Q3 Portfolio Management

Earnings yield on stocks is significantly higher than 10-Years Treasury yield implying stocks are
more attractive investment than bonds. The outlook for earnings is still extremely positive even
though earnings acceleration peaked in 2Q. Valuations are at higher end of range, however, low
yields, strong earnings growth overrule higher valuations. Yields have risen and credit spreads
have fallen sharply over the past year, a favorable backdrop for risk asset.

The path of inflation and economic growth should determine market leadership in the second.
half. If inflation fears abate then bond yields remain lower for longer, expect growth and
technology stocks to outperform. However, should economic growth remain strong, above trend.
line, then bond yields move higher and cyclical stock sectors (value stocks), and smaller cap.
stocks would outperform. Historically, stocks respond positively to modest rise in inflation.

I still think there will be enough economic momentum that growth is going to stay strong,
perhaps a plateau in next year, which means invests where earnings growth is more
cyclical and balance equity exposure with FAANG/TECH stocks to hedge against any
soft patches in global growth. I see the Technology, Consumer Discretionary, Energy, and
Financials sectors benefitting most from present mix of cyclical and structural growth trends. I
expect the upward trend for these inflation trades to resume as earnings growth outpaces the broader market. Whereas the Tech sector earnings growth, revenue growth should continue to rise faster than the broader market.

The global economy is still re-opening! I have exposure to Energy as an inflation hedge, for dividends, and growth. The energy sector is in its best condition in years. Companies have been disciplined capital allocators and are benefiting from higher oil prices. Most projections are for oil demand to climb by 7% on average through 2030.

Financials are an interest rate hedge in portfolios. The prospects of a re-steepening yield curve and higher loan growth in the second half is enough to hold onto Financials. Furthermore, banks are free to buy back stock and increase dividend payouts after passing latest stress test.

Dividend paying stocks are also particularly good inflation hedges—as stocks are real assets, unlike bonds. Companies can pass along the cost pressures they face in price increases for their goods— dividends and earnings kept up with inflation in the high inflation environments of the 1970’s and ‘80s. I have been buying dividend stocks in the Tech, Energy, and Financial sectors.

I reduced my exposure to commodities, material stocks, and gold as inflation has peaked. I continue to hold some positions as inflation hedges.

I am underweight Foreign and Emerging market equities. Ex-U.S. the rest of the world is struggling.
with re-opening economies. I prefer U.S. Equities because U.S. dollar may have bottomed.

I am underweight credit based on rich valuations and prefer to take risk in equities. Credit,
especially non-investment grade, does not compensate investors for credit risk. Credit spreads
are as narrow as they can be.

I am holding off on buying Investment grade bonds as their yields do not compensate for
duration risk. COVID cases declining and pandemic coming under control means yields should
rise and Fed stops bond purchases this Fall.

I do not own Treasuries except for TIPs (Treasury Inflation Protected Bonds). Treasuries are
producing negative real returns. Treasury and mortgage Bonds are mispriced – overvalued
because of Fed emergency bond buying program. Ten Years Treasury yield could rise to 1.95%
level over the next 12 months. Moderate inflation pressure that subsides late 2022 would limit its
rise in yields. I prefer inflation-linked bonds (TIPs) as I see risks of higher inflation ahead. TIP
break even yields are 2.2%. I think inflation will be greater than 2.2% next year.

I am overweight in short term bonds that hold their value better than long term bonds as yields rise. The short-term bonds I own also are floating rate bonds that adjust coupon rate as rates rise.