20 meeting abroad next week. This process has been a travesty and shows a total lack of leadership from Biden and his administration. The Virginia election next week should be very interesting.?

Economic growth slowed during the summer as we combatted the outbreak of the Delta variant. Domestic GDP expanded at a 2% annualized rate in the third quarter, following a 6.7% advance in the second quarter. Personal consumption grew at just a 1.6% pace after a rapid 12% jump previously. Shortages, supply bottlenecks, higher prices, and the Delta variant all contributed to the weakness. Shortfalls were evident in residential fixed investment, federal government spending, and exports. The PCE price index increased 5.3% in the third quarter and 4.5%, excluding food and energy prices down from the prior quarter. Personal savings remains elevated at $1.6 trillion, which translates into an 8.9 percent savings rate well above historical levels. Recent data has been encouraging as we put the Delta variant in the rearview mirror: jobless claims keep falling and are down to 281,000 last week; consumer confidence rose to 113.8 in October from 109.8 previous months while short term inflation concerns rose to a 13 year high; and holiday sales are projected at a record $800 billion, up 10% from a year ago.

On the other hand, weakness continues in durable goods manufacturing due to shortages and supply line bottlenecks. New orders declined 1.3% in September and 2% excluding defense. We are closely monitoring higher energy prices as it could hurt consumer spending over the winter as heating bills and gasoline at the pump are likely to increase significantly.

Economic growth abroad has been lowered for 2021 from earlier forecasts due to the outbreak of the Delta variant over the summer, shortages, and supply line bottlenecks, including energy. We expect all of this will diminish as we move through 2022, which is why we remain optimistic about growth trends in 2022 into 2023. The BOJ and ECB announced last week that policy will remain highly accommodative well into 2023. We expect the PBOC to continue easing policy by injecting money into the system and lowering the repo rate over the winter to support China's economy. We were pleased to see Evergrande resume work on many of its projects last week too.?

Investment Conclusions

Third-quarter earnings reports have been sensational, with over 85% exceeding expectations despite the surge in coronavirus cases over the summer along with shortages and supply line bottlenecks. Management has done a great job overcoming so many issues. Some we have never seen at these levels. For instance, one CEO commented that over 95 force majeures occurred during the quarter, meaning that he could not get sufficient supplies to build his products, but he still beat forecasts. That is just one example of what we heard during recent earnings calls. Can you imagine what this company will make when these issues abate? That is one of the reasons why we remain optimistic about 2022.?

It all comes down to leadership and management. It is important to note that demand is not the problem. It is super strong.??As these problems ease, we see a significant improvement in production until inventories are normalized, which will take until the end of 2022 at the earliest. We also expect operating margins, earnings, and cash flow to increase further as costs normalize. At the same time, monetary and fiscal policies here and abroad will remain accommodative. Inflationary pressures should ease, too as we move through 2022 into 2023. This is an excellent recipe for higher stock prices. But not all stocks are alike.

We continue to favor the production side of the economy as we strong demand and improve operating margins, earnings, and cash flow over the next few years, benefitting from overall solid capital spending and government-promoted infrastructure programs virtually everywhere. Technology will remain a core holding as the future has never been better as we have indeed entered the digital age. Financial and energy are strategic parts of our portfolios as we expect the yield curve to continue to steepen and energy prices to remain elevated as demand exceeds supply as production stays limited. Finally, we have several special situations which sell well beneath intrinsic value.

Our overriding theme is to bet on management as their leadership can make it or break it.?