One of the most important macroeconomic variables we’ve been tracking here at Titan is inflation. In this note, we'll outline how we think about it and how we're managing your portfolio around it.
As we discussed in our Q1 letter, early this year we had begun seeing signs of increasing inflation pressures due to supply bottlenecks in areas ranging from shipping costs to semiconductors.
Our view has been that the recent inflationary bump would prove more transitory than expected, as we believe massive secularly deflationary pressures (many of which stem from technological innovation) would on net outweigh the near-term supply shortage-driven boost in commodity good prices (e.g., staples, semis, commodities).
However, since then, we’ve seen data that suggests inflation is moving higher/faster than we expected. From consumer price index (CPI) data to commodities (i.e. copper, lumber, etc.), prices seem to be soaring everywhere.
While the jury is still out on whether these inflationary dynamics will prove transitory vs. structural (we remain in the transitory camp), we are proactively managing the portfolios in an attempt to mitigate risk in the event that these trends continue.
The recent market rotation away from tech / growth and towards more cyclical sectors that underperformed in 2020 (such as energy and financials) became much more apparent during Q1 as investors became focused on higher interest rate dynamics.
These increased inflationary concerns have impacted growth stocks particularly meaningfully as it translates into higher discount rates for long-term cash flows.
High-quality companies are not immune to this: we've seen multiple world class software/cloud names in our Opportunities strategy get hit by inflation fears.
Why? Because these types of companies tend to reinvest excess cash flow into internal growth opportunities, a meaningful portion of their cash flow – and hence their stock price valuation – is "long duration" and thus more sensitive to interest rate movements.
As a result, inflationary trends have weighed on recent performance of our strategies despite the broad-based strength in fundamentals seen in Q1 results.
First, our investment team is currently re-underwriting all three of our equity portfolios after Q1 results, analyzing how their long-term earnings trajectories have evolved (or not) following Q1 earnings.
Second, we're diving deep on fundamentals and technicals. We're decomposing the inflationary components of our stocks' P&Ls and factor exposures to understand the go-forward risks for our holdings amidst a potentially sustained inflationary market environment.
Finally, we are prioritizing speed and focus for your capital. We recently brought on two new investment analysts, John and Justin, who bring a wealth of secular and cyclical investing experience to the team. We're thrilled to have them join the team and expand our coverage universe and research capabilities - expect to hear more from them going forward.
Stepping back, we are working hard to position the strategies for what we believe to be some of the leading risk/reward prospects regardless of the direction of any macroeconomic shifts. Stay tuned for more updates from the team in the coming weeks.
At a high level, our global outlook remains positive.
First, widening vaccination efforts should promote lower COVID-19 infection rates after peaking in early Q1.
Second, healthy consumer balance sheets, bolstered by nearly $1.7 trillion in excess savings, should fuel robust consumption growth throughout the year along with a meaningful recovery in the services sector.
Further supporting this positive outlook, US policy makers proved successful in turbocharging the economy with the passing of the $1.9 trillion fiscal stimulus package in March, equal to ~8.5% of GDP.
From a timing perspective, this boost comes on the heels of the $900 billion stimulus already passed in December and amidst an accelerating domestic recovery already underway from expanding vaccination efforts.
As a result, we believe both the US and global economies remain well positioned to fire on all cylinders throughout 2021 and well into 2022. For context, US 2021 GDP growth estimates have been revised upward to +6.5% -- levels the country hasn’t seen in more than 20+ years.
That said, inflation is real and increased investor focus on that narrative is hitting growth stocks right now. The jury is still out on whether these inflationary dynamics will prove transitory or structural (we remain in the transitory camp), but we are working hard to make Titan portfolios anti-fragile in either scenario.
Look out for additional updates from us in the coming weeks. Meanwhile, we believe long-term investors would do well to add capital on this selloff. Speaking personally, I've been adding opportunistically to my Titan account on the recent weakness.
Clay Gardner Chief Investment Officer
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