December 31, 2021

“There are two times in a man’s life when he should not speculate:  when he can’t afford it and when he can.”  -Mark Twain

The fourth quarter and the year 2021 represented another year (and quarter) of growing wealth for our clients. All of our traditional and defensive strategies were positive in the fourth quarter and for the full year.  In fact, each of our defensive and traditional strategies returned double digit gains for the year. This follows similar robust gains in each of 2020 and 2019.

As our thought piece indicated, the period from 2010 to 2021 provided significant compounded gains in wealth for our clients.  The S&P 500 Index actually grew at a very significant clip of 15.2% annualized.  We attribute these gains to the following:

– Growing corporate earnings

– Growth in domestic GDP

– A significant increase in both monetary growth and fiscal stimulus

– Extremely low interest rates beginning with the financial crisis and following the government imposed economic shutdown after the onset of the pandemic

– A very strong consumer

– Following the near collapse of our banking system in 2008/2009, large money center and regional banks became very strong with all major banks passing stringent federal stress tests

– High levels of employment prior to the pandemic and gains in total employed since the pandemic lows now achieving near pre-pandemic employment levels 

However, despite all of the positives mentioned above, many of which should continue to benefit us in 2022, we as investors are confronted with the following challenges:

– Record national debt

– The highest inflation rate in 39 years

– The Federal Reserve indicating that it will start tapering and concluding asset purchases in advance of raising short-term interest rates in 2022

– Financially strained safety nets of both Social Security and Medicare

– Climate change

– Geopolitical challenges with oppressive regimes in China, Russia, and Iran

– Our government paralyzed by extremism on both sides of the aisle

Thus, we do not believe, after leading our clients to significant wealth accumulation, that speculation should be considered rather than prudent asset allocation with a goal of growing wealth on a real basis after inflation and taxes. This is especially so when considering the “wall of worry” that we must scale in the years ahead (including learning to live with the coronavirus, which we believe will become endemic).

I urge you to read our thought piece which was recently sent to you if you have not already digested it, and consider that we believe the next several years of investing will probably not be as robust as the last decade.

We are delighted to have helped our clients achieve great gains in 2021 and look forward to continuing working on your behalf in 2022!

Wishing you a healthy, safe, happy and prosperous New Year.

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results. Partnership returns are estimated and are subject to change without notice. Performance information for Dividend Growth, FLI Core and AB Concentrated US Growth strategies represent the performance of their respective composites. FLI average performance figures are dollar weighted based on assets.  

The views expressed are the views of Robert D. Rosenthal through the period ending January 27, 2022, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.

References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

Copyright © 2022 by First Long Island Investors, LLC. All rights reserved.

On Thursday December 9, 2021 First Long Island Investors held an online web seminar where Marshal Cohen, Chief Industry Advisor at The NPD Group, spoke about the seismic shifts in the retail industry.  Marshal spoke on a wide range of topics including:  which segments of the retail industry are doing well and which are lagging, which pandemic related buying behaviors are continuing and which are starting to decline, the supply chain bottlenecks and how the relieving of those will impact buying and pricing, channels used for shopping and much more. Some of the key points are below:

• In 2021, there will be about $3 trillion worth of US retail spend (including restaurants and grocery) which is comparable to but ahead of spending in prior years which indicates that retail in the US is healthy. 
  •  Dollar growth for the week ending December 4 (this includes cyber Monday week) was up 3% vs. 2020 and up 3% vs.  2019, a more normalized year.
  • 2021 monthly data through the end of November shows 16% higher dollar growth and 7% higher unit growth over 2020.

• Breaking things down by pre-COVID, COVID, and 2021 year to date there are some interesting data points:

• In “normal times” 3-5% year over year growth would be considered good, and more than 5% would be considered great. 
  • The COVID period started with store closures that went all the way through December, including the 2020 holidays. Deep decliners were accessories, apparel, beauty, and footwear while housewares and small appliances, which were a very important part of the COVID lifestyle, were gainers.
  • 2021 year to date, the “COVID decliners” rebounded and many of the “COVID winners” are down but still growing at very healthy rates.

	Dollar Percent Change vs. Prior Year
Category	Pre-COVID (12 months ending Feb 2020)	COVID (Mar – Dec 2020)	Current (Jan – Oct 2021)
Accessories	-5%	-34%	+30%
Apparel	-1%	-19%	+30%
Beauty	+2%	-21%	+31%
Footwear	+2%	-16%	+27%
Housewares	+1%	+24%	+8%
Small Appliances	+3%	+28%	+10%

• There is a seismic supply shift happening.  Marshal remarked many CEOs of large retail companies have shared with him that they are wrestling with how to get all of the merchandise that is out on the waters or on the docks transferred onto railroad cars or trucks and to the consumer. 
  • The current supply shortage is very likely going to turn into a very different scenario – it actually could turn into a supply overage.
  • Three months’ worth of inventory (September, October, and November) are all being received right about now.  For example, you couldn’t get a bicycle last year but now they have more bicycles than they can sell. 
  • Retail sales typically rise throughout the year, peaking in December and then in January there is less demand.  Some retailers are discounting the overages now, a little earlier than Marshal would have expected, because they’ve got more inventory than they can sell. 
• Pricing.  Marshal shared a graph showing weekly data for dollar and unit change going back to February 2020.  The data demonstrated a number of upticks.  He shared that each of the upticks coincides with government stimulus money.  Stimulus money absolutely propped up consumer spending across all major retail industries. 

• In addition to spending more, the average selling price also increased.  Consumers, even at the lower income levels, were driving the growth during the pandemic and willing to trade up and buy better products. In some cases, it was because it was the only choice and in some cases it was because they felt like stimulus money was free money and why not upgrade. 
  • Price increases are somewhat due to fewer promotions, the consumption of higher priced products, and less price sensitivity.  For example, the first time gas crossed the $3 threshold we were shocked, the second time we were “oh this is not good”, yet by the third time it becomes almost acceptable.

• Employment – October had the highest level of people resigning from their jobs, a new record.  Additionally, workers are changing their work environment and working from home in a hybrid or on a full time basis.  Pre-pandemic only 8% of the workforce worked from home.  That climbed up to close to 85% during the pandemic.  It hovered, went down, and then went back up with the delta variant.  The NPD Group feels it is roughly now at the level it will reside at, ~20%. 

• Work from home impacts many different things. 
  • Over the last two-three years we’ve seen a decrease in the female side of the labor force.  The male side has also decreased, but not at the same rate.  As women left the workforce simultaneously the amount spent at restaurants dropped and that wasn’t coincidental. 
  • Wardrobe and footwear is impacted by work location.  The use of automobiles is impacted. 
  • Based on pre-pandemic trends, more than 47 million workers age 55+ were projected to retire.  More than 49 million actually retired.  This acceleration in retirement also impacts retail. 

• Leisure time correlates to retail in how people are spending their time and therefore their money. 
  • People are returning to experiences and some travel.  Amusement parks, sporting events, movie theaters, and bowling are showing recovery.   
  • Fine dining is starting to come back.  Country club dining saw elevated levels in 2021. 
  • Cruise lines have been the slowest to recover.

• There was an expectation that once experiences started to recover we would see a decline in tangible items but that is not happening.  People are not planning as far out and not buying as far in advance due to worry that a trip or an event may get cancelled.

• The consumer is feeling wealthier than they have felt in years.  They’ve been paying off their credit card debt, they’ve certainly been saving more money.  Those rates are coming down in recent times but not quite to pre-pandemic levels.  The personal savings rate peaked at 33.8% in April of 2020 and as of August 2021 it is back below 10%. 

• The number of U.S. households with total household income over $100K has been rising over the last six years and these folks are driving retail growth.  2020 vs. 2019 all of the growth came from the upper end consumer and we are seeing the same in 2021 vs. 2020. 
  • Demographics are shifting as well.  The 55+ generation accounts for nearly one third of discretionary dollar sales.  This age group is also shopping online more.   
  • This is showing you both income and age are the big components driving the consumer, so retailers are recognizing that they should market to the less sexy audience which is that experienced consumer.

• Shift to Digital:

• Marshal shared that in 2015 he was presenting at the National Retail Federation and the speaker before him predicted the death of the retail store with everything sold online by 2020. This speaker also predicted that by 2018 department stores would be obsolete.  Marshal took the stage and explained to the audience, that this was absolutely not going to happen.

• Marshal shared a graph looking at monthly data for the percent of sales in-store vs. online. 

	% In-store	% online
Jan 2019	71%	29%
April 2020	52%	48%
Sept 2021	64%	36%

• The pandemic accelerated the use of the online channel. As we come out of the height of the pandemic consumers are still using digital channels but also returning to brick and mortar stores. 

• Looking at the shifts in channels it is best to look at Jan-Aug 2021 vs. Jan-Aug 2019 (pre-pandemic) and we see that e-commerce, grocery stores, mass merchants, and warehouse clubs, all of which were the high flyers during the pandemic, have continued to maintain growth.  Tech stores, off-price retailers, and manufacturer owned stores are growing but at much slower rates.  Specialty retail is the most challenged, particularly in apparel (e.g. Victoria’s Secret), department stores (i.e. JC Penney), and the restaurant business.  The expectation is that the restaurant business is not likely to catch up to 2019 levels until 2023.

• Holiday Dynamics.  Looking at the five weeks ending 12/4/21, the total dollars spent in retail is exceeding 2020 by 9% and 2019 by 14%. 

• If you go back 20 years you see the same pattern – a decline post-Thanksgiving and then another uptick.  2020 didn’t show this trend because there was not as significant of an uptick for Black Friday.  Marshal is not alarmed by the softening as there are still three usually strong weeks to go. 

• The NPD Group’s survey on holiday purchasing intentions in September 2021 found the following: 30% of consumers plan on spending more than last year, the #1 item people think to give as a family gift is a TV (35%), the number one self-gift is the thousand dollar plus iPhone (55%), free shipping is the most important priority to consumers when choosing a retailer. This beat out the usual number one answer of value. 

• Marshal concluded by sharing that he wants people to think about which businesses are set up to be nimble; to recognize that the consumer is shopping in the here and now; and to sell to a wider sector of consumers.  For example, in the beauty business you can sell the same anti-aging skincare products to different age groups by focusing on a different purpose with each, one is anti-aging and one is preventative.
• The COVID lifestyle was driving work from home, healthy from home, fitness from home, educate from home and entertain from home. 

After sharing his prepared remarks, Marshal took questions from attendees. 

Q:  Can you talk a little bit about the buy now, pay later strategy and how that impacts consumers and the overall economy for both the short term and the longer term?

A: Short term it gives the consumer the ability to buy without the same kinds of constraints and shift some spend. As I showed you savings and credit card debt were coming down, but are now back on the rise. As we get through the holidays I anticipate the consumer basically maxing out their credit cards.  The buy now, pay later methods gives them the ability to expand their horizons, upgrade their products, buy more expensive products, etc.

Q: (from Bob – CEO and CIO of FLI):  The home building and home improvement areas seem to be, from your presentation, very strong.  We invest in Home Depot, Lowes, and Williams Sonoma.  How do you see the trends for those kinds of companies going forward?

A: We certainly know that those companies can’t maintain the momentum of their growth, but they will continue to be a big driver.  Keep in mind a lot of people who moved and bought homes didn’t necessarily have the budget to then upgrade the home, but they have the desire to do it, so there’s still plenty of runway room for the home improvement areas.  We did see a decrease in the “do it yourself side” but “the do it for me” part of the business is growing.  I’ll give you a great example in home décor – last year, people decorated their home to keep it cozy and comfortable, and they would buy throw pillows and blankets, pajamas and slippers because we were staying home. This year is all about expanding the nucleus, inviting more friends and family, so we’re back to decorating to impress.  To your point about Lowes and Home Depot, I don’t think they will maintain the level of growth reached during the pandemic, but they will still be an integral part of the investment that people make in their homes. 

Q: You talked a lot about the supply and then the overages and prices and how that’s going to impact the consumer. At a very high level, where do you see that impacting faster, is it more in the luxury goods or in staples?  We see shelves and stores empty across the board.  Who do you think will rebound first?

A: The biggest rebound is going to be in the commodity side of the equation, where sourcing is distributed across a wider sector of product. Commodities, which includes grocery products but also includes things like underwear and jeans, intimate apparel, etc.  They had a lot of challenges early on, but now they’re the ones that I think that are going to hit retailers with an abundance of product.  Fashion is the one that’s most vulnerable because those goods are perishable and can’t just be put to the side and sold later in the year.  They’ve got to sell them now because they’ve already put into play product for next year.  The thing to look for is who’s got product that they’re going to move quickly?  Which retailers are going to take the hit early?  Think of Old Navy that is selling the product at deep discounts to manage through the inventory.  They don’t want to have to go into 2022 with 2021 merchandise, so they are going to be aggressive which could hurt margins. 

Q:  Do you have any kind of insight or timing as to when the backup at the seaports will kind of ease up and kind of get back to normal.

A: Good luck figuring that one out, but now the answer is we’re already starting to see certain industries have product that is now readily available which is good news.  It’s not going to be a universal answer.  Fashion will be probably one of the earlier ones to get back in position, hard goods like technology will take a little bit longer, video games will take even longer.  I look at tech as one of the slower to recover, and I look at fashion as one of the quicker to recover and toys is another one that’s going to be challenged during Christmas, but right after Christmas there will be plenty of product. 

Q:  The percentage balance between in store and online you shared feels contrary to what we have been hearing in the news.  What do you think is driving the desire to return back to in-store?

A:  Excellent question.  What’s happening is that as the nation was vaccinated to a sizable degree, and even those that didn’t get vaccinated, we certainly saw events start to just fill with people.  In store shopping is not only advantageous because of the touch and feel nature but shopping in store is also a social aspect of our lives. We meet people either in restaurants or we meet people to shop.  Furthermore if you are at a loss about what to buy it’s a lot more difficult to navigate on a site to find a substitute product or a product idea than it is to go shop in a store and get that element of education and impulse and feel.

2022: Our Thoughtful View

“There are two times in a man’s life when he should not speculate:  when he can’t afford it and when he can.”  -Mark Twain

A Tale of Two (Plus) Decades

As we look towards 2022 and beyond, it is worth discussing each of the past two plus decades of stock market and economic performance.  Two periods of time which brought about very different results for most investors.  This review is to ensure that we have a fair perspective on both investment and economic achievement, or lack thereof.  In the period beginning in 1999 and ending in 2009 (seems like a long time ago) both stock market performance, as evidenced by the S&P 500 Index, and economic growth were lackluster to say the least.  We may not remember, but it was a frustrating time.

As can be seen in Chart 1 on the previous page, it was a period of time that most equity investors would prefer to forget.  A tech boom ended in a bust (2000-2002), economic growth was choppy, and the “decession” of 2008/09 almost led to the collapse of our banking system.  Annual returns for the S&P 500 Index during this period were a dreary 0.96%. 

This contrasts greatly with the most recent twelve year period that just ended December 31, 2021.  A period of time during which equity returns and economic growth were robust and made us forget the prior eleven year period despite the coronavirus pandemic and the virtual self-imposed depression in 2020.

These charts demonstrate the tale of these two different periods of time.  The past twelve years saw compounded stock market growth of 15.16% per year while economic growth was also quite impressive.  Of significance, S&P 500 earnings growth over this period propelled, in our opinion, a good deal of the impressive stock market gains.  The following chart shows consensus S&P 500 earnings growth historically and projected for 2022 and 2023.  This continuation of earnings growth is typically essential for stock market appreciation.

The powerful combination of earnings growth and growth of the economy is a part of the story of these significant financial gains.  However, commencing with the financial crisis in 2008/09, and exacerbated by the Federal Reserve’s action to help combat the coronavirus pandemic, we have lived through a period of declining interest rates.  This, combined with very low inflation, is another part of the plausible explanation for a much higher stock market in the last decade plus versus the previous one.  As a matter of fact, we believe that equity markets have benefited from negative real interest rates (0% or below since January of 2020) for the 10-Year U.S. Treasury, which historically has occurred very infrequently (real interest rates are the nominal yield minus the inflation rate):

The charts above show just how low both nominal and real interest rates have been.  Another factor in the rising stock market is, to some extent, TINA (an acronym for There Is No Alternative (to stocks)). Should investors accept a 10-Year U.S. Treasury yielding below zero on an after inflation basis (without even considering the fact that the interest is taxable, which reduces returns) or cash with an even worse real return?  For the past few years the 10-Year U.S. Treasury has yielded between 0.5% and 2.8% with inflation at about the same rate, and most recently increasing to 6.8%.  Even prior to the supply chain shortage and energy price increases of late, the real yield for the 10-Year U.S. Treasury has been 0% or worse since January 2020 and that rate is locked in for a ten-year period.  It is no wonder our Dividend Growth strategy has fared so well.  In fact its yield has generally been above that of the 10-Year U.S. Treasury since inception and for the past ten years dividend growth for our strategy has averaged greater than 8%. 

Chart 6 shows the path of inflation over the past forty plus years.  (We chose this time frame because that is the last time we suffered with inflation at very elevated levels.)

Fed Chair Jerome Powell has finally accepted that this rise in inflation is not just “transitory.”  It is elevated in part due to supply shortages, increases in wages, and rising energy costs somewhat related to failed domestic policy, in our opinion.  Additionally, housing costs have increased.  These are real concerns especially for the average family.  Inflation is the cruelest of tax increases (in our opinion).

How Do We Enter 2022?

This analysis was designed to make us all think about the past two plus decades.  The 2010-2021 period was financially rewarding for equity investors, despite COVID-19, but during the prior eleven years many investments and thereby investors failed to keep pace with inflation.  Economic growth spurred by massive governmental relief programs, low interest rates, earnings growth, expanding multiples because of declining and low interest rates (in our opinion), and excess liquidity helped overcome the financial impacts of COVID-19 and the shut-down of the economy in 2020.  However, there has been a price to pay.  Both the Fed and the government have pumped trillions of dollars into our economy to help combat the pandemic and the economic hardships it created.  The Fed kept short-term rates historically low while expanding its balance sheet and the federal government spent trillions of dollars between COVID-19 relief, and most recently, an infrastructure bill.  This has led to record government debt.

The net result is that we can look forward to an economy in 2022 and possibly 2023 characterized by domestic economic growth, continued growing earnings, low but rising interest rates (the 10-Year U.S. Treasury in a range up to 2% to 3% in our opinion); and elevated inflation (which we believe will abate to an extent sometime in the second half of 2022 and level off in a range of 3% to 3.5%).  There is no question in our minds that the Fed, as announced, will begin tapering and conclude its asset purchases while raising short-term interest rates over the next year.  (Tapering could possibly induce long rates to also increase.)  However, we think this will be in moderation, as suggested by our estimate on the 10-Year U.S. Treasury of no more than 2% to 3% (higher long-term rates could be difficult for equity and real estate markets to digest).  Keep in mind that as a country we have to service debt that will soon exceed thirty trillion dollars, so interest rates matter.

How To Invest

Our discipline has always been to customize a prudent asset allocation for our clients.  In recent years this has meant an under-allocation to bonds (with their low to negative real yields), and we will continue this.  A similar under-allocation to internationally domiciled companies  where we have been significantly underweight for quite some time (at least ten years) and that has benefited our clients and we believe will continue to.  We will continue to barbell our allocations to both growth- and value-oriented strategies across market capitalizations.  We remain focused on investments in strong companies which are dividend growers and/or earnings growers, have solid fundamentals, and have proven management teams.  Given the significant wealth appreciation achieved over the past twelve years, we agree with Mark Twain.  Why should our clients, who can afford to speculate, speculate?  We do not believe they should (other than some non-core assets to have fun with, if that is of personal interest).  Therefore, depending on age, income needs, estate planning for the next generation, and the appropriate cash buffer, we continue to stay the course with a long-term view of being fully invested aside from the aforementioned cash buffer.  We will stick to high quality, dividend growing and or earnings growing companies, and quality real estate-oriented investments while avoiding areas of speculation or lack of understandable history.

In the last few years there have been areas of excess or speculation.  An old concept called SPACS (Special Purpose Acquisition Companies) has become the recent rage; a reasonable concept that attracted huge amounts of capital in public pools looking to make acquisitions.  We have avoided this area.  There has been a surge of initial public offerings where valuations were well above what we could tolerate.  Many were extreme multiples of sales, not earnings.  Not for us.  Finally, the surge in cryptocurrencies led by Bitcoin has attracted a lot of attention.  I believe you might compare the concept of block chain or bitcoin to the internet of thirty some years ago.  Perhaps it is the answer to our growing debt and possible debasement of our currency?  It might just be a better hedge against inflation and poor fiscal and monetary policy of our government than gold.  Perhaps more on this asset class in future writings.  We continue to study it.

We do not expect the next ten years to create as much wealth as the last twelve years, but we expect it to generate more wealth than the previous decade (1999-2009).  We will face a down year or two as we have in each of the past decades.  These down years will most likely be brought about by a recession or two.  We cannot predict when that will occur, and at least historically, recessions have coincided with declines in the stock market.

The good news is that, barring an unforeseen and unpredictable event, we do not see a recession on the horizon in the coming year or two.

Final Thoughts

The last twenty plus years have shown us that long term investing does pay off handsomely by staying the course.  However, some periods are better than others and we have just fortunately experienced an excellent twelve year period.  Long-term investing can entail different asset allocations tailored for each of us with a goal of growing our wealth above the level of inflation and after taxes.  To do otherwise will mean a permanent loss of wealth if we give in to inflation or direct too much of an allocation to cash and fixed income with negative real yields.  We can develop asset allocations, without speculation, that we believe can achieve our goal even with inflation at 3%.

Finally, we still face geopolitical hot spots and must stand up to oppressive regimes such as China, Russia, and Iran.  Our own political divisiveness must be overcome to confront issues such as climate change, equality, and the needs of social security and Medicare, as well as ensuring productivity, innovation, and a strong economy and military.  Perhaps 2022 and beyond will find more politicians thinking America and Americans first and party second.  These factors, and others, can at times create volatility and while in the short term that is never enjoyable, having a prudent asset allocation and the appropriate cash buffer (both discussed above) provides for the ability to weather such volatility and focus on long-term investing. 

Enjoy the New Year and let us hope that come this time next year COVID-19 will be in our rear view mirror.  As always, know that you can call on any of us at First Long Island Investors to help with an asset allocation that allows you to sleep at night.

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

P.S.  We hope that you will join us on February 10^th at 11:00 a.m. EST for our market outlook web seminar.  You can register here. 

The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance.  Actual results may differ materially.  Past performance statistics may not be indicative of future results.  The views expressed are the views of Robert D. Rosenthal through the period ending January 13, 2022, and are subject to change at any time based on market and other conditions.  This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.  References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.  Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

All performance data presented throughout this communication is net of fees, expenses, and incentive allocation through or as of December 31, 2021, as the case may be, unless otherwise noted.

FLI believes the information contained herein to be reliable as of the date hereof, but does not warrant its accuracy or completeness.  This communication is subject to modification, change, or supplement without prior notice to you.  Some of the data presented in and relied upon in this document are based upon data and information provided by unaffiliated third-parties and is subject to change without notice.

NO ASSURANCE CAN BE MADE THAT PROFITS WILL BE ACHIEVED OR THAT SUBSTANTIAL LOSSES WILL NOT BE INCURRED.

Copyright © 2022 by First Long Island Investors, LLC.  All rights reserved.

First Long Island Investors is proud to share that Robert D. Rosenthal, our Chairman, CEO, and Chief Investment Officer will be inducted in the Hofstra Law Hall of Fame.  The Maurice A. Deane School of Law at Hofstra University has established the Hall of Fame to honor alumni whose exemplary careers, or extraordinary service to the betterment of society, or outstanding contributions to the Law School have significantly impacted the Hofstra Law community and beyond. The Hall of Fame inductees were nominated by their peers, and selected by a committee of Hofstra Law alumni, faculty and administrators.

Read full article on Hofstra Law website

September 30, 2021

  “Quiet people have the loudest minds.” – Stephen Hawking

After five consecutive quarters of robust performance for equities in general (domestic consistently outperformed international and growth stocks led most of the way), the third quarter ended with near flat performance (S&P 500 +0.6%) after giving up 4.7% in the month of September.  Additionally, value outperformed growth in September, but growth still outperformed for the third quarter.  September is typically a soft month for stocks (average decline of 0.5% over the past 70+ years), but this year’s decline reflected a lot of serious issues as well as some noise including a potential government shutdown, a very questionable exit strategy from Afghanistan, genuine concerns about growing national debt and inflation, and concerns about when the Federal Reserve will start to taper its asset buying program (known as quantitative easing).  Of course, the Delta variant, COVID infection rates, and mask and vaccine mandates brought into question the pace of our economic and emotional recoveries from this pandemic.

On top of all of the above, attempts by the Biden administration to pass two major spending bills, possibly aggregating almost $5 trillion, have been the daily headlines.  Progressives want more social engineering and steps to address climate change, while conservatives worry about debt, inflation, and higher taxes on both corporations and high-net-worth individuals.  As of this writing, these legislative initiatives (including traditional infrastructure with bipartisan support) have yet to be passed.  These matters seem to be held hostage by a group of progressive Democrats on the left and two centrist Democrat Senators who are adamantly against the passage of a $3.5 trillion social infrastructure package and who want to limit the spending to no more than $1.5 trillion.  (These appear to be gross numbers, not taking into consideration any potential offset of revenue generated by tax increases.)  Furthermore, several moderate Democrat Congresspeople have suggested they would not vote in favor of the larger bill unless it includes a repeal of the cap on the State and Local Tax deduction (SALT) which is vehemently opposed by progressives who think it is a gift to the rich.  The moderates believe the progressives are failing to realize the wealthy are fleeing high-tax states leaving state revenues somewhat depressed.

With all of the above consuming investors, it is time to be the “quiet people with the loudest minds.”  In other words, let us quietly dive into the fundamentals that should drive investment strategy instead of getting caught up in the loud noise surrounding various issues.  At our recent web seminar, we presented the following chart which shows GDP growth for recent years with projections for next year:

Certainly these actual and projected results indicate a relatively strong domestic economy rising from the government imposed recession due to the pandemic.  Consumers (both domestic and European) meanwhile have been hoarding cash since the beginning of the pandemic.  This suggests that domestic consumers remain in a very strong financial position and could increase spending when supply shortages abate and the Delta variant is brought under more control.  Certainly this could support the aforementioned GDP growth and possibly support financial markets as well.

In addition, the actual earnings growth for this same period also presents a positive picture:

These actual and projected results (note: projections do not incorporate the potential impact of a corporate tax increase) also reflect a strong showing from the S&P 500.  Strong GDP growth coupled with growing earnings should be supportive of a strong stock market and thus far it has been.  However, valuation has to be considered and in order to gauge the reasonableness of valuation it is our view one must look at current interest rates and where they might go.  This is because we have always believed that interest rates impact valuation of most financial and hard assets.  Accordingly, we offer the following to show just where rates have been and where the Fed projects they are going:

In our opinion, these low interest rates coupled with growing earnings supported by a robust economy are important reasons why stock prices as well as private equity deal volume and real estate values have risen.  Another factor supporting rising prices in financial assets is the huge liquidity that has been pumped into the U.S. economy:

Now we can add to the analysis of why we have enjoyed stock market appreciation this additional factor of so much liquidity looking for a home.   Additionally, given the Fed’s concern about getting back to full employment, its appetite to raise interest rates and commence tapering is tempered by a number of factors.  It does not want to strangle an economy rebounding from a pandemic, and it also may consider the impact of higher rates on servicing our national debt.  Every 100 basis point increase in the average cost of our debt would, by definition, increase our deficit by $283 billion a year!  This analysis comes from one of our outside economic consultants Strategas Research Partners, and is supported by the following chart:

Taking stock in all of these points: the growing economy, robust earnings, very low but somewhat rising interest rates, and abundant liquidity, what must we really worry about that could derail this seemingly strong environment for investors?

The first is inflation.  There is no question that supply constraints are at fault for some inflation, although the Federal Reserve believes that currently inflation is transitory.  Our research indicates that inflation will somewhat abate, but over time.  So, some inflation is here for the shorter term.  In addition, oil prices have risen over 50% this year and that is reflected in both gasoline and heating oil costs.  This too adds to short-term inflation and possibly longer term.  It remains to be seen whether the Fed is right and inflation is transitory.  If true the Fed should not have to raise interest rates in order to curtail inflation.  If inflation is longer term in nature there would be greater pressure on the Fed to taper and ultimately raise rates. The pace and magnitude of any such rate increases could affect pricing of financial assets.  The market’s current expectations were shown earlier in chart 4 on page 3.

Another factor weighing on investors is the current debate on spending in Washington, D.C.,  If the progressives get their way and new (not including the COVID relief programs which equaled nearly $7 trillion) spending programs of $3 trillion to $5 trillion are passed, this too could lead to even higher national debt, higher interest rates, and inflation.  The higher taxes that are proposed at both the corporate and individual levels could somewhat depress corporate earnings as well dampen consumer spending.   Of course, these are our opinions and I’m sure some would differ.  Centrist Democrat Senator Joe Manchin has called this potential spending “fiscal insanity.”

Where does this leave us as investors?

Growing GDP, higher forecasted corporate earnings, historically low interest rates, a strong consumer, and the current abatement of COVID infections are factors that would lead us to some optimism for the balance of the year and into 2022.  On the other hand, we must watch the rate of inflation, the ultimate outcome of the current spending and tax debates in Washington, D.C., and what preemptive actions the Fed takes, if any, if inflation proves not to be transitory.  Also, and not to be forgotten, is that equity markets do correct (declines of at least 10%) from time to time.  We have not had such a correction this year, although in September we experienced the first drawdown of approximately 5% from the recent market high.  In past years since 2009 the average number of 5% drawdowns has been approximately two per year, with only 2017 not having such a drawdown.  (That is not unprecedented, but it is unusual.)  For the record, the fourth quarter is typically a strong quarter for equity markets having risen on average 2.7% during the quarter when looking back historically to 1928.

Exercising caution and taking into consideration valuation of stocks and bond yields, we remain underweighted fixed income as a negative real yield (absolute yield minus the inflation rate) on an after-tax basis for treasuries as well as investment grade corporates and municipals is not something we can ignore.  Compounding a negative real return is a prescription for loss of purchasing power.  We do not see a recession in the near term thus we do not believe interest rates will decline.  Additionally, trying to reach for yield by buying longer-term bonds will cause mark-to-market losses if rates tick up.  We continue to suggest an overweight to our in-house defensive strategies which have performed well for many years and include both large-cap growth and value companies which in our opinion, provide opportunities regardless of how the economy performs based on what Washington, D.C. decides to do, if they can decide to do anything.  Each of our defensive strategies aim to protect on the downside, which should help if we encounter greater volatility.   We remain modestly underweight traditional equities given fairly robust valuations which somewhat corrected in September.   Please keep in mind that neither the traditional nor social infrastructure spending bills are an immediate positive catalyst to the economy.  Those funds, if approved, will be deployed over a number of years.

In summary, we remain committed to being fully invested with a modest cash buffer depending on each client’s personal financial situation.  Our strategies give both growth and value ample exposure (in both our defensive and traditional equity baskets) to reward long-term secular growth while also having exposure to some cyclical strength and dependable dividend streams.  Fine-tuning asset allocations can be done once we see where Washington, D.C. sorts out its current battles, how transitory inflation really is, and when we can anticipate the Fed starting to taper asset purchases and ultimately raising interest rates.  At this time we see the Fed beginning to taper later in the year or early in 2022 and completing that process sometime in the second half of 2022.  Based on recent statements by Fed Chair Powell (who is up for re-nomination in February of 2022), he does not expect rates to rise until after tapering has concluded.  Of course, everything is data-dependent.

These are certainly interesting times for investors given the confluence of a pandemic, excess liquidity, a growing economy, cash-strong consumers, rising inflation, and political battles not just between the Republicans and Democrats, but within the Democrat Party.  As our quote suggests, now is the time to be quiet, think, focus on fundamentals, and let our minds, not the noise, direct our long-term investing.

Enjoy the fall and upcoming holiday season.  Please do not hesitate to call or meet with us.

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

P.S. We will be putting out a piece on any significant tax changes if they occur from the current legislative debates and our view on any investment impact.

*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results. Partnership returns are estimated and are subject to change without notice. Performance information for Dividend Growth, FLI Core and AB Concentrated US Growth strategies represent the performance of their respective composites. FLI average performance figures are dollar weighted based on assets.  

The views expressed are the views of Robert D. Rosenthal through the period ending October 22, 2021, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.

References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

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