Weekly Market Commentary By H.E.R.O. (12 to 16 July 2021)

The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators rose 1.1% during the week while U.S. stocks registered their worst weekly performance in at least a month, with S&P 500 -1%, Nasdaq -1.9%, Russell -5.1%, ARKK Innovation ETF -7.2%, and cloud software ETFs tumbled -3.7% to -5.1%, as data showing a fall in consumer sentiment overshadowed an earlier report on a sharp rise in retail sales and optimism over Powell’s comments that tapering is still “ways off”, while corporate earnings reports remained mixed and accelerating inflation raises concern about the cost pressures on corporate earnings and the possibility of a sharper-than-expected economic slowdown, igniting 1970s-style stagflation fears. Treasury yields fell for a three consecutive week, while real yields tumbled to their lowest (most negative) since mid-Feb and junk bond yields tumbled below CPI for the first time in history. Meanwhile, the "Most Shorted" stocks tumbled almost 8% this week, the worst week (or best if you're short) since Oct 2020, while a basket of retail traders’ favorite meme stocks of 2021 showed fresh signs of investor fatigue as the group extended losses past 20%. A number of very famous hedge funds were reported to have registered double-digit losses for the year to date. With the highly contagious Delta coronavirus variant now the dominant strain in the U.S., Covid-19 cases are rising in nearly every state after falling in about half of them a week earlier.

Notably, there’s increasing divergences within the U.S. market, as indicated by fewer and fewer stocks participating in the headline-grabbing strength of the leading indices. One indicator of these divergences is that only about 10% of the S&P 500 index’s constituents outperformed the S&P 500 by 10% in the second quarter, down from more than 30% of constituents during the first three months of this year. Another indicator is the growing number of stocks hitting new lows. In the Russell 2000 index, on July 13 there were more new lows than new highs within that index for the second consecutive day, and what happened this week has happened only three other times — in September 2014, July 2015 and October 2018. In all three cases, three months later both the S&P 500 and Russell 2000 were at least 10% lower. Implied volatility in S&P 500 puts that look three months out reached the highest level since 2018 relative to similar call contracts as demand for downside risk hedges soared. The Fed’s rate-setting committee’s next meeting will be on July 27-28, followed by its annual Jackson Hole, Wyo., policy symposium a month later and another FOMC meeting three weeks after that. One of those will almost certainly serve as the forum for the unveiling of the Fed’s tapering timeline, which could begin in late 2021 or early 2022. There’s growing concern that the more the central bank waits to taper its US$120 billion of monthly bond purchases, the more likely it will be forced into slamming the policy brakes on at some point.

Across the Atlantic, DAX -0.9% and London’s FTSE 100 declined -1.6% in its biggest drop in four weeks. A 40% jump in coronavirus infections in England in the week to July 10 meant the UK economy would hit slowing growth momentum and all signs point to voluntary social distancing constraining demand over the coming months. The focus on bond-purchase tapering and interest-rate hikes will only become more salient in the months ahead. Meanwhile in Asia, Biden warned banks to reconsider their presence in Hong Kong because China is tightening its grip on the territory’s legal and financial systems, which could cause a major rethink of strategic plans. China also reported during the week that its economy expanded at a slower-than-expected 7.9% in the second quarter compared to a year earlier as small firms continue to struggle and credit impulse crashes.

As euphoric traders piled into the trendy Cyclicals, Value Traps, we believe that there is a high probability of downside risk in chasing and catching them at exactly the wrong time after their sharp run-up from being blinded by the fiscal stimulus hopes and vaccine euphoria — the light at the end of the tunnel — and things can turn very nasty suddenly, as markets tend to underestimate how long that tunnel is, and how dangerous that tunnel is. This situation is very vulnerable for cyclicals to degenerate or revert back into its true ugly colors as cheap-gets-cheaper Value Traps once the vaccine euphoria fades or something negative happen on the mass vaccination roll-out or the vaccine does not prevent people from carrying and spreading the virus to others or new mutated virus strains erupt to render the vaccines ineffective. Once the vaccines actually start being administered at scale and the pandemic recedes, a lot of investors are going to wake up to the fact that the global economy is still dogged by a host of thorny problems that both predate and have been exacerbated by the virus. The current unsustainable market euphoria over Cyclicals, Value Traps, Zombies (companies who cannot cover their interest expense with cash from operations) and Vampires (junk-rated corporations with negative EBITDA) has created opportunities for long-term investors in the inexorable rise of a selected group of fundamentals-based structural growth innovators. These winners solve high-value real-world problems to generate visible and vigorous quality earnings growth before and during the pandemic, as well as are poised to enjoy continued healthy demand and staying power in a post-pandemic future when the world recovers painfully and slowly to transition from the Pandemic Health Crisis to the next crisis – the PTSD Post-Pandemic Growth Crisis. Our portfolio companies have shown resilience and scalability during this tumultuous environment and the management continue to make key strategy decision to expand their market leadership in their respective fields. The quiet HE.R.O. innovators have invested wisely in innovations that sharpen their exponential competitive edge for long-term value creation, strengthened their market position in the value chain that supercharged their cashflow dynamics, developed new channels, new markets and new customer base for revenue growth while improving their profitability at a time when most businesses are struggling, and nurtured their human capital and corporate culture to foster innovation and ESG sustainability. While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.