Talking, Tapering, Tightening

Market Recap

Intermediate and long-term inflation expectations cooled this quarter as supply/demand imbalances corrected across a few material sectors such as corn, soybeans, copper, platinum, and lumber. Additionally, the U.S. Central Bank slightly altered its monetary stance from “not talking about even talking about tapering or tightening, to talking about tapering or tightening.” This nuance in policy change plus the reduction in overall longer-term inflation expectations has pushed 10-year U.S. Treasury yields lower to 1.30% in early July from 1.75% in March and has shifted equity market style focus to growth from value. From March 31st to June 30th, large-cap growth has outperformed large-cap value and small-caps by approximately 6.73% and 7.64%, respectively.

Transitory or Permanent?

Inflation within commodity markets appears to be ROLLING. As Ed Yardeni states, “the best cure for rising commodity prices is rising commodity prices.” Or to say it another way, supply/demand imbalances in commodity markets self-correct over time. Just as oil has reached a 4-year high in early July, Energy stock prices have begun to decline, validating the economic principles noted above. Another is example is lumber. High lumber prices forced home builders to lift home prices, which has reduced affordability which, in turn, has temporarily reduced demand. Other commodity markets should function similarly.

While the short-term nature of commodity boom and bust cycles depict TRANSITORY inflation, over 50% of inflation is highly correlated to unit labor costs. Prior to the pandemic in January 2020 as unemployment dipped to 3.5%, wage inflation climbed to 3.0%. Post pandemic, as the labor supply/demand mismatch accentuates especially among lower wage workers, average hourly earnings in that group, who currently account for 81% of payroll employment, rose 9.3% over the 24-month period through May. Although some of the demographic constraints will be relieved as more states stop paying Supplemental Pandemic Unemployment Benefits and parents return to the workplace when in-person school begins, constraints in the lower wage group existed prior to COVID. This source of inflation is likely PERMANENT and potentially presents a large obstacle to continued expansionary Fed policy from this point forward.

Second Quarter Performance Highlights

  • The Navigator® International Equity/ADR strategy delivered annualized gains of 12.73% gross (9.42% net) vs. the gains of 9.38% for the MSCI All Country World ex-USA Index over three years ending June 30, 2021. For the second quarter of 2021, the strategy had a gain of 5.87% gross (5.07% net) versus the 5.48% gain in the MSCI All Country World ex-USA Index.
  • Our positioning in Industrials and Consumer Staples helped relative performance while positioning in Consumer Discretionary and Materials acted as a drag. Our holdings in TFI International and Deutsche Post helped performance in the quarter as positions in Vipshop Holdings and Komatsu hurt performance. From a country perspective, the portfolio benefited from strong performance in our positions in United Kingdom and Ireland while performance in China and Switzerland lagged.

Positioning and Outlook

Just as the best cure for rising commodity prices is rising commodity prices, the best cure for rising value stock prices is value outperformance. From September 2020 thru May 2021, large-cap value outperformed large-cap growth by 21% and had gained 94% since the COVID March 23, 2020 low. Similarly, the S&P Small Cap 600 Index’s 134% gains pushed its price-to-value ratio to 110% or two standard deviations higher than its 10-year average. Additionally, as Q2 earnings growth across market capitalization segments likely represents the peak in year-over-year growth, it makes sense that value and small-cap stocks pause to allow earnings catch up. Prior gains likely reflected both undervaluation and an anticipation of large future earnings gains due to the back-to-work recovery.

Given mixed market conditions, which include a strong labor market and economy for the foreseeable future, some permanent inflation above 2%, an accommodative Fed leaning hawkish, and relatively high equity prices, we think DIVERSIFICATION and balance between growth and value, large-caps and SMID caps remain our wisest choice. Early on in COVID, our focus was on “survive and thrive”, then portfolios transitioned to “high quality, cyclical winners.” Now as the bull market reaches its later stages and many cyclicals have reached “full value,” we need to redouble our focus on core undervalued, high quality companies with improving business momentum that are capable of compounding growth regardless of economic outcome.

International Equity/ADR Top Contributors as of June 30, 2021

Company Name Average Weight (%) Contribution to Return (%)
TFI International Inc. 2.60 0.55
Deutsche Post AG Sponsored ADR 2.37 0.54
Ajinomoto Co. Inc. Unsponsored ADR 1.90 0.46

International Equity/ADR Top Detractors as of June 30, 2021

Company Name Average Weight (%) Contribution to Return (%)
Vipshop Holdings Ltd Sponsored ADR 1.21 -0.51
Komatsu Ltd. Sponsored ADR 0.53 -0.35
Volkswagen AG Unsponsored ADR Pfd 1.27 -0.19

The views expressed are those of the author(s) and do not necessarily reflect the views of Clark Capital Management Group. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Clark Capital investments portfolio. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. For educational use only. This information is not intended to serve as investment advice. This material is not intended to be relied upon as a forecast or research. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Past performance does not guarantee future results.
This document may contain certain information that constitutes forward-looking statements which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology (or the negative thereof). Forward looking statements cannot be guaranteed. No assurance, representation, or warranty is made by any person that any of Clark Capital’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards and political and economic risks. These risks are enhanced in emerging market countries
The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.
The S&P SmallCap 600® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.
The MSCI All Country World is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.
The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 26 Emerging Markets (EM) countries*. With 2,206 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.
The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.
Index returns include the reinvestment of income and dividends. The returns for these unmanaged indexes do not include any transaction costs, management fees or other costs. It is not possible to make an investment directly in any index.
The Russell Large Cap Value Index is a subset of the broader Russell 1000 Index that seeks investment results (before fees and expenses) that correspond to the total return (which includes capital appreciation and income) of the Russell Top 200® Value Index.
Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request. CCM-508