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This Week’s Update

We have defended the market for years, forecasting higher operating margins, profits, cash flow, and higher earnings yields than bond yields. The debate continues as we remain in a choppy market due to the coronavirus, shortages, and higher rates as the fed fights inflation. Even the bears see lower inflation, federal funds rate within a year, and a better market. While the averages are down 15 to 25%, we are not. We are up for the year by sticking to our disciplines. We are analysts of the global economy, including geopolitical issues and company specifics. There is a reason investors look up to Warren Buffett. He sticks to the disciplines outlined in his annual reports. He invests rather than trades. He understands if you sell a stock, capital gains taxes are paid if there is a gain, and you have to buy at least 20% lower just to be even. Compounding is a powerful tool, as is minimizing losses. We are more the turtle than hare emphasizing quality, outstanding management, and owning undervalued companies as investors recognizing corrections along the way. Still, we win in the end, sticking to our disciplines, like this year. We are up for the year versus the markets being down 15 to 25%.

Why? We buy quality selling at reasonable values to earnings, cash flow, and discounted cash flow. Yes, there are difficult periods, but you need conviction to hold the course unless, of course, fundamentals dictate otherwise. Yes, the fed raised rates, but if the valuation is off of 10-year yields, including a risk factor, the market remains favorable over a 1 to 3-year basis.

Companies are all improving profitability over that span. Even Google, a great company, is now looking to improve productivity by 20%.

Technology and better business practices are part of our belief in higher operating margins. Of course, not all companies will succeed, nor is every good company undervalued. Here’s where our strengths come in. We have proven over 50 years to lose less in bear markets but make the same or more in better times, giving us outperformance. The market has corrections, but over the last ten years, it’s earned 10% a year, which if you compound it is over a 100% return for investors.

This Weeks Financial Update

We are undoubtedly in the midst of an economic slowdown as monetary authorities have declared war on inflation. While the markets continue under pressure as short rates and the dollar rise, it is time to take a longer view. Lessons learned during the pandemic will favorably impact operating margins, productivity, earnings, and cash flow for years to come.

Technology, as does healthcare, remains the key to a better future. We are still in the early innings of the technological revolution with huge benefits on the come as the world normalizes. Yes, we have gotten our arms around the coronavirus but don’t expect it to go away, much like the flu, which still kills many thousands a year. The WHO estimates that 300,000 - 650,000 people die annually from the flu. As we control the virus, an improved vaccine will also occur annually.

We are still living in a volatile world with political, geopolitical, economic, and natural disaster risks, to name a few, so remain an investor or risk getting whipsawed, as we have seen repeatedly over 45+ years. We invest like Buffett.

Many long-term macros and micro investment opportunities remain, from technology to healthcare to consumer, defense, and industrials/commodities. You only want to invest where the wind is toward your back, such as government support, and valuation is attractive relative to alternative investments like bonds (earnings yield vs. bond yield) and stays diversified.

Management is key to our decision-making process. As you know, we only invest in best-in-class if their valuation is attractive. Always remember to Include buybacks when valuing total shareholder return. Naturally, we may invest in special situations throughout year as opportunities present themselves.

We continue to believe that the Fed will raise rates throughout the year, no surprise, pausing around the election to review the full impact of their actions and to get out of the way to show no bias. Earnings will likely improve over the next two years, but the discount factor remains the key to valuation. We find the market attractive for investors with short rates around 3.5%, long rates around 3.3%, and the market multiple around 16 times projected earnings. We will add during the correction after reducing risk and expecting a better late fall through 2023. The yield curve with flatten as short rates declines over the winter along with inflation.

We aim to sustain our 45+ year outperformance compared to our peers and, frankly, the markets. As you may know, our strengths are hands-on daily research and understanding the interaction among all the constantly changing variables.

Enjoy the holiday weekend.

Bill Ehrman

[email protected]

Storm Clouds Lifting

Markets hate uncertainty, so when the unanswered questions get resolved, the markets react positively. Despite all the uncertainty surrounding the coronavirus, monetary and fiscal policies, shortages, and supply line bottlenecks, markets have risen for six straight weeks! And we are on the precipice of entering the strong season for the market to boot. This past earnings season has been nothing short of phenomenal, with over 85% of the companies reporting beating their estimates despite all the headwinds.

Elections this past week went even better than we anticipated, with the Republicans a clear winner and Biden, his policies, leadership, and the progressive Dems, the losers. Polls say it all. Most Americans feel that we are going in the wrong direction. We must agree. Whatever happened to energy independence? We still expect that the $1 trillion traditional infrastructure bill will be passed. A watered-down $1.75 trillion social infrastructure bill will eventually make it over the goal line without punitive taxes on individuals and corporations.

We applaud the Fed and Powell, who threaded the needle last week by starting to taper and separating that decision from raising rates. Powell was masterful when responding to the media.

Higher inflation is being caused primarily by shortages and supply line bottlenecks which Federal policy cannot affect. Higher rates, which generally are used to slow the economy and reduce inflationary pressures, are not the answer, and the Fed gets it. Patience is needed. We continue to believe that inflationary pressures will move lower as these problems ease next year. We also expect the labor participation rate to increase over time as we put the virus further in the rearview mirror, which will ease labor wage pressures which is being offset by higher productivity due to a surge in technology spending. We see inflation easing but staying elevated throughout 2022 and normalizing around 2+% later in 2023.

We have entered the strong season for the market. The markets will continue to move higher over the next year, supported by accommodative fiscal and monetary policies here and abroad. Shortages and supply line bottlenecks will improve, boosting production while reducing inflationary pressures. We expect continued good news on the coronavirus as we vaccinate the unvaccinated. And Pfizer’s news yesterday that it had a pill that reduced the risk of hospitalizations and deaths by around 89% was a real game changer.

We forecast that S&P earnings will reach $230+/share in 2022, up from $210/share in 2021 and $163/share in 2019. Operating margins could exceed 13.3% in 2022, up from 11.5% in 2019. The yield curve will continue to steepen, with the 10-year treasury breaching 2% next year.

The bottom line is that we see at least a 10% upside in the market over the next year. Dividend hikes and buybacks will increase meaningfully, supporting markets. We favor the production side of the economy who will benefit most from pent-up demand, easing shortages and supply line bottlenecks; technology; financials, industrial commodities including energy; and several unique situations.

While the news on the coronavirus gets better by the week, we will continue to discuss it until the end of the winter session as the risk of outbreak remains as we move indoors. The number of cases and death continue to decline domestically and globally on a two-week basis: U.S cases and deaths are down 6% and 18%, respectively, and 13% and 15% globally. More than 3.93 billion people worldwide have received at least one dose of a covid vaccine, equal to approximately 51.2% of the world population. Vaccinations by region are: 68% in the U.S.; 63% in Latin America; 60% in Europe; 59% in Asia; 43% in the Middle East; and only 8.7% of all Africans have been vaccinated. Specifically, more than 7.12 billion doses have been administered across 184 countries at a daily rate of 31.6 million. Four hundred twenty-four million doses have been given at an average rate now up to 1.33 million doses per day. While we are making significant progress vaccinating the unvaccinated, it still takes almost six months before we are all vaccinated. Fortunately, Pfizer, Moderna, J&J, and others will have sufficient supplies to vaccinate the world, including booster shots next year if needed. Last week, the CDC gave final approval for Pfizer’s covid shot at a reduced dosage for kids 5-11. And the best news of the week was the announcement yesterday that Pfizer has developed a pill that reduces hospitalizations and deaths by 89%. Wow! Let’s hope everyone remains diligent over the winter so that we can put this totally behind us.

The Fed meeting did not disappoint. Powell and the Fed communicated the end of tapering so well that the markets rallied. We agree with the Fed that, for the most part, inflationary pressures are transitory and will ease as the labor participation rate rises, shortages end and supply chain bottlenecks abate. Powell was challenged whether the Fed was behind the curve at the follow-up new conference call and should begin hiking rates even sooner than the dot plots indicate. Tapering will begin this month, reducing Fed buying by $15 billion per month ending in 8 months with no significant economic changes. That means that the Fed will be buying at least another $500 billion in bonds over the next nine months, which is anything but tightening. In addition, we still expect the Fed to hold off hiking rates until the end of 2022 or the beginning of 2023. Here again, the real Federal Funds rate will be negative, which again is anything but restrictive. The bottom line is that the Fed will remain our friend for a long time, favorable for owning risk assets. We certainly hope that Powell is renominated for Fed head as he is a great leader.

What an election this past Tuesday! The Republican candidates did even better than we expected. While the Dem progressives may not back down from their far-left agenda, the moderate Democrats’ hands were strengthened, limiting the far-left agenda from ultimately passing in the House and Senate. Biden and his administration may still sound confident regarding their agenda, but we expect them to make sufficient adjustments to appease the moderates at the expense of the progressives. We finally expect the House to decouple the traditional infrastructure bill from the social infrastructure bill and pass it soon, giving Biden a much-needed victory. The social infrastructure bill is in trouble and may not come to the floor of the Senate this year. If it does, we expect it to be around $1.7 trillion without many changes in the corporate tax rate except a 15% minimum tax for the largest companies. The markets have grown so impatient that Congress will get anything done that passage of the traditional infrastructure bill will be a welcome relief. It will boost the stocks of the beneficiaries. We are there!

The U.S economy reaccelerated after slowing over the summer due to the outbreak of the Delta variant. Specifically, the consumer confidence index increased to 113.8 in October from 109.8 in September, the present situation index rose to 147.4, and future expectations increased to 91.3; ADP job openings increased to 571,000 in October with a significant boost in hospitality, and jobless claims fell to a new low at 269,000. The October employment report was strong with a 531,000 increase in nonfarm payrolls, a 4.6% unemployment rate, 4.9% and an increase in average hourly earnings year over year. The average workweek fell slightly, and the participation remained weak at 61.6%. On the other hand, shortages and supply line bottlenecks have hindered manufacturing growth as the ISM gauge of factory activity fell to 60.8 from 61.1 in September, the new orders index fell to 59.8, the production index was 59.3, the backlog index was 63.6, and the inventory index fell to 57. Companies reported dealing with unprecedented shortages of critical materials, rising commodity prices, and difficulties in transporting products. Notwithstanding, companies are very optimistic about future growth as new orders are growing, exports are improving, customer inventories are at record lows, and consumption is increasing. Since shortages and supply line bottlenecks hamper production, it is not surprising that productivity is declining, 5% in the third quarter, and unit labor costs rose 8.3%. We expect these numbers to turn around significantly as these short-term problems diminish next year.

Growth has reaccelerated overseas, too, except in China, as opening have increased. The number of coronavirus cases/deaths is steadily declining overseas. Monetary and fiscal policies are accommodative everywhere too. ECB’s Lagarde went out of her way last week to cool expectations that there will be rate hikes next year, and the BOE surprised markets Thursday, voting not to change its accommodative stance. China’s Premier Li commented last week that their economy is facing downward pressures, and the government is preparing “cross-cyclical adjustments” to continue to grow in line with projections. China’s PBOC has accelerated cash injections into its financial system. We expect both additional fiscal and monetary accommodation by early 2022 to boost/support China’s economy.

Even though global growth is accelerating, it won’t reach its full potential until shortages end and supply line bottlenecks ease. Inflationary pressures will remain elevated immediately ahead, but fortunately, all monetary bodies realize that their policies will not cure these problems.

The storm clouds are lifting such that global growth will be strengthened as we move through 2022 into 2023. The problems will abate as pent-up demand is met and inventory levels are restored to normal. Inflationary pressures will subside too. Not bad!

Investment Conclusions

Financial markets continue to rise on a wall of worry, fooling the skeptics. Markets are driven by liquidity, and we have not altered our long-standing view that the supply of capital will continue to exceed uses, benefitting risk assets. We do not see this changing until shortages end and supply line bottlenecks ease. Inflationary pressures will stay elevated during the period immediately ahead, but a successful investor looks over the valley on the other side. Management must be congratulated for successfully navigating the pandemic and all problems around it. Third-quarter results were nothing short of phenomenal, with 85% beating forecasts. All of this portends great results ahead when these problems abate.

It was an important week as questions/answers regarding fiscal and monetary policies became more evident. The election sent a shot across the bow to Congress that it was time to act, and they better not move too far to the left. Fed policy became in focus, too, as tapering was announced with rate hikes well into the future. Both fiscal and monetary policies will remain accommodative well into 2023.

We see the storm clouds lifting as we move through 2022. Next year, market leadership will shift from those companies who benefitted from today’s problems to those who will help when these problems subside. The only sector that benefits regardless of the environment is technology, as we have entered a period ahead of accelerated tech spending as the world digitizes. We favor the producers who will benefit from pent-up demand, inventory building, and higher margins; financials as the yield curve steepens and loan demand finally grows; industrial commodities, including energy as demand, will outstrip supply; and several special situations.

Each week our belief that an investor must be patient gets reinforced.

Importance of Leadership

The most crucial analysis we make, as investors, is assessing an organization's leadership team, understanding their objectives and strategy so that we can measure their ability to deliver results against them.

We are living through unparalleled times, and that calls for a higher caliber of leadership. We need leaders who can create focused attention on shared objectives. The efficacy of the leadership team determines results. They can make or break an organization, regardless of industry. The proof is extensive. Look at what new, competent management did for Google, Microsoft, AMD, UPS and Ford, to name a few.

The financial markets continue to rise on a wall of worry, with market leadership changing along the way. It is a complex environment. We all recognize that the key to future growth is getting our arms around the virus, increasing capacity in critical areas to end shortages, and resolving supply line bottlenecks. Liquidity trends remain extremely favorable, with many trillions in the system along with continued accommodative fiscal and monetary policies everywhere in the world. We recognize that corrections can occur anytime, but we are far from a market top which happens only well after liquidity trends turn negative, which won't begin until the end of 2022 when inventories can finally be rebuilt, loan demand increases, and the demand for funds exceeds supply.

Corporate America has done a great job navigating through the pandemic, shortages, and supply line bottlenecks. Third-quarter reports have been outstanding, with over 85% exceedingly forecasts! Our long-term thesis of higher operating margins despite all the headwinds is proving true. We continue to forecast S&P earnings reaching over $210/share in 2021 with an operating margin of 13.1% vs. $163/share in 2019, pre-pandemic, and an operating margin of 11.5%. We see further gains in earnings and margins ahead, reaching $240/ share and 13.8%, respectively, in 2023. Not too bad.

We also have not altered our view that the Fed will begin tapering before year-end, finish tapering by the end of summer 2022, and finally increase the Federal Funds' rate early in 2023. Again, tapering is NOT tightening, and the "real' funds rate will not be negative for years, which is not restrictive. Nevertheless, we expect the curve to continue to steepen as the economy improves and inflation stays elevated as long as shortages and supply line bottlenecks exist, at least until the summer of 2022. We expect the ECB and BOJ to remain overly accommodative well into 2023 too. Finally, we expect the PBOC to ease further too to stimulate China's economy.

Negotiations in Washington on the social infrastructure bill have been a joke. Each day a new trial balloon goes up as to what may be included in the bill, which now appears to be around $1.75 trillion funded with tax surcharges on multi-millionaires and billionaires and a corporate minimum tax of 15% and a 1% tax on buybacks. Most of Trump's tax cuts which Biden targeted, will not be touched. We expect a deal to be reached soon on the social infrastructure bill, which will permit passage of the $1 trillion infrastructure bill shortly and be on Biden's desk in weeks. It is interesting to note that investors have given up on our government passing anything, so if this does come to fruition as we expect, those sectors that benefit will lift. We are there.

Progress continues to be made with the Delta variant. The number of cases and deaths is falling domestically and worldwide on a 14-day trailing basis. More than 6.91 billion doses have been administered worldwide across 184 countries at a rate of 27.7 million per day. Four hundred fifteen million doses have been given at an average current rate of 822,893 doses per day. Enough doses have now been administered such that 45% of the global population has been vaccinated. It will take another three months to fully vaccinate the U.S population and six months to vaccinate 75% of the world population at current rates. Fortunately, we expect sufficient doses to be available next to vaccinate everyone, including children and a third booster shot. We continue to expect a combination vaccine will become available in 2022 to protect against the coronavirus and flu. All good news!

We expect the Fed will announce next week at its monthly meeting that tapering at $15 billion per month will begin in December and end by the summer of 2022 data-dependent. Chairman Powell will reiterate that tapering is not tightening, and potential rate hikes are an independent decision. We still do NOT see the first federal funds rate hike until 2023, and when it occurs, it will not be restrictive as the "real" rate will remain negative. Powell will discuss at the conference call that inflation is likely to run hot longer than initially envisioned as it will take more time for shortages and supply line bottleneck problems to lessen. Still, he remains confident that inflation will fall back later in 2022 into 2023. It is worthwhile to note that Microsoft CEO Nadella commented on their earnings conference call last week that "digital technology is a deflationary force in an inflationary economy. Business-small and large- can improve productivity and the affordability of their products and services by building tech intensity." He concluded that Microsoft helps companies manage inflation while boosting productivity and reducing waste. Our government should show more support for our great tech companies as they continue to innovate, improving our lives every day. We support Powell's reappointment as Chairman of the Federal Reserve as we have confidence in his leadership.

It appears that the framework for a $1.75 trillion social infrastructure deal is close? The plan includes a one-year extension of the expanded child tax credit through 2022 plus a provision making the break permanently available to low-income families that don't pay income taxes; it funds six years of universal prekindergarten; six years of child care subsidies; $150 billion to support long-term healthcare for elderly and disabled Americans; $555 billion for climate-related provisions including $320 billion in 10-year expanded tax credits for utility-scale and residential renewable energy, transmission, electric vehicles and clean energy manufacturing. It will be paid for by introducing a 15% minimum corporate tax($325 billion); a 1% surcharge tax on stock buybacks($125 billion); a 15% country by country global minimum tax($350 billion); a millionaires surtax on incomes above $10 and $25 million($230 billion); expanded Medicare tax on the wealthy(($250 billion); a provision to limit excess business losses for partnerships, limited liability companies and pass-through entities($170 billion); IRS stricter enforcement($400 billion); and prescription drug savings($145 billion). Once there is general acceptance by all factions of the Democratic Party, the House will vote on the $1 trillion-dollar traditional infrastructure bill soon thereafter and have it ready for Biden to sign when he returns from the G-20 meeting abroad next week. This process has been a travesty and shows a total lack of leadership from Biden and his administration. The Virginia election next week should be very interesting.

Economic growth slowed during the summer as we combatted the outbreak of the Delta variant. Domestic GDP expanded at a 2% annualized rate in the third quarter, following a 6.7% advance in the second quarter. Personal consumption grew at just a 1.6% pace after a rapid 12% jump previously. Shortages, supply bottlenecks, higher prices, and the Delta variant all contributed to the weakness. Shortfalls were evident in residential fixed investment, federal government spending, and exports. The PCE price index increased 5.3% in the third quarter and 4.5%, excluding food and energy prices down from the prior quarter. Personal savings remains elevated at $1.6 trillion, which translates into an 8.9 percent savings rate well above historical levels. Recent data has been encouraging as we put the Delta variant in the rearview mirror: jobless claims keep falling and are down to 281,000 last week; consumer confidence rose to 113.8 in October from 109.8 previous months while short term inflation concerns rose to a 13 year high; and holiday sales are projected at a record $800 billion, up 10% from a year ago.

On the other hand, weakness continues in durable goods manufacturing due to shortages and supply line bottlenecks. New orders declined 1.3% in September and 2% excluding defense. We are closely monitoring higher energy prices as it could hurt consumer spending over the winter as heating bills and gasoline at the pump are likely to increase significantly.

Economic growth abroad has been lowered for 2021 from earlier forecasts due to the outbreak of the Delta variant over the summer, shortages, and supply line bottlenecks, including energy. We expect all of this will diminish as we move through 2022, which is why we remain optimistic about growth trends in 2022 into 2023. The BOJ and ECB announced last week that policy will remain highly accommodative well into 2023. We expect the PBOC to continue easing policy by injecting money into the system and lowering the repo rate over the winter to support China's economy. We were pleased to see Evergrande resume work on many of its projects last week too.

Investment Conclusions

Third-quarter earnings reports have been sensational, with over 85% exceeding expectations despite the surge in coronavirus cases over the summer along with shortages and supply line bottlenecks. Management has done a great job overcoming so many issues. Some we have never seen at these levels. For instance, one CEO commented that over 95 force majeures occurred during the quarter, meaning that he could not get sufficient supplies to build his products, but he still beat forecasts. That is just one example of what we heard during recent earnings calls. Can you imagine what this company will make when these issues abate? That is one of the reasons why we remain optimistic about 2022.

It all comes down to leadership and management. It is important to note that demand is not the problem. It is super strong. As these problems ease, we see a significant improvement in production until inventories are normalized, which will take until the end of 2022 at the earliest. We also expect operating margins, earnings, and cash flow to increase further as costs normalize. At the same time, monetary and fiscal policies here and abroad will remain accommodative. Inflationary pressures should ease, too as we move through 2022 into 2023. This is an excellent recipe for higher stock prices. But not all stocks are alike.

We continue to favor the production side of the economy as we strong demand and improve operating margins, earnings, and cash flow over the next few years, benefitting from overall solid capital spending and government-promoted infrastructure programs virtually everywhere. Technology will remain a core holding as the future has never been better as we have indeed entered the digital age. Financial and energy are strategic parts of our portfolios as we expect the yield curve to continue to steepen and energy prices to remain elevated as demand exceeds supply as production stays limited. Finally, we have several special situations which sell well beneath intrinsic value.

Our overriding theme is to bet on management as their leadership can make it or break it.

The Inflation Conumdrum

The big question facing financial markets is whether inflationary pressures are transitory or not. We really will not know the answer until shortages end, supply issues/bottlenecks abate, and inventory levels normalize. Will markets and the Fed have enough patience to wait until we get to the other side or react well before we get there? That is the 64-thousand-dollar question, and we do not have the answer, so we own companies with pricing power, great long-term fundamentals, and selling below intrinsic value.

While we are putting the virus behind us, global economic activity is being held back by shortages and supply line issues/bottlenecks. As long as demand outstrips supply, prices are going up, Eco 1. Higher food and energy prices are also contributing to inflation. It is almost the perfect storm.

But better days are ahead for the patient investor. We expect these problems to all abate as we move through 2022, which will lead to increased production, improved operating margins, higher profitability, and lower inflation. This period will go down as ‘the pause refreshes.’ Those industries that suffered through this period and have market dominance will become more robust and profitable than ever. On the other hand, those companies that benefitted from this period, like the retailers, will lag as promotional activity returns. Technology will continue to flourish as we are in a sustained period of increased spending to improve productivity while substituting for the inability to fill positions.

It is hard to keep this market down as it continues to climb a wall of worry bolstered by trillions of excess liquidity in the financial system and supported by accommodative monetary and fiscal policies. We do not expect a market top until the demand for funds exceeds the supply, which won’t even begin to happen until inventories can be rebuilt. We anticipate this starting by the second half of 2022 at the earliest. Inflationary pressures will subside at that point.

The key to the sustainability of the global economic expansion remains to get our arms around the coronavirus. The news gets better by the week as the 14-day moving average of cases and deaths is declining at an accelerating rate. Domestic issues have fallen by 25% and deaths by 15%, while global cases and deaths have declined by 22% and 17%, respectively. More than 6.73 billion doses have been administered worldwide at a rate of 26.8 million doses per day. In the U.S., 409 million doses have been administered at an average rate of 815,541 per day. The key remains vaccinating the unvaccinated, and here too, the news is getting better as the FDA and CDC are now approving shots for children and booster shots for all over 40 years of age. In addition, we are just learning that mix-and-matching work, too. All three producers are now approved. Moderna, Pfizer, and J&J. Openings will continue to accelerate as people return to work which portends for better days ahead as we enter 2022.

How much patience will the Fed and the financial markets have as inflation will run hot, well above trend, for at least another 6 to 9 months as long as shortages and supply chain bottlenecks issues exist. However, as these pressures ease as we move through next year, we would expect inflationary pressures to subside sequentially, which is how, after all, inflation data is reported. We do not see inflation returning to 2+% until sometime in 2023. Notwithstanding, our economy no longer needs extraordinary monetary support, so we expect the Fed to announce tapering shortly and end by the middle of next year. Again, tapering is NOT tightening.

On the other hand, the Fed’s second mandate, the unemployment rate, will be reached by year-end for the wrong reason-people are leaving the labor force. We are disturbed that Janet Yellen, Treasury Secretary, failed to mention this when commenting that the country will reach full employment next year. The Beige Book came out last week and commented that the economy expanded at a “modest to moderate rate,” citing supply constraints and concerns over the Delta variant. Price increases were driven by supply shortages, transportation bottlenecks, and labor constraints. Inflation is running above target while hiring is below forecasts—hence, the conundrum. The Board is evenly split whether rate increases should begin by the end of 2022 or sometime in 2023. The bottom line is that supply line bottlenecks causing elevated inflation will last well into 2022 before moderating which remains our base case. Interestingly, the Fed staff of 400 Ph.D. economists predict inflation falling back to 2% by the end of 2022. Not!

The Biden administration and the Democratic Party are under tremendous pressure to produce as their poll numbers continue to decline, reflecting especially that Independents no longer have confidence in their ability to govern and improve their standard of living. We have a crucial election in a few weeks, and the Dems need to pass the traditional infrastructure bill now to gain momentum at the polls. It appears that the $3.5 trillion social infrastructure bill has been reduced to less than $1.75 trillion and that corporate/individual tax rates won’t budge much, if at all. We must applaud the efforts of Senators’ Manchin and Sinema. They remain steadfast against enormous social spending paid for with a tax structure that would hurt our global competitive position and ability to invest in America. We expect the Democrats to reach a deal on the social infrastructure bill of around $1.7 trillion before the election such that the traditional infrastructure bill will hit President Biden’s desk in a few weeks.

Despite the well-acknowledged economic headwinds, we remain optimistic that our economy will pick up steam as we move through the winter into 2022 as we put the pandemic behind us. However, the economy will remain constrained by shortages and supply line bottlenecks, which presents a massive opportunity for us as both problems ease as we move through the year. Interestingly, overall operating margins will improve throughout this period, but there will be a shift of winners and losers.

Production at U.S factories fell by the most in seven months in September, 1.3%, as supply disruptions in the auto industry and lingering effects of Hurricane Ida hurt manufacturing and mining output in the month. Specifically, auto production decreased 7.2%, utility output fell 3.6%, and mining by 2.3%. Excluding motor vehicle sales, production of durable goods rose 0.5%. Overall capacity utilization fell to 75.2 from 76.2 in August. On the other hand, initial unemployment claims were 290,000 last week, down 6,000 from the previous week. Also, builder confidence rose 4 points to 80. Existing home sales rose 6% in September, well ahead of forecasts.

China’s third-quarter GNP slowed sharply as expected to 4.9% but is likely to hit its annual target of 6.0+% set in March. Officials keep playing down the risks from the debt crisis at Evergrande Group. Regulators say that risks will be contained, and lenders should keep credit in the sector “stable and orderly.” Evergrande apparently did make an important debt payment yesterday Interestingly, the retail consumption accelerated in September, rising 4.4% from a year earlier, and the unemployment rate fell to 4.9% in September from 5.1% in August. Power shortages hurt production in September and will penalize growth for the next few months. Government attempts to control global commodity prices, including oil and coal, will fail. We will closely watch what is said at next month’s plenum and next year’s Party Congress.

Shortages and supply line bottlenecks are holding back economic activity everywhere and causing higher inflation. While the key to better days was formally putting the pandemic behind us, we are now focused on these issues expecting them to diminish as we move through 2022, making for higher production, increased efficiencies, and lower inflationary pressures.

Investment Conclusion

Financial markets continue to rise on a wall of worry focused on the inflation conundrum rather than the pandemic. It is interesting to note that the BofA Securities fund managers’ survey and other technical confidence indicators are the most negative on growth since the depths of the pandemic while stagflation worries are surging. When everyone is focused on the same thing, it is time to think out of the box, looking at the other side.

Growth has been hurt by shortages and supply line disruptions/bottlenecks, which has resulted in increased inflation that will stay elevated as long as these problems persist. We remain confident that these issues will diminish, however, as we move through 2022 into 2023.

A successful investor looks through the front windshield when most are looking back in the rear-view mirror. While we could always have corrections, we are entering the seasonally strong period for stocks, and the preconditions for a major top are not present. We have trillions of excess liquidity that will continue as long as the we cannot build inventories, an accommodative Fed that will keep real rates negative for years, and stimulative fiscal policy that will be boosted by soon to be passed infrastructure programs without punitive tax increases.

Our portfolios emphasize companies that will benefit from the global economic expansion that we envision for 2022 into 2023. Each one is best in class, has a winning strategic plan, pricing power even when shortages and supply line bottlenecks end, strong financials, and great management teams. We favor the production side of the economy, which will benefit from pent up demand, rebuilding inventory and improving margins; technology as we have entered the age of digitalization; financials which will benefit from a steepening of the yield curve and finally loan growth in 2022; industrial commodities, including energy, which will benefit from much higher spending in plant/equipment, going green and infrastructure programs, and special situations each unique unto themselves. We own no bonds expecting the yield curve to continue to steepen.

Stagflation Ahead?

Investors fear that we have entered a period of slow growth and high inflation: stagflation.

We concur. However, this period will be short-lived as we wrap our arms around coronavirus, shortages ease, and supply line issues abate. 2022 has all the potential to be an outstanding year as production builds as these short-term problems ease as producers fill pent-up demand and rebuild woefully low inventories. Go to Home Depot to buy paint or new windows. Go to your car dealership and attempt to buy the car of your choice. We could go on and on, but you get what we mean. Capacity utilization rates/production is being held down, so manufacturing efficiencies are penalized, causing margin pressure. Shortages and supply line issues have resulted in significant price increases as demand is high and availability limited. This is Economics 101.

All of this turns around by the middle of next year, as the negatives become positives: production surges, utilization rates increase, productivity rises, margins improve, and prices normalize, bringing inflation back down towards 2% by mid-2023. We expect energy prices to ease next year, too, but prices are not likely to come down much unless OPEC meaningfully increases production and/or Biden changes his domestic policies. Of course, if we have a very cold winter, energy prices will surge first before falling back.

And don’t forget that we will have accommodative monetary and fiscal policies globally next year too. Finally, we expect multi-year major infrastructure programs both here and abroad that will boost growth.

The global economy will slowly accelerate as we move forward but will not reach its full potential until shortages ease and supply line issues abate. Unfortunately, that may not happen until the second half of 2022. Notwithstanding, the Fed will most likely begin tapering before year-end as extraordinary measures are no longer needed. Remember that is NOT tightening. The Fed will most likely wait until the end of 2022 or the beginning of 2023 to start raising the Federal Funds rate. Regardless, the funds' rate will not be restrictive for years as the “real” rate will remain negative.

We remain positive on financial markets as money creation will continue to exceed uses until at least the end of next year, favorable for risk assets. Saving, including money market funds, is over $4 trillion, a record, and loan demand remains tepid. Corporations are flush, too, generating lots of free cash flow. By the way, China has a 46% savings rate, over $6 trillion, and its foreign reserves are more than $3.3 trillion, so don’t worry too much about the real estate problems; Evergrande’s total debt is $300 billion, so the government can easily contain them, lower rates, and introduce fiscal stimulus programs. Remember that employment growth is their number one objective.

Patience is a necessity, but better days are ahead as we move through 2022. Despite all the short-term problems, the IMF is projecting global growth of 5.9% in 2021 and 4.9% in 2022, both well above historical trends.

The key to sustained global recovery is putting the coronavirus in the rear-view mirror to open fully. The news gets better by the week as cases have declined 22% over the last two weeks in the U.S and 13% globally, while deaths have fallen 6% and 16%, respectively. More than 6.62 billion doses have been administered worldwide across 184 countries at a daily rate of roughly 26.5 million doses per day. In the U.S., 405 million doses have been given so far at an average rate of 841,731 million per day, which is up from last week. Merck asked regulators last week to approve its promising covid-19 pill, and a decision is expected within weeks. Booster shots will become the norm, as well as vaccinating people of all ages. We are confident that there will be sufficient availability next year for all to receive even booster shots which should contain the virus much like the flu.

In its recent minutes this week, the Fed made clear that tapering will begin before the end of the year and end around mid-2022. We concur that extraordinary measures are no longer needed. While inflation is running well above targets, recent employment data has been disappointing despite 10.4 million jobs opening and much higher wages offered. The unemployment rate has dropped only because the participation rate has fallen as record numbers leave the labor force. Why? Blame excessive government support and flush balance sheets as well as continued fears from the pandemic. Fed officials project that inflationary pressures will ease back to their long-term goal by the end of 2022. We consider it overly optimistic and forecast that it will take until mid-2023 for inflation to move closer to 2%. Tapering is not tightening, and we still do not see the first federal funds rate hike until the first half of 2023, and as long as real rates are negative, it won’t be restrictive.

Last week, the House voted to extend the debt ceiling until December, basically kicking the can down the road as both parties are no closer on a social infrastructure bill, basically keeping hostage the broadly supported $! trillion-dollar traditional infrastructure bill. Biden is having trouble getting the progressive wing supporting a $2 trillion social program, which we expect to come out in the end. The Democratic party is really in trouble, as evidenced by their decline in most polls, and is likely to lose control of Congress next year unless they get their act together. Pelosi has targeted the end of October to agree on both bills. Good luck!

We were pleased to see that Biden brokered a deal to keep the Port of Los Angeles open 24/7, and retailers pledged to step up efforts to move goods. Unfortunately, this is only a drop in the bucket as we need so much more done globally to improve supply lines. But it is a start.

Due to the pandemic, the domestic economy slowed over the summer but is slowly picking up steam again, limited by shortages, supply line issues, and less fiscal support. Applications for unemployment benefits fell last week to the lowest level since March 2020, falling to 293,000, a decrease of 36,000 from the prior week. Interestingly, job openings fell in August to 10.4 million with more people voluntarily leaving their jobs. Workforce participation remains depressed due to ongoing virus fears, choppy school openings, and built-up savings accounts. Despite a flush consumer, economic growth will be held back due to shortages and supply line issues. Still, all of this will reverse as we move through 2022 when we see an acceleration in production to fill pent-up demand and rebuild inventory levels. Unfortunately, consumer and producer prices will continue to run hot until these problems diminish, which may not happen until the second half of 2022. Inflation expectations among U.S consumers have hit the highest level since this survey was published. This week, Barry Sternlicht, head of Starwood and a longtime friend, said that consumers would pay virtually anything just to get what they want. That is what happens when there are shortages, but that will reverse by mid-2022.

While we expect the economy to improve as we move forward, we won’t reach our full potential until these problems diminish next year. As production accelerates and utilization rates increase, expect operating margins to improve and inflation to subside. It won’t hurt that 69 million social security recipients will receive a 5.9% cost of living increase which should exceed inflation.

The global economy is recovering but is being held back from the same problems plaguing us, but here again, this will reverse as we move through 2022 into 2023. Even though the IMF lowered its forecasts slightly for 2021 and 2022 to 5.9% and 5.6%, respectively, these numbers are well above historical norms. The IMF forecasted that inflation would subside to 2% in advanced economies by the middle of 2022. We find that optimistic but agree that inflationary pressures will ease by the second half of 2022. It’s interesting to note that China’s exports surged to a record $305 billion in September as demand is strong. Unfortunately, inflation rose 10.7% from a year earlier while consumer prices increased 0.7% year over year. The PBOC eased restrictions on mortgage loans yesterday to ease the real estate problem, said that Evergrande’s risks are controllable and will not spread to other real estate sectors.

We have gone through a recent slowdown due to the pandemic while shortages and supply line issues increased inflationary pressures. Yes, you can call this stagflation period, but it will end as we move forward, and these problems lessen. We could have a great year in 2022 by all measures as production increases to fill pent-up demand and rebuild inventories while inflation subsides.

Investment Conclusion

We are in a stagflation environment today as growth has slowed while inflation has increased. But that will change. A successful investor looks over the valley with a 12-to-24-month time frame at least. We see shortages and supply line issues easing as we move through 2022, which will reverse all the problems that we are currently having. 2022 could be an outstanding year with record operating margins, profits, and cash flow. We expect large increases in dividends and buybacks that will support the market offsetting a steepening yield curve.

We favor investing in the production side of the economy, which has suffered most from shortages and supply line issues but will benefit on the other side as these issues reverse. These companies will also benefit from increased capital spending and government-supported infrastructure programs. Technology remain a meaningful portion of our portfolios as growth will be outstanding for years to come as we have entered an era of digitalization. Finally, we added some financials and energy companies as we expect a steepening yield curve and higher energy prices over the winter.

2022 Could be a Great Year

Even though we are rapidly putting the delta variant in the rear-view mirror, financial markets are struggling due to a lack of leadership in D.C. We have shortages and supply line issues that hamper production and profitability. All of this will pass.

What is the problem? Our government is dysfunctional, and we need leadership, especially now, to handle the myriad of domestic and foreign issues facing all of us. We will muddle through and finally get a much-needed traditional infrastructure bill and possibly a scaled-down $2 trillion social spending bill along with lower-than-expected punitive tax increases, this year but 2022 could be a great year, not just a very good year, if only we worked together.

We have not altered our view that S&P earnings could exceed $220/share in 2022 and $235/share in 2023 as operating margins hit nearly 14% in 2023, up from 11.5% in 2019. Why? Corporations have learned to do more with less during the pandemic; shortages and supply line issues will ease, and substantial increases in technology spending will go a long way, offsetting higher labor costs while improving operations/efficiencies on all levels. Powell will be right that higher inflationary pressures will be transitory, but it may take longer to normalize. We will continue to have accommodative fiscal and monetary policies in 2022. Not a bad market scenario, so use corrections as opportunities to add to your positions. So, as I’ve said before, invest, don’t trade

Economies are reaccelerating as the number of Delta cases and death have peaked. Domestic cases have declined 23% and deaths 13% over the 14 days and 17% and 14%, respectively, globally. More than 6.43 billion doses have been administered globally across 184 countries at a daily rate of 28.7 million doses per day. In the U.S., 398 million doses have been given so far at an elevated rate of 931,983 doses per day. We still see over 75% of the global population vaccinated within six months and herd immunity sooner. Pfizer filed Thursday with the FDA its vaccine for children ages 5-11, bringing shots for all school-age children closer, which will boost the economy as parents can return to work. We expect that both Pfizer and Merck’s filings with the FDA will be approved well before year-end. All good news!

The Fed is itching to start tapering, ending its extraordinary monetary support, which is no longer needed as the economy is on firm footing, and it appears that the Delta variant is subsiding. Unfortunately, Powell and the Fed have been called out for oversight over board members’ trading. Two governors have already resigned, and we expect one more may leave shortly. Tapering will probably begin before year-end if the next employment report improves from September and be finished by the third quarter of 2022. Again, tapering is NOT tightening, and we do not expect the Fed to start hiking the funds’ rate until early 2023. The “real” funds' rate will be negative for some time which is NOT tightening at all. By the way, we disagree with Elizabeth Warren’s criticism of Chairman Powell and hope that he is renominated next year. The bottom line is that the Fed will remain your friend for at least another 18 months. Don’t fight the Fed!

We are so frustrated by what is happening in DC. It is all about politics, no surprise, and not about doing what is best for this country. Why do we always have to go to the brink before action is taken? That is precisely what happened this week when the Republicans caved and offered a two-month short-term debt limit extension letting the Dems off the hook from going the route of reconciliation. It passed Thursday night. Daily negotiations continue for the massive social infrastructure program. It will be much smaller than initially proposed, closer to $2 trillion rather than $3.5 trillion. We expect the individual and corporate tax increases to be much more reasonable than initially proposed, which is a clear positive for the economy and financial markets.

The domestic economy is recovering from the Delta variant, which penalized growth during the summer months. The areas hit most over the summer; travel, dining, and leisure are coming back strongly, as evidenced by the recovery in the high-frequency data. Other recent data points include: initial jobless claims fell more than expected to 326,000; the index of consumer sentiment rose in September to 72.9, current economic conditions increased to 80.1, and consumer expectations rose to 68.1; the September Manufacturing PMI increased to 61.1, new orders to 66.7, employment up to 50.1, supplier deliveries to 73.4 and prices index increased to 81.2; the services index grew for the 15th month hitting 60.1, new orders at 63.2, employment at 53.7 and supplier deliveries at 69.6; new orders for manufactured goods increased 1.2% while shipments rose 0.1% and unfilled orders increased 1.0%; and the trade deficit widened to $73.3 billion as imports increased more rapidly than exports due to the strength of the domestic economy. Growth and profitability would be even more robust if not for shortages and supply line issues. But that will turn around in 2022 and be a big plus. The September employment data was disappointing with only 194,000 jobs created. The private sector did better adding 317,000 jobs while the public sector lost 123,000 jobs. Interestingly the unemployment rate fell to 4.8% which is the Fed’s year-end target as the participation rate declined to 61.6. Hourly earnings rose 0.6% and are up 4.3% in the year through August. The Fed will most likely wait to see the next employment report before beginning tapering.

The Eurozone economy has finally exceeded pre-covid levels, with most of the 20 indices that we monitor accelerating in recent weeks as cases/deaths have declined meaningfully. Shortages and supply line issues have hampered production while increasing inflationary pressures and won’t ease until mid-2022. Energy costs are a real problem and may penalize growth next year. Unfortunately, OPEC opted against a big output boost lifting production by only 400,000 barrels/day, which will not be enough to limit further price increases, especially if we have a cold winter. And natural gas prices have gone through the roof, which will crimp consumer spending and hurt corporate operating margins.

Significant changes are occurring in China as President Xi moves to make society more “equitable” concerned for the average workers. The primary goals will be to tax high, unreasonable incomes and pressuring private firms to commit to the Party’s economic objectives. We are concerned that China may become a more difficult place for foreign firms to operate in. On the other hand, we expect the PBOC to ease its monetary policy soon and the government to announce a large stimulus plan offsetting current economic weakness due to the pandemic and the failure of specific real estate companies. Remember that total employment is their number one objective and concern. Don’t ever forget the vast reserves China has built over the years from its trade surpluses.

The global economy is improving as the number of covid cases, and deaths have peaked. Growth would even be more robust if not for shortages and supply line issues, but that will reverse as we move through 2022.

Investment Conclusions

Thursday, there was a massive sigh of relief when Congress agreed to extend the debt limit two months, ending the stalemate. We expect the Dems to coalesce around a roughly $2 trillion social infrastructure bill that will permit passage of the much-needed $1 trillion traditional infrastructure bill. What is a government? Fiscal policy will remain stimulative for years to come.

Then we have a monetary policy. We expect the Fed to remain accommodative for a few more years. We do expect tapering to begin before year-end if the November employment reports improves from the last one, but we do not see a rate hike until 2023, and even then, the “real” funds’ rate will be negative, which is not restrictive at all.

Shortages and supply line issues have played havoc on production and profitability for many industries/companies around the world in 2021, but this will reverse as we move through 2022, creating opportunities for investors willing to look over the valley.

The bottom line is that we could have a great year in 2022 if our government could get its act together. The key remains keeping the coronavirus out of the picture, so we must vaccinate all the unvaccinated.

While we have not many changes in our portfolio over the last few months. We have concentrated on the producers that will benefit from a robust global economy and tech companies benefitting from the digitalization boom. We recently added some financials and energy companies as we expect the yield curve to steepen more than previously anticipated. Higher energy prices are immediately ahead as demand outstrips supply. Next year, the big story will be the significant increase in dividends and buybacks well above the historical trend.

Challenging Times

Markets like to climb walls of worry. Therefore, all markets are challenged today by the many issues we are dealing with such as the coronavirus, a more hawkish Fed, fiscal policy disarray, shortages, and supply line issues now hitting energy supply around the world.

The good news is that we are getting our arms around the coronavirus. Cases and death are falling, and it appears that we all will be vaccinated within six months, with amble booster shots available for all in 2022. We also expect that vaccinations for children will be approved within two months. The best news was that Merck has come up with an anti-viral pill that dramatically reduces hospitalizations and death rates. A game changer. We, therefore, see growth in the world reaccelerating as we move through the fall into 2022. On the other hand, shortages, and supply line issues, including energy, are hitting production, and raising costs. These problems will not go away quickly, but we still assume that the worst will be behind us by the end of the winter, 2022, which will lead to higher production, reduced costs, and more robust margins/profitability.

While we remain favorably inclined to the financial markets over the next 12 to 24 months, we did make some midcourse corrections adding more financials and some energy companies to our portfolios, reducing a few high multiple technology companies as we expect a steepening yield curve and higher energy prices as we move through the winter months. Like most commodity companies, energy companies have maintained discipline in controlling capital spending, which will result in higher prices as demand grows and considerable increases in free cash flow. Saudi Arabia's huge energy company is public and is doing the same thing.

Our longer-term thesis of higher operating margins and profits remains intact, but there are challenges immediately ahead. We have entered a technological revolution with positive implications for years to come, and managements have learned to do more with less during the pandemic. Shortages and supply line issues will diminish as we move into the second half of 2022, which will boost production while enhancing profitability. And we have entered a period of stepped-up capital spending worldwide, not even including trillions of governments’ backed infrastructure programs on the horizon.

We realize that corrections are challenging, but successful investors view them as opportunities. Patience is needed. Even though the Fed sounds more hawkish, monetary policy will remain overly accommodative for another 18 months. We expect fiscal support, too. The preconditions for a market top are not present, so we must all stay the course.

The key to a reacceleration of global growth remains to get our arms around the Delta variant. The news continues to get better by the week as the number of cases over the last two weeks has fallen by 26% domestically and 17% worldwide. The number of deaths continues to lag but improves, increasing only 2% domestically while declining 13% worldwide. More than 6.25 billion doses have been administered worldwide across 184 countries at a rate of 30.3 million doses daily. In the U.S., 392 million doses have been distributed at an average rate of 706,711 per day. At this pace, it will take less than six months to cover 75% of the total population, creating herd immunity. The vaccines are successful in reducing hospitalizations and deaths. It appears that the current wave has peaked here and abroad, setting up for a reacceleration of growth moving forward. We expect the FDA and CDC to approve vaccinations for children and booster shots for all before November. Pfizer, Moderna, and J&J will have more than enough doses available worldwide to handle all contingencies, which supports our belief that the virus will be in the rearview mirror by the spring of 2022, and we will get annual booster shots much as we do for the flu. And now we have Merck’s anti-viral pill on the horizon. What great news!

Powell and the Fed are facing some tough decisions as hiring has slowed while inflationary pressures have picked up due to shortages and supply line issues. Powell is under attack, too, for the lack of oversight over some of the members' financial transactions. Powell commented last week before Congress that supply line bottlenecks and other challenges related to the reopening of the economy have been larger and longer lasting than anticipated. “But they will abate, and as they do, inflation is expected to drop back toward the Fed’s goal of 2%.”

Odds favor that the Fed begins tapering by year-end and finish by the end of the third quarter of 2022. We do NOT expect any rate hikes until early 2023. All of this is naturally data-dependent, and the key will be growth in employment and the end of shortages and supply line issues which we expect to diminish by mid-2022.

What more can I say about our government’s ability to govern than it is a mess and dysfunctional. Without a traditional infrastructure bill that we all want, a budget resolution, and the debt limit extension. The progressive wing of the Democratic Party is holding Congress hostage, acknowledging that this is a once-in-a-lifetime opportunity to pass their social agenda. Fortunately, it cannot happen as is without the support of moderate Democrats who have held firm. Congress did pass a temporary bill to keep the government operating until December, but lots more needs to be done. Senator Manchin has publicly stated that he will not support a social infrastructure bill above $1.5 trillion, which would mean a more minor increase in individual and corporate tax rates, which is a good thing.

The economic picture has been a mixed bag as we are just putting the Delta variant in the rearview mirror. Unfortunately, shortages and supply line issues are holding back production while boosting inflationary pressures. It appears that areas hit most by the Delta pandemic are improving, such as travel and entertainment. The high-frequency data is getting better, too, pointing to more robust growth ahead. Interestingly, unemployment claims continue to rise, so to 362,000, a seven-week high, which suggests another disappointing employment number ahead, complicating the Fed’s next move as inflationary pressures remain strong even though they may be transitory. The production side continues to do as well as possible with all the constraints, with durable orders increasing 1.8%, shipments fell 0.5% due to shortages and supply-side issues, unfilled orders rose 1.0%, and inventories increased 0.8%. Home prices have increased an impressive 19% year over year, adding to record wealth for the U.S consumer. On the other hand, consumer confidence fell further in September to 109.3, not an alarming number; the present indication index fell to 143.4, pretty good too, and expectations declined to 86.6. Nevertheless, the U.S economy is on the cusp of reaccelerating, which will pick up steam even more as shortages and supply line issues diminish in 2022.

China, the second-largest economy globally, has slowed as evidenced by the decline in the September manufacturing PMI, which fell to 59.6 while the non-manufacturing PMI bounced back to 53.2. Interestingly, the Caixin/Markit manufacturing PMI increased to 50.0. Goldman lowered its growth forecast for 2021 to 7.8% from 8.2%, we agree. China is suffering from shortages and supply line issues, especially energy, which is penalizing growth. The PBOC vows to ensure a “healthy” property market and protect homeowners. The central bank continues to inject billions of liquidity into the banking system. Evergrande sold an asset raising over a billion-dollar last week, and its bonds lifted. We expect the PBOC to lower reserve requirements and the government to announce a significant fiscal program to boost growth and employment.

The Eurozone economy is recovering to pre-pandemic levels as the number of Delta variant cases decline. The OECD weekly tracker of economic activity is improving as the labor market remains strong; job vacancies are at record highs; Europeans are spending less time at home and spending more out; use of public travel has surged, consumers are more confident, and flights are increasing. We are concerned about the high prices paid for energy as it could penalize growth in cold winter. Interest rates in the Eurozone, while still negative, have increased considerably as the reflation trade is alive and well as it is here too.

Vaccinations have increased considerably in India, and their economy is primed to accelerate. The services sector is resuming expansion, and manufacturing activity picked up growth in August. Japan elected a new Premier, Fumio Kishida, a former banker, who pledges to steer away from “neo-liberal” economic policies. Finally, Australia’s economy is picking up steam too.

We continue to expect improving growth here and abroad in 2022, supported by easy monetary and fiscal policies.

Investment Conclusions

Global economic growth is on the cusp of accelerating as we get our arms around the Delta variant. It will only get better in 2022 as shortages and supply line issues abate. Despite all the problems in 2021, S & P earnings and margins will reach record levels hitting over $210/share vs. $163/share in 2019. We expect further improvement to over $225/share in 2022, which may prove conservative as shortages and supply problems ease. The real story will be cash flow generation. We expect record buybacks and dividend hikes in 2022, which will support the market. Our long-term improving margin thesis is alive and well. We expect operating margins to get close to 14% in 2023 vs. 11.5% in 2019 and earnings to reach nearly $240/share.

Monetary policy here and abroad will remain overly accommodative even if tapering begins before year-end. Tapering is NOT tightening. Fiscal policies will be supportive of growth too. We expect infrastructure spending to accelerate everywhere in 2022 on top of significant increases in capital expenditures.

We have adjusted our portfolios to reflect higher energy prices and a steeper yield curve as the Fed appears more hawkish. We added energy and financials which sell below market multiples and have been out of favor for years, so we see an opportunity for revaluation on top of higher earnings, increased buybacks, and higher dividends.

Challenging times are opportunities for those willing to invest with a 12–24-month time frame. Sell when participants are overly optimistic but buy when pessimism is at high.

Getting Off Life Support

Monetary authorities both here and abroad feel more confident in future economic growth as we are finally getting our arms around the Delta variant. Openings can accelerate once again.

They are on the brink of slowly removing extraordinary measures such as buying $120 billion of bonds here and nearly $100 billion abroad per month. This is excellent news as it is a vote of confidence that better days are ahead, so it’s time to get off life support and return to standard monetary policies. Tapering is not tightening, and even when they begin to hike rates, it probably won’t be until 2023, and the “real” funds rates will likely remain negative, which won’t put the brakes on growth.

Monetary authorities realize that their policies cannot impact shortages and supply line issues which penalize economic growth while boosting inflation. Investors have not appropriately factored into their forecasts what the other side will look like after these problems abate. We see much higher production rates as pent-up demand is filled and inventory levels are normalized. We see higher operating margins, profits, and cash flow as extraordinary costs normalize next year, for example, transportation expense. S&P operating margins are forecasted to hit close to 14% by the end of 2023, up from 12.1% in 2019, and earnings could exceed $235/share up from $162/share in 2019.

While we remain positively inclined to equities over the next 12 to 24 months, uncertainties persist, keeping a lid on markets for now. While monetary policy is more in focus, fiscal policies here and abroad are still in the air. And we still need to vaccinate the unvaccinated! Our government is dysfunctional, and China needs to take a more proactive role over Evergrande, a problem caused by their own monetary and fiscal policies. It will take many months for shortages and supply line issues to diminish. Still, the other side looks better by the day as global liquidity continues to build; we expect a surge in capital spending supported by governments everywhere, and inflationary pressures subside.

Let’s look at the key issues facing investors.

News on the Delta outbreak continues to improve by the week. The number of new cases has declined by 12% here and abroad over the last 14 days, while deaths, which lag, continue to increase here but are still falling abroad. More than 6.03 billion doses have been administered worldwide across 184 countries at a daily rate of 31.5 million doses per day. In the U.S., 387 million doses have been given so far at an average rate of 750,942 doses per day. Infectious disease experts that vaccinating 70-85% of the population would enable a return to normalcy which should be reached globally within six months. Fortunately, Pfizer, Moderna, and J&J will have enough doses available to handle globally even booster shots next year. We learned last week that the FDA panel recommended booster shots for ages 65 and up as well as those in need and that J&J’s booster shot provides 94% protection two months after the first dose. All good news. Hopefully, drug companies come up with a combination flu/coronavirus shot within a year.

The Fed took a more hawkish view gaining control over the narrative in their meeting last week, commenting that tapering is ready to begin now, although raising rates is well down the road. The financial markets took it in stride as the Fed will continue buying hundreds of billions in debt over the foreseeable future. The “real” funds' rate will remain negative for many years, which is anything but restrictive. Fed Chairman Powell said all the criteria to begin tapering were “all but met,” implying that it would be announced and start in November and be finished by mid-2022. We still do not see a rate hike until 2023 and we question the Fed’s trajectory of hikes into 2024. While no one knows when shortages and supply issues diminish, we are confident that inflation, on the other side, will be a positive surprise as productivity gains will be solid, benefitting from the surge in technology spending and operational changes made during the pandemic. Flows from abroad arbitraging rates continue to limit the steepening in our yield curve, which supports our markets.

What can be said about our political system other than it is dysfunctional? Everyone agrees that we need a sizeable traditional infrastructure bill, so why tie it to a social agenda and a debt ceiling? Passing the debt ceiling should be a non-event, too, but here again, the Dems are holding it hostage to their huge social spending bill. Our domestic and foreign policies are in disarray, as shown by Biden’s falling poll numbers. It may be so bad that he needs a victory, so he forces his party to separate the bills and move forward asap with the traditional infrastructure bill needed to rebuild our aging base to enhance our global competitive position. That’s our bet.

The domestic economy is a tale of two cities as services are suffering due to the Delta variant. At the same time, the production end is strong, producing everything that it can limited only by shortages and supply line issues. Key data points reported last week include: index of the consumer in September rose slightly to 71.0, current economic conditions fell to 77.1, and consumer expectations increased to 67.1; August leading indicators rose 0.8% to 117.1, coincident rose 0.2% to 105.9 and lagging increased to 106.3; composite output index fell to 54.5 in September due to shortages and supply line issues, services index fell to a 14 month low at 54.4, manufacturing PMI was a still strong 60.5, and manufacturing output was 55.2; building permits rose 6% in August and housing starts increased 3,9%, but builder confidence fell to a 13 month low, and jobless claims unexpectedly increased to 351,000. It is important to note that consumers see the worst buying conditions in decades due to high prices. And finally, the U.S opened air travel to vaccinated foreigners which should boost growth. The economy is set to reaccelerate as the Delta variant ebbs. Still, shortages and supply line issues will limit growth for the foreseeable future, setting up a very strong and profitable mid-2022 onward as these problems diminish, especially if an infrastructure bill is passed.

The OECD lowered its forecast slightly for global growth in 2021 to 5.7%, keeping China’s growth unchanged at 8.5% (we are lower); Japan at 2.5%; U.S. growth down to 6.0%; India at 9.7% for FY 2022; 4.3% in the Eurozone; Southeast Asia at 3.1% and 4.0% in Australia. The recovery pattern remains uneven due to the coronavirus, shortages, and supply line issues, with increasing inflationary pressures everywhere. The outlook for 2022 growth was lifted to 4.7% as these problems abate.

Investors are focused on China. Not only has growth slowed quickly due to covid, but their largest developer, Evergrande, is on the brink of bankruptcy. It has been here before. While we expect the financial fallout to remain limited to China, it clearly will penalize near-term growth, which had already been under pressure due to the Delta variant. The People’s Bank of China has already injected around $71.0 billion into the banking system and stands ready to do more. We fully expect the PBOC to lower reserve requirements shortly and pump a lot more money into their system. Plans are also being made to step up fiscal support, as jobs are the government's number one priority. Don’t bet against China?

While global growth for 2021 was revised slightly lower due to the spread of the Delta variant, the outlook for growth in 2022 has improved, permitting monetary authorities to look at removing life support tools soon.

Investment Outlook

It is good news that monetary authorities no longer believe that extraordinary measures are needed to support their economies. Tapering does not mean that tightening is on the horizon. 2021 will go down as an extraordinary year as we have had to deal with the pandemic, shortages, supply line issues, geopolitical risks and more. Nevertheless, economies recovered substantially only to slow down over the summer due to the outbreak of the Delta variant. But that is changing as the world gets vaccinated. Better days are ahead.

Investors have not factored into their 2022 projections the positive impacts of ending shortage and supply line issues which ratcheted costs up dramatically in 2021 while also curtailing production/sales. Inventories are at all-time lows everywhere and need to be rebuilt. Infrastructure plans are on the horizon globally on top of significant increases in capital spending and research. All good for growth.

We continue to favor investing in value stocks tied to global economic growth and technology companies riding the wave of digitalization. Companies hurt by shortages and supply-side issues will be the winners next year, too, as these problems abate. Inflation will subside too. We continue to see a steepening yield curve, but it will be held down by large inflows from abroad arbitraging the yield differential.

Getting off life support is a good thing.

Markets Hate Uncertainty

There are many questions out there today: when will the Delta variant peak; will opening reaccelerate; will shortages end; will supply line issues abate; will inflationary pressures ease; will the Fed begin tapering; will Congress pass an infrastructure bill and raise the debt limit, and when and if will Federal Chairman Powell be reappointed. That’s quite a lot of uncertainty, and there’s more to factor in. The successful investor must formulate an opinion on each. That is why each week, we believe the greatest value we can bring you is to discuss issues and what is happening overseas, to help you develop your investment outlook.

After taking a top-down global economic, financial, and political view, we then take a bottom-up approach analyzing industries/companies searching for the best investment opportunities. Our approach is analytical and systemic. We attempt to take emotion out of the decision as best, which is not easy at times, we can especially if our conclusions point to going against the grain. We invest with a 12 to 24-month time frame while the market is dominated by day traders who rely on charts and momentum, which creates unusual opportunities for us at times. Several long-term investable trends are apparent today, such a digitalization, the cloud, the web, security, EV, going green, 5G, and infrastructure spending, but patience is necessary as the rewards come over a few years, not months, weeks, or days. Do you have the patience to be an investor?

Let’s look at each of these issues, including an update on current economic data points, then formulate a market opinion including a view on interest rates, and finally discuss the sectors we emphasize in our portfolios. We continue to focus on shortages and supply line issues as overcoming them is pivotal to accelerating growth next year and beyond.

The spread of the Delta variant continues to impact global growth. Fortunately, the number of cases here and abroad continues to decline on a 14-day basis, although deaths continue to increase here but are falling abroad. More than 5.83 billion doses have been administered globally across 184 countries at a rate of 30.3 million doses per day. In the U.S., 382 million doses have been given so far at an average rate of 787,751 per day. At this pace, it will take six months to cover 75% of the global population, which should be enough for herd immunity. Studies indicate that a booster shot slashes the rate of covid infections and restores waning immunity. We must vaccinate the unvaccinated, including children. Fortunately, there will be ample supplies of doses available over the foreseeable future to vaccinate the world, including booster shots six months after being vaccinated. We also need to worry about the upcoming flu season. Get your flu shots too. While we are learning to live with COVID, the opening will slowly reaccelerate here and abroad as we move through the fall, which will naturally help the global economy.

We expect no change in Fed policy next week or a proposed time frame for tapering to begin. There are tremendous crosscurrents in the economy from a slowdown in travel and leisure, an increase in unemployment claims, a turndown in high-frequency data, and the end of extra unemployment benefits. On the other hand, we have strong capital spending, higher industrial production, and retail sales. The Fed has a dual mandate: reducing unemployment and controlling inflation. The last employment report was a big disappointment while the rate of change in the CPI slowed in August. The jury is out whether higher inflationary pressures will be transitory. Powell thinks so, as do we. He wants the economy to run hot rather than risk taking the punch bowl away too soon. Also, the Fed knows that their policy will have little impact on shortages and supply line issues. If the economy improves over a few months and employment numbers improve again, we expect the Fed to announce tapering in November and begin by the end of the year or early 2022. We expect them to finish tapering by the fall of 2022 and start hiking the fund's rate by mid-2023 if the data points support the move. Remember that tapering and a negative real funds rate are NOT tightening. Finally, Powell seems to be gaining ground in the Senate for his reappointment as Fed Chairman with bipartisan support. Even Chris Dodd and Barney Frank (remember Dodd-Frank?) support Powell’s renomination.

Biden and his party are pushing hard for their vast $3.5 trillion-dollar social infrastructure bill as well as hiking the debt limit. Highlights of the Ways and Means proposal to pay for the bill include: top capital gains increases to 25% from 20%; maximum corporate rate rises to 26.5% from 21%; increases carried interest holding period to five years from three; cut some estate tax discounts; cuts tax rate for small businesses to 18%; crypto subject to wash rule; and a Medicare surtax on high earners. The package is expected to raise $2 trillion. The Dems are looking for $700 billion in revenue and cost savings from Medicare drug price changes and $600 billion from faster economic growth. Democratic Senator Manchin and other moderates are against this enormous social spending and tax bill, a deal-breaker for the Dems which dooms Biden’s economic agenda. Fortunately, he needs a win as his poll ratings are hitting new lows, so we believe that he will support the $1.2 trillion infrastructure bill, in the end, without tying it to his $3.5 trillion social infrastructure bill. This bill could be on his desk within a month, which would be a pleasant surprise for the market benefitting specific sectors tied to infrastructure.

Recent data points continue to be a mixed bag: industrial production increased by 0.4% in August despite shutdowns caused by Hurricane Ida; wholesale sales increased 2% in July while inventories rose only 0.6%, bringing the I/S ratio to new lows at 1.25; monthly retail sales increased a surprising 0.7% in August and are up over 15% from a year ago; the CPI increased only 0.3% from July and excluding food and energy the core inflation index rose only 0.1%, the smallest gain since February; and finally, the Phili and Empire Manufacturing surveys were robust. On the other side, unemployment claims rose to 332,000, an increase of 20,000 from the previous week; small business optimism fell to 99.7, and the August PPI index rose 0.7% and is up 8.3% year over year while the core PPI increased 0.6% and 6.7% vs. last year. Shortages and supply line issues are continuing to penalize sales and production while increasing inflationary pressures. We do not see improvement for both problems until mid-2022, but by then, we see higher sales/production/margins and lower inflation.

While the outlook for the Eurozone, India, Australia, and Japan have improved, China’s economy has not begun to recover from the outbreak of the Delta variant. ECB President Christine Lagarde said, “unprecedented monetary and fiscal aid and more vaccinations have brought the region to a point where it is recovering more rapidly than anticipated and output should reach pre-pandemic levels before the end of the year.” Most Japanese firms see the economy recovering to pre-pandemic levels in FY2022. The Japanese economy grew by 1.9% in the April-June quarter. India’s economy is expected to expand by over 7% this year and more next year, while Australia could expand close to 4% in both years.

On the other hand, China's outlook has slowed over the last month due to the outbreak of the Delta variant and needs additional monetary and fiscal stimulus to reaccelerate. So far, the government has targeted programs for smaller businesses and pledged additional support using local government bonds. We expect the Bank of China to announce another cut in the reserve requirement soon plus additional stimulus programs to boost consumption, which has been hit far more than production. The financial problems of Evergrande, a huge developer in China, will force the Bank of China to inject trillions into the domestic economy to prevent a Lehman moment. Foolishly, the government continues to release industrial commodities from its inventories, including oil, to put downward pressure on inflation just as global demand increases and supplies are tight.

Investment Conclusions

As indicated by the latest bull/bear ratio, market psychology has turned decidedly bearish, which is interestingly a contra-indicator, meaning that it is an excellent time to be nibbling at the market. It helps that inflows continue at a record pace; corporate deals and buybacks are nearing prior peak levels; dividends are increasing at a record pace; we have record excess liquidity in the trillions; the earnings yield compared to 10-year bond yield has never been wider; operating profits/margins/cash flow are increasing to record levels, and the Fed is our friend. Of course, there are negatives. We are worried about COVID, excessive federal spending, taxes that hurt our global competitiveness and investing in America, the buildup in government debt, excessive speculation, the political climate in America, geopolitical risks, and the power of fringe factions.

We maintain a positive view of the financial markets over the next 12-24 months based on an improving global economy as put the coronavirus in the rear view mirror; shortages and supply line issues abate; record operating profits and cash flow; accommodative fiscal and monetary policies; continued record flows from abroad keeping a lid on our interest rates; and trillions of excess liquidities still in the financial system. The preconditions for a market top are not present, but there can always be corrections like now.

As always, it is where you invest that counts. We maintain a balanced approach between growth, mainly technology and value. We like to invest where the government is our friend, so we own sectors that will benefit from the infrastructure bill, increased capital spending, and higher high-tech defense spending. While we expect the yield curve to slowly steepen, we do not expect the 10-year treasury yield to get much above 1.80% over the next year, which is good for stock valuations.

Markets detest uncertainty, creating opportunities for true investors with a positive longer-term outlook. The key has always been to remain patient, which most can’t do, and always maintain reserves.

Darkest Before Dawn

ADarkest Before Dawn

If the Delta virus weren’t enough, the global economy must deal with multiple shortages and supply line issues, penalizing production and causing higher inflation. Demand is not an issue, which is very good news, because as these problems abate, production will ramp up rapidly to meet pent-up demand and rebuild inventories that are at record lows.

Employers have to offer higher wages and increased benefits to attract employees. Job openings are at a record 10.9 million while the total unemployed is less than 8.4 million. While many are worried about labor inflation since it is approximately 65% of the cost of goods, we agree with Microsoft CEO Satya Nadella, who said on Thursday that innovation in digital technology would help alleviate some of the inflationary pressures by making work far more productive. The market is in a tug of war between the economy slowing due to the pandemic, shortages, supply line issues, and reopening, which we expect over the next few months as the number of cases appears to be peaking here and abroad, too.

The real question for investors is how quickly shortages and supply lines issues will begin to ease. We do not see much improvement until mid-2022, which means that monetary and fiscal policies will have to remain overly stimulative during this transition period which will backstop the financial markets. Remember that liquidity creation greater than economic needs finds its way into risk assets which is what we see ahead until the market transitions to accelerating global growth as the pandemic comes under control, shortages ease and supply line issues abate.

A successful investor must be willing to look over the valley when it is darkest before the dawn, where real opportunities exist for the patient investor ready to go against the grain. We know that it is not easy, but it has worked for us over our 50+ year career. We are maintaining a barbell approach, owning companies that will thrive during this challenging period, mostly technology companies, and adding to those that will benefit as we make progress to the other side, such as industrials, capital goods, and commodity companies. All our investments are best in class, generating substantial free cash flows, and are selling well beneath their intrinsic value.

We appear to be getting our arms around the Delta variant as the number of cases over the last 14 days has declined by 2% to 148,562 in the United States and fell by 11% to 586,852 globally. Unfortunately, deaths, a lagging indicator, have increased here but have declined globally by 9%. More than 5.63 billion doses have been administered globally across 184 countries at a rate of 35.7 million doses per day. In the U.S., 378 million doses have been given so far at an average rate of a reduced 786,492 per day. It will take five months to vaccinate 75% of the global population, which should be enough for herd immunity. We expect the CDC and FDA to approve booster shots shortly, and Pfizer/Moderna/J&J will have enough doses of vaccines available to handle all here and abroad. Moderna and we believe Pfizer, too, are working on a two-in-one vaccine for covid and the flu. Don’t forget that the flu is very dangerous, killing on average 38,000 Americans per year. The bottom line is that it appears that the coronavirus is peaking, and we can look forward to better days ahead. We are also confident that new vaccines would be readily available if new variants popped up. It is essential that our government support research spending and domestic supply in our drug industry. Any moves to the contrary are against our national interests.

The Fed is on the horns of a dilemma as the economy has slowed in recent weeks, as evidenced by high-frequency data, a decline in eating out, travel, and tourism. Many sectors are also being restrained by continued supply chain disruptions and labor shortages. Businesses are feeling more substantial inflation and paying higher wages, too. This was all reported in the recent Beige Book. While the Fed appears split on the timing of when to begin tapering, it seems that the date has been pushed out to year-end or the beginning of next year. All of this depends on the speed of opening, returning to school, the impact of fewer unemployment benefits, and getting vaccinated. Remember that the Fed would rather be a day late than a day too early as they want a strong economy. The Fed will also wait to see what Congress ultimately does on its traditional and social infrastructure bills plus the debt limit. The bottom line is that we expect the Fed to remain overly accommodative for the foreseeable future, which will support financial assets. We still do not see a rate hike until sometime in 2023.

In September, Congress has a lot on its plate dealing with the traditional infrastructure bill, the social one, and the deficit. The Republicans clearly will be obstructionists on all counts, so that the key will be the moderate Democrats in both chambers. Biden needs a victory as his polls continue to fall. While the extremists in both parties are making the most noise, odds favor passage of the traditional infrastructure bill as written and a watered-down, much smaller social spending bill without the onerous tax hikes earlier proposed. We continue to believe that the Dems are likely to lose control of the House next year, creating gridlock in DC for the rest of Biden’s term in office.

While not much economic data was not reported last week, the U.S economy has slowed rather significantly over the past few weeks. While covid appears to be peaking, the real issues facing the economy moving forward are shortages and supply line problems. There is nothing that monetary and fiscal policy can do to alter these problems short term. It just takes time but rest assured that everyone is moving forward to rectify these problems.

Hurricane Ida has not helped the situation, as many plants are still shut down and won’t reopen until power is fully restored for them and their suppliers. Damage exceeds $95 billion. While all this will penalize growth in the third and fourth quarters, it is only deferred growth-boosting demand for 2022. We have raised our economic forecasts for 2022 as production accelerates to fill pent-up demand and restore inventory levels to normalized levels. Liquidity numbers remain off the charts. In addition, we expect the infrastructure bill to begin to kick in late in 2022, moving into 2023. This will be a long cycle as the U.S has underbuilt for the last ten years creating unique investment opportunities in EV, going green, 5G, digital technology, and capital goods. Industrial commodity prices will increase next year as demand increases without the proportional increase in supply.

Growth overseas has been a mixed bag starting to improve in the Eurozone and India but not yet in China. The ECB, at its meeting this past week, revised up its 2021 economic forecast to 5.0% from 4.5%, raising its inflation forecast to 1.5%, which appears low. The ECB did not alter its policy, although it alluded to reducing its bond purchases to a “moderately lower pace.” It stressed, however, that its approach will remain highly accommodative. While China’s growth has slowed over the last month, its August trade surplus increased on an unexpected surge in exports, up nearly 26% from last year, to the U.S. and the Eurozone. Iron ore imports hit a record last month, arguing against reducing their domestic inventories of industrial commodities, including oil. We continue to believe that the Bank of China will make additional accommodative moves to assist its economy as it recovers from the pandemic.

Investment Conclusions

The world is beginning to get its arms around the surge in Delta coronavirus cases. While it is not there yet, there is light at the end of the tunnel, as seen by the global reduction of cases/deaths over the last 14 days. We remain confident that enough doses will be available to vaccinate all, including booster shots, over the next twelve months. The real problem that the global economy is facing is shortages and supply line issues. Unfortunately, it will take time for these problems to diminish, and there is little that monetary and fiscal policy can do to change this but provide additional support during this period. There is no demand problem whatsoever and we will come out of this with substantial pent-up demand needing to be filled with incredibly low inventory levels that need to be rebuilt.

A successful investor must be willing to stay disciplined in the darkness just before the dawn. Patience is a necessity as is controlling risk. We are confident that our portfolios, which are a blend of companies that can thrive during this environment and those that will benefit from growth and margin expansion on the other sideas supply line issues abate will outperform.

The Opening Trade Revisited

The Reopening Trade Revisited

The Delta variant, Hurricane Ida, shortages, and supply line issues are penalizing growth in the third quarter but not our view of the other side. It may ensure higher growth in 2022 than previously estimated as governments boost spending from previous plans and monetary authorities remain overly accommodative longer, with the Fed postponing tapering until next year. We expect our economy to regain momentum in the fall and the global economy to pick up steam next year. Recent economic data points here and abroad confirm the near-term slowdown, but the solid underlying longer-term fundamentals have not changed.

The financial markets continue to hit new highs, but there has been constant rotation from growth to value and back to growth again. We believe that the next move will be back to value/economically sensitive companies as governments react to the slowdowns by accelerating spending plans, mainly infrastructure, while monetary bodies maintain their overly accommodative policies longer delaying tapering, pointing to the recent pause in growth. While we will continue to own an outsized technology position as we are still in the early innings of elevated spending levels as companies must boost productivity to control costs and remain globally competitive, we have begun to add to economically sensitive/value companies who will benefit from accelerating global growth and trillions of new infrastructure spending. Liquidity trends remain strong, so we would take advantage of any corrections by adding to positions.

The key to the economy reaccelerating remains to getting our arms around the Delta variant by vaccinating all the unvaccinated. It appears that Dr. Gottlieb may be right as the number of cases/deaths is peaking in the south, where the outbreak occurred first. Unfortunately, cases/deaths are still increasing in the North and West, but he expects them to peak in a few weeks. More than 5.39 billion doses have been administered across 182 countries at a rate of roughly 41.6 million per day. In the U.S., 372 million doses have been given so far at an average rate of 918,000 doses per day. It will take less than five months to vaccinate 75% of the world population fully. Moderna filed for U.S authorization for a booster shot, indicating that it raised antibody levels 40-fold in clinical studies. We expect the FDA to approve booster shots within a few weeks, and Pfizer, Moderna, and J&J will have over 7 billion doses available worldwide to handle everyone and all contingencies. Even if a new variant pops up, we expect vaccine modifications could be completed very quickly. We see no reason that vaccines should not be mandated for all, as we have done in the past for other pandemics.

While we did not hear from Fed members this week, they face challenges ahead. In the last few weeks, the economy has softened considerably as the Delta variant spread. Also, pandemic unemployment benefits end in September for 7.5 million people. They will not even discuss tapering until the delta variant spike is under control and they see the impact of reduced government support on spending. While we do believe that most of the inflationary pressures will be transitory, shortages and supply line issues may extend well into 2022, testing the Fed’s resolve.

We are getting more confident that the $1 trillion-dollar plus traditional infrastructure bill will be on President Biden’s desk within a month as it will be political insanity for Pelosi and the Dems to hold it hostage to the $3 trillion plus social infrastructure bill after all the damage caused by Hurricane Ida. Here is what is included in the traditional infrastructure package: $110 billion for roads, bridges, and major projects; $39 billion to modernize public transit; $66 billion for passenger and freight rail; $65 billion for broadband infrastructure; $17 billion for ports; $25 billion for airports; $7.5 billion for zero and low emission buses and ferries; $7.5 billion for electric chargers; $65 billion to rebuild to grid plus another $50 billion to make it more resilient; and $21 billion to clean up Superfund and brownfield sites. The House will address the larger bill under reconciliation. And suppose Democratic Senator Joe Manchin sticks to his guns, urging a “strategic pause” on the $3.5 trillion bills wanting a far smaller reconciliation bill that America can afford and needs to spend. In that case, it is dead in the water as is. We expect a far smaller bill with less tax bite to keep America competitive and the entrepreneurial spirit alive.

Economic data points have been a mixed bag over the last few weeks: employment rose only 235,000 compared to an estimate close to 750,000; TSA airport screenings dropped to the lowest level since March as travel and fares are dropping; high-frequency charts show a weakening economy from Delta; pending home sales fell 1.9%; the Dallas Fed Manufacturing Survey fell to +9 from +25; airline booking for Labor Day is 19% below 2019 levels; consumer confidence fell to a six month low, and total productivity increased by only 2.1% while manufacturing productivity increased a more robust 8% in the second quarter. On the other hand, U.S manufacturer's gauge of factory activity rose to 59.9 as the backlogs index increased to 68.2; the new orders index stood at 66.7; unemployment insurance claims fell to 340,000, and construction spending increased by 0.3%.

Economic data points abroad also show weakening trends due to the Delta variant, shortages, and supply line issues. China’s weakness stood out as the government took extreme actions to eradicate the virus: the non-manufacturers purchasing managers index fell to 47.5 in August from 53.3 with specific weakness in services down to 46.7; the manufacturers' index slipped 49.2, down from 50.3. In addition, Japan’s August Manufacturing PMI fell t0 52.7 while confidence in the Eurozone economy dropped to 117.5 as order books deteriorated and retail sales weakened. On the other hand, Europe’s factory backlog hit a record high as companies struggled to meet demand due to shortages and supply line constraints. India’s economy grew 20.1% in the second quarter but has slowed since then due to covid such that growth forecasts have been reduced to 9.5% for the fiscal year ending March 2022. Finally, Australia’s final Markit Manufacturing came in at 52.0 vs. 56.9 last month.

Investment Conclusions

Global growth has slowed over the last month due to the outbreak of the Delta variant, shortages, and supply line issues. We believe that governments and monetary authorities will respond quickly to support their economies just as the variant peaks. Growth, on the other side, will be more robust than initially projected. The market remains one step behind emphasizing growth over value/economic sensitivity. It is time to rotate again and invest in the re-reopening trade, as we did late last summer. We will continue to hold most of our tech positions as we remain in the early innings of above-average tech spending that we discussed last week. We also added to defense positions after Afghanistan.

The time has come for our government to pass a much-needed traditional infrastructure bill that strengthens the very core of America and rewards investment/risk-taking. If we have learned anything from the pandemic, we need to shorten supply lines and support research to remain an economic powerhouse. And we must always be there for our friends.

The Age of Digital Transformation

Corporations' operating profits, margins, cash flow, and ROIC are moving to new highs as the economy recovers from the pandemic, and managements have learned to do more with less spending heavily on technology while maintaining fiscal discipline in the boardroom.

While technology stocks are near-term beneficiaries of record spending as we move digital, the long-term winners will be technology buyers as the benefits accrue over time. Even we are surprised about how quickly operating margins and returns are improving from the depths of the pandemic. The surge in tech spending will boost productivity, improve profitability, lead to higher returns on invested capital and keep a lid on inflationary pressures.

We now believe that operating margins can get close to 14% by the end of 2023, up from 10.3% in 2020 and 11.5% in 2019, which would translate into S&P 500 operating earnings over $245/share in 2023, up from forecasted earnings of $215/share this year. The real surprise will be the profitability and returns on invested capital of economically sensitive value companies over the next few years, which will lead to outperformance over time. It is not that we don't like tech stocks. We do. But expectations are high, and there is little room for disappointment, unlike other areas.

Economic growth is being held back by the surge in coronavirus cases/deaths, shortages, and supply line issues, but this will lessen as we move into 2022, boosting global growth. In addition, we expect to see continued monetary accommodation to go along with additional fiscal support,

The stock market remains the only game in town, with 10-year treasuries yielding 1.34% and the earnings yield on the market at 4.7% based on 2022 earnings and 5.4% on projected 2023 earnings. Even if rates go up, it will have to move a long way, which we do not expect, to make the stock market unattractive. We expect record buybacks next year, along with significant increases in dividends.

The key to the global economy remains to vaccinate the unvaccinated so that we can move forward. It was vital that the FDA formally approved Pfizer's vaccine last week as it removed a legal impediment to vaccinate all. More than 5.11 billion doses have been administered across 183 countries at a rate now of 38.4 million doses per day, a record. In the U.S., 366 million doses have been given so far at an average daily rate close to 880,000, a substantial increase from a few weeks ago. The Pfizer formal approval will lead to an acceleration in vaccinations, including booster shots for those vaccinated eight months ago. We continue to believe that we will get an annual covid booster shot like for the flu. We are pleased to see companies, schools, and government agencies make getting vaccinated a requirement. It appears that Dr. Gottlieb was correct, and the Delta outbreak is near its peak, which will lead to a re-acceleration in economic activity as we move into the fall.

The financial markets are transfixed on tapering as if that meant tightening. It is not! The U.S economy is in good shape and no longer needs extraordinary support from the Fed. Several members of the Fed, including Esther George, James Bullard, and Robert Kaplan, want to begin tapering this fall and end It by the summer of 2022. We cannot disagree, but the key will be forthcoming economic data points, especially employment, as tapering will not impact inflationary pressures, mainly caused by shortages and supply line issues. Powell at Jackson Hole emphasized that tapering is not tightening; he gave no hint when it will begin, and raising rates is a different decision. He sees continued progress to the goal of tapering, but future data points will tell when. It has become clear that if the virus peaks soon, tapering may begin before the end of the year and conclude by the third quarter of 2022. Rate hikes are still expected sometime in 2023. Again, tapering is not tightening, and the Fed will be maintaining an accommodative stance for at least two more years.

Biden's and the Dem's economic agenda moved forward last week as Nancy Pelosi made a deal with the moderate Democrats to get a hard vote on the traditional infrastructure bill by September 27th while moving forward on the reconciliation bill, which will include the blueprint for the $3.5 trillion social infrastructure bill. We continue to see the passage of the $1.2 traditional infrastructure bill this fall. Still, we expect the moderate Dems in the Senate and House to significantly alter the larger bill lowering its size significantly and the tax rates from what was initially discussed. We were pleased to hear that Biden's advisors, including Treasury Secretary Yellen, support Powell's renomination to continue as Fed Chairman with Lael Brainard as Vice Chairman.

Economic data points continue to big a mixed bag but generally support an improving economy, especially as we get our arms around the Delta variant. Remember that most of this data was accumulated before the severe outbreak of the Delta variant so take it with a grain of salt: U.S. PMI Composite Flash was 55.4 vs. 59.9 prior; Manufacturing PMI was 61.2 vs. 63.4; Service PMI was 55.2 vs. 59.8; July existing home sales rose 2%; July durable goods orders fell 0.1%; July consumer spending increased 0.3% while income rose 1.1% resulting in a 9.6% savings rate up from 8.8% in June; the July PCE excluding food and energy rose 0.3% sequentially down from 0.5%; the July trade deficit fell to $86.4 billion as exports rose while imports fell; second quarter GNP growth stays at 6.6% as there were upward revisions to nonresidential fixed investment and exports offset by downward revisions to inventory investment and state and local government spending, and finally consumer confidence fell to 70.3 in August down from 81.2 in July. The domestic economy has slowed somewhat as Delta variant cases/deaths rose over the last month. Hopefully, vaccinations continue to pick up meaningfully, which we expect such that growth reaccelerates into 2022.

The spread of the Delta variant has impacted economic growth overseas too: Japan's PMI fell to 45.9 in August from 48.8; Germany's Flash Manufacturing PMI fell to 62.7 from 65.9; France's PMI fell 55.9 from 56.6, and growth in China has slowed too. President Xi commented that his government would strive to reach its economic and social targets this year, even if it includes more monetary and fiscal stimulus. Foolishly, China continues to reduce its stock of industrial commodities, just as global growth is about to accelerate in 2022. We continue to see an acceleration in global growth in 2022 as all the unvaccinated get vaccinated.

Investment Conclusions

While the spread of the delta variant has dented near-term growth, better days are ahead as we all get vaccinated. We are enthused by the long-term opportunity to significantly improve S&P operating margins, earnings, cash flow, and returns on invested capital as corporations’ benefit from the surge in their technology spending on all aspects of their business and finances. We know that it is hard to be a long-term investor due to the daily news sound bites and volatility, but that is just what you should do, a la Warren Buffett, the most significant investor of our time. While we continue to be overweighted in technology, the best long-term opportunities will be the value/economically sensitive companies that will benefit from all their tech spending over time.

The Pause that Refreshes

The financial markets are under pressure as the economy slows due to the increase in Delta variant coronavirus cases while the Fed considers tapering, which makes no sense. Why would the Fed change policy now as retail and housing activity is slowing, consumer confidence is falling, commodity prices are declining, the dollar is rising, and high-frequency data is flattening out?

It is also important to note that Biden’s popularity is dropping as his domestic and foreign policies falter, impacting his administration and investor confidence. Hence, his party sorely needs a victory-like passage of the traditional infrastructure package currently being held hostage by Pelosi in the House. Adversity creates opportunities for investors willing to look over the valley. We expect the Delta variant wave to peak within the next few weeks as vaccinations ramp up as the FDA formally approves the vaccines and the CDC permits booster shots for all. Near-term growth is slowing, but that does not change our longer-term view as we get our arms around the coronavirus; monetary and fiscal policies remain accommodative; and excess liquidity continues to build, especially during the current period. While the market is focused on the near-term economic weakness and Fed tapering, we will be adding to the economically sensitive and opening stocks discarded over the last few weeks. We view this as the pauses that refresh. Remember that tapering is not tightening, and we still do not expect the Fed to hike rates until mid-2023.

The key to future growth is to vaccinate the unvaccinated and give booster shots to increase immunity against all variants. Daily vaccinations are rising dramatically as the number of cases/deaths increased over the last few weeks, causing businesses to delay opening and demand vaccinations for all before even considering the return to the office. Masks again are being emphasized to reduce the spread of the variant. All of this has slowed the recovery here and abroad. More than 4.85 billion doses have been administered globally across 183 countries at an increased daily rate of 37.3 doses per day. In the U.S., 360 million doses have been given so far at an increased rate of 823,355 doses per day, a significant increase over the last few weeks. It appears that over 75% of the U.S population will be vaccinated over the next few months, and it will take six months to hit the same level of vaccinations abroad. Booster shots will be recommended for most Americans 8 months after vaccination to boost the immune system against all variants. Fortunately, Pfizer, Moderna, J&J, and others will have over 7 billion doses in 2022 to handle all contingencies. Scott Gottlieb, MD, who has been the most accurate source on the virus, believes that cases will peak within the next month following the course in England and Israel. That is good news and supports our view that the economy will be back on track in the fall, reaccelerating into 2022.

Market participants are concerned that the Fed may begin tapering shortly after having read the Fed notes from the previous meeting along with comments from a few Fed governors. It appears that the Fed is evenly split on moving sooner or later; however, Chairman Powell will be the deciding force in the ultimate decision. We find it hard to imagine that the Fed would begin tapering anytime soon. Recent data points suggest a slowing economy impacted by the increase in Delta variant cases and deaths. The key will be future data points, especially employment and inflation levels. While employment will continue to increase as companies try to fill positions, inflation data at the margin will improve sequentially as shortages and supply lines improve. We have not altered our view that the Fed will announce tapering in the fall, begin tapering early next year, end tapering by year-end, and begin hiking the Federal Funds rate in small increments by mid-2023. We want to remind you that tapering is NOT tightening, and the Fed intends on rolling over its existing huge portfolio, which means that they will be actively buying all the time. Jackson Hole is likely to be a non-event as participants will continue to say that Fed policy is data-dependent, and the fact is that recent data has weakened as the variant spread. We are glad to hear that support is increasing to keep Powell as Fed Chairman.

Biden and his administration are under pressure as the number of coronavirus cases has increased, the economy is slowing, his agenda is not moving forward, and his actions in and around Afghanistan were a disaster. As he said, “the buck stops here!” He needs a victory, so we expect him to push the traditional $1 trillion Senate passed infrastructure bill in the House. The Democratic party hopes to approve the bipartisan infrastructure bill and a $3.5 trillion social infrastructure bill next week. Still, we see significant resistance building against tying one to the other. Biden and his party sorely need a victory as their chances in the 2022 and 2023 elections are rapidly diminishing, so we expect them to vote for the traditional infrastructure first to give them a win.

Recent economic data points are a mixed bag as the rise in coronavirus cases has slowed economic activity from its current torrid pace: retail sales and housing starts declined in July; builder confidence fell to a 13-month low; housing starts fell more than expected; high-frequency data has flattened out; credit card usage has declined, and commodity prices are falling but on the other hand unemployment claims have continued to fall; July leading indicators increased and industrial production was robust in July before the surge in cases. Goldman and other economists have reduced their third-quarter growth estimates significantly while increasing their inflation forecasts as it is taking longer to alleviate shortages and shorten supply lines. The chip crisis alone is expected to cut auto output by 7.1 million cars this year. Also, the largest port in China is closed due to the virus, and it won’t come on stream for several weeks. All of this is transitory once we get our arms around the virus outbreak, which we expect over the next month or so.

Growth overseas is under pressure, too, due to the spread of the Delta variant. China’s economy is faltering as factory output, retail sales, and fixed investment growth has slowed as coronavirus outbreaks and floods have disrupted business operations. Governments everywhere are stepping up vaccinations and increasing fiscal stimulus, which will support growth later in the year into 2022. For instance, India just announced a 1.4 trillion-dollar infrastructure plan. We expect China and other countries to follow close behind.

Investment Conclusion

We consider this the “pause that refreshes.” Governments and monetary authorities must reset as their economies are slowing due to the outbreak of the Delta variant. We expect a sharp reacceleration in growth here and abroad as we put the coronavirus in the rear-view mirror. It will take longer to end shortages and replenish supply lines, but it will happen as we move forward in 2022, boosting growth and lowering inflation. Investors are focused on the current slowdown and have shifted their portfolios to growth, tech and consumer non-durables with steady earnings and rising dividends. We did the same thing , but are now focusing on the value, economically sensitive stocks, which got hammered creating real opportunities for investors as we see an acceleration in growth as we put the virus behind us.

Think Globally in 2022

While U.S economic growth will slow incrementally from its current torrid pace, global growth will pick up as we enter 2022. Economic growth from other parts of the world will accelerate as coronavirus/delta variant cases decline.

We will still see above-average growth in the U.S next year supported by continued accommodative monetary policy, additional fiscal stimulus, and vast amounts of excess liquidity still throughout the financial system. Getting vaccinated remains the key to growth both here and abroad. We remain optimistic. Pfizer, Moderna, J&J, and others will have over 6 billion doses available next year to handle all contingencies, including booster shots which we expect to be recommended by the CDC and other medical authorities abroad. Think globally when investing as opportunities for multinational companies are improving, benefitting as supply lines shift and production rates sustain well above demand as inventories are replenished to normal levels, which may take until the second half of 2022.

Part of our thesis is to leverage improving operating margins and well above average cash flow generation, which will lead to record levels of dividends and stock buybacks in 2022. We continue to favor the producers and tech companies as we see several years of above historical growth rates and returns on invested capital which will support higher valuations down the line. None of this happens overnight. Patience is needed. So far, all the data points support our view.

The race to vaccinate the unvaccinated continues around the world. More than 4.56 billion doses have been administered across 183 countries at a rate of 39.1 million doses per day. In the U.S., 353 million doses have been given at an average rate of 729,000 per day, which is up meaningfully from last week. We expect the FDA to change the status of these vaccines from experimental to fully accepted within a few weeks, which should accelerate vaccinations. Corporations and government agencies now insist that their employees get vaccinated before returning to their offices which is good news. We believe that the CDC will recommend that we all get booster shots to enhance our immune system against all virus variants. We will likely get annual boosters, much like the flu vaccine. If the acceleration in delta variant cases follows the course, it should peak in the states and other countries within a few weeks.

Some members of the Fed, like the Dallas Fed President, have called for the Fed to announce their intent to taper bond purchases in September. We find that highly unlikely as the outbreak of the Delta variant has begun to penalize parts of our economy in areas such as travel, hospitality, and consumer confidence. The recent moderation in the CPI reported last week was due to declines in the used car, and travel prices support the Fed’s view, ours too, that near-term above-average inflationary pressures will be transitory and will recede during 2022. Nonetheless, suppose we get our arms around the Delta variant. In that case, we expect the Fed to announce that they will begin tapering early 2022, complete tapering by the end of 2022, and will begin hiking the Fed funds rate in small increments by mid- 2023. Remember that tapering is not tightening, and we expect the Fed will maintain its overly accommodative stance for years. Expect Jackson Hole to be a non-event as the Fed will emphasize the recent rise in coronavirus cases, the moderation of the CPI, and the change in consumer confidence as justification for its wait-and-see policies. The outbreak affects all of us and the Fed, too, who would rather be late to tighten than too early.

While the Senate passed the $550 billion traditional infrastructure bill by a 69-30 vote last week, it will be a long and challenging road to passage if Pelosi and the left-wing Democrats hold it hostage to the vast $3.5 trillion social infrastructure bill. The House will not come back into session until September 20th. The Senate also passed the blueprint for the $3.5 trillion social infrastructure bill without specifics. Fortunately, Senator Manchin objects to the bill's size and the “grave consequences” of such spending on the national debt as well as the country’s ability to respond to other potential crises. We continue to doubt whether Congress would pass a social infrastructure bill anywhere close to $3.5 trillion with attendant tax increases that impede future growth, investment, and employment. In addition, the Dems are running a substantial risk by pushing their far-left agenda and are therefore likely to lose control of the House next year.

While the domestic economy continued to improve over the last few weeks, most recent data points like credit card usage and consumer confidence have weakened considerably due to the rapid rise in Delta variant coronavirus cases. Most of the data collected were before the outbreak increased, so it must be taken with a grain of salt: unfilled job opening hit a record of 10.1 million jobs while there are 5.7 million remaining unemployed; median single family-existing home sale prices rose 22.9% in the second quarter; jobless claims fell to a seasonally adjusted 375,000 in the week ended August 7th; the core CPI was lower than expected rising at an annual rate of 4.3% down from the previous month as used autos, apparel and airline ticket prices were weaker than anticipated. The PPI came in hot, increasing 1% in July and up 7.8% from a year ago. The real shocker of the week was that Consumer Sentiment fell to 70.2 in August vs. 81.2 in July; current economic conditions fell to 77.9 vs. 84.5 prior; consumer expectations fell to 65.2 vs. 79.0, and inflation expectations rose to 4.8% vs. 4.7%. Do you think the Fed will even talk about tapering with the Delta variant still increasing, causing consumer attitudes to fall? Doubt it! But this too shall pass.

We would also expect economic data to weaken slightly overseas until the number of Delta coronavirus cases peaks. All of this will reinforce overly accommodative monetary and fiscal policies, even in China, which will lead to an even stronger 2022.

Getting vaccinated is the key to growth here and abroad. Fortunately, there will be enough doses available to vaccinate everyone by the end of the first quarter of 2022. We continue to see a synchronous global expansion beginning next year that could last for years supported by monetary and fiscal stimulus.

Investment Conclusions

The increase in delta variant coronavirus cases may alter the near-term growth trajectory but not our positive longer view. We have never seen an environment with so much monetary and fiscal stimulus with more to come in 2022. RULE ONE: If liquidity creation exceeds uses, the excess liquidity will force investors further out on the risk curve into financial and hard assets. We certainly saw this in 2020 as well as this year too. This won’t change anytime soon due to the outbreak in Delta cases. We continue to favor the global producers and tech companies as shortages are alleviated, inventories are replenished and supply lines are brought closer to home, boosted by trillions of additional infrastructure spending. Don’t forget our view that margins, earnings, cash flow, dividends, buybacks, and ROIC will surprise on the upside for 2022 and 2023.

The Other Side

The outbreak of the Delta variant has taken us by surprise. Still, it will not stop the global economy from expanding rapidly in 2022 thru 2023 as the number of vaccinations increase, and cases decline over the next year. Pfizer and Moderna will have over 5 billion doses of 90+% effective vaccines for the delta and other variants available in 2022 and more, if needed, in 2023. Other companies will have billions of doses of less effective vaccines available, but they still will be sufficient to reduce hospitalizations and deaths, which is good news. Remember that the annual flu vaccines we take usually are only 60% effective, giving you an idea of how successful our drug industry has been in getting a highly effective vaccine for the coronavirus.

We must applaud how governments and monetary authorities responded to the virus by providing financial assistance and flooding the system with trillions of liquidity to get us to the other side. There was much more liquidity provided than needed by the economy, such that investors were forced out on the risk curve, which led to much higher prices for stocks, commodities, and other assets. Today, we remain with a record level of individual savings, including $5.1 trillion in money market funds, and corporate balance sheets have never been stronger. Corporate buybacks have exceeded $683 billion to date this year, the second highest on record, while dividends have started to increase meaningfully too. Even though the S & P is up over 38% over the last year, the dividend yield on the market still exceeds the 10-year treasury rate. There is no reason the market multiple can’t sustain in the low 20s if rates stay below 2% and capital/liquidity ratios remain so high. In addition, we expect S & P earnings to increase from $140/share in 2020 to over $205/share in 2021 and further to $225+/share in 2022 as operating margins increase from 10% to nearly 13% over that time frame. While the market could correct at any time, we see higher prices ahead over the next eighteen months. It’s worth noting that Buffett’s key valuation metric, earnings yield versus treasury yield, continues to support the stock market valuation. It won’t hurt that we will have additional fiscal stimulus and continued easy monetary policies over this period.

The key to controlling the outbreak of the coronavirus, including all variants, is getting vaccinated. This has turned into a pandemic of the unvaccinated. The biggest vaccination campaign is underway, with more than 4.31 billion doses having been administered across 180 countries, with the latest rate at roughly 42.5 million doses per day. Three hundred forty-nine million doses have been administered so far in the U.S., and the daily rate has increased to near 700,000 doses per day. These global run rates mean that it will take less than six months to cover 75% of the world, enough for herd immunity. We expect the FDA to formally approve both vaccines by early September, which should go a long way to convince the unvaccinated to get vaccinated. We continue to believe that we will all get booster shots to enhance our immune systems, and this may become an annual affair, much like the flu vaccine. Fortunately, Moderna and Pfizer will have sufficient supply to handle all of this as we move forward to the other side, putting the coronavirus in the rearview mirror.

While the debate about Fed policy has gotten louder, we still believe that the Fed will hold the line providing an overly accommodative policy thru 2022 into 2023. The key to future Fed policy hinges on when employment returns to pre-pandemic levels and whether the increase in inflation, currently well above 2%, moderates in 2022 as shortages end and supply lines issues go away. While this level of inflation may be transitory, we still expect inflation to run well above 2% for all of 2022 before going down further in 2023. We continue to believe that the Fed and all global monetary bodies want their economy to run hot rather than taking the punchbowl away prematurely. The Fed is likely to openly debate tapering at Jackson Hole later in the month, comment further that tapering is on the way in the fall, begin tapering in $40 billion increments thru 2022, end tapering by early 2023 and begin hiking rates in small increments by the summer of 2023. All this hinges on the economy continuing to strengthen over the next 18 months, employment continuing to increase, and inflation moderating as we move through 2022. We expect employment levels to disappoint and long-term inflation to stay contained as corporations have learned to do more with less accelerating technology spending that will increase productivity and hold down unit labor costs.

The Senate is likely to pass its $550 billion infrastructure bill this weekend. Still, its fate in the House is doubtful if Nancy Pelosi holds it hostage to the vast $3.5 trillion social infrastructure spending bill. We are totally for the traditional spending package as we need to upgrade our roads, bridges, electric grid, ports, rail system, water system, and broadband. While the CBO said that this package would add $256 billion to the deficit over ten years, we doubt that to be accurate as they did not use dynamic scoring nor full credit for some of the offsets. The proposed $3.5 trillion social infrastructure bill is another thing, and while some of it has its merits, including some tax increases, the sheer size and scope are far too large, and the pay for would damage our economy. We do not see the Senate passing a budget resolution and reconciliation bill before summer break so that it will carry over to the fall. Hopefully, Senator Manchin can hold his ground and force the Democrats to moderate their social spending plan. If not, and it passes by the end of the year, we believe that the Dems will lose control of the House in 2022.

Economic data has continued to be strong in July, although most of the data were collected before the severe outbreak of the Delta variant. An essential report was Friday’s employment report which showed that jobs increased by 943,000 after an upward revision to June to 938,000. The labor participation rate was 61.7, average hourly earnings rose 0.4%, and the workweek was unchanged at 34.8. It is important to note that the 10-year treasury rose from around 1.20% to near 1.30% by the end of the week. This is good news. Other data points reported were initial unemployment claims fell to 385,000; the trade deficit rose to $78.7 billion as imports increased by $6 billion due to the strength of the domestic economy; there are over 9.2 job opening while only 8.7 million are unemployed; the July PMI hit a high of 63.4; construction spending rose 1.2%; the Manufacturing PMI was 59.5 as backlogs rose significantly; new orders for manufactured goods increased 1.5% while unfilled orders increased over 1%; and the Services PMI was a strong 64.1, the highest reading ever. Again, most of this data was collected before the acceleration in the pandemic outbreak, but it certainly shows an improving economy.

Economic data points have improved abroad too, but that is before the acceleration in coronavirus cases. Specifically, the July Eurozone Manufacturing PMI was at 62.8 while new orders and hiring accelerated too; Eurozone composite output index was 60.6 while services was 59.8; Japan’s July Manufacturing PMI rose to 53.0; India’s output, new orders, and exports all returned to expansion in July after contracting over the last several months; and China’s business activity index rebounded to 54.9 in July from June’s 50.3. All of this is excellent news as we are just starting to come out of the pandemic abroad, except China which began its recovery last year.

Investment Conclusion

The key to future growth hinges on vaccinating all the unvaccinated. We are confident that there will be enough doses available to vaccinate the world over the nine months. The global economy can then commence a synchronous expansion like we have not seen in a decade, as it will be supported by continued easy monetary policies with additional fiscal stimulus. Don’t forget that we are beginning this expansion with trillions of excess liquidity throughout the global financial system. We continue to favor the economically sensitive areas of the market and technology as both have entered long term cycles with above-average growth, earnings and cash flow potential.

Better Days Ahead

While we are amid an increase in coronavirus cases around the world due to the highly infectious Delta variant, a successful investor will look over this valley, analyze the future landscape, including monetary and fiscal policies, do research on industries and companies looking for positive and negative incremental change and invest accordingly.

This is not a replay of one year ago. We now have vaccines and therapeutics to protect against the virus and help us get better should we contract it. The key is for all of us to get vaccinated so that we reach herd immunity such that we can all return to life as it once was before the virus. We see better days ahead as we get our arms around the Delta variant. Yes, the timing and speed of the global recovery may be altered by the increase in cases. Still, we remain confident that we will have a multi-year global expansion beginning next year supported by accommodative monetary and fiscal policies. We continue to favor the production side of the economy as we envision years of stepped-up capital spending to alleviate shortages while shortening supply lines. Inventories are so low (supported by 2nd quarter GNP data), it may take until the second half of 2022 to return to normal levels.

Technology will remain a mainstay in our portfolios. We are still in the early innings of a technological revolution where companies must spend to stay competitive and be cost-efficient. While we could always have corrections, the conditions for the market top are not present. Don't forget the trillions of excess liquidity in the financial system combined with accommodative monetary and fiscal policies. We still expect the yield curve to steepen slowly over the next year, but it is held back by massive inflows from abroad, where rates are negative.

We need to get all vaccinated to protect ourselves and each other. It is time that the FDA approves the coronavirus vaccine so that it is no longer labeled as experimental. We also need clear and consistent messaging from the CDC as to how best to move forward. The CDC reversed course last week on some masking guidelines, recommending that even vaccinated people return to wearing masks indoors in parts of the U.S., where the Delta variant is surging. Many companies have shifted their policies to recommending the use of masks in their stores and offices.

More than 4.02 billion doses have been administered across 180 countries, with the latest run rate at approximately 39 million doses per day. In the U.S., 344 million doses have been given at an average rate of 615,404 per day. We still expect the U.S. to reach herd immunity by September and by spring 2022 for the rest of the world, which is consistent with our view that we will have a synchronous multi-year global expansion beginning in 2022 supported by accommodative monetary and fiscal policies everywhere.

The Fed met last week, and there was no change in their monetary policy as expected nor its message that the economy is a way away from tapering despite "making significant progress to reaching its goals." Powell went out of his way at the follow-on conference call that tapering is now being discussed in earnest but that the officials want to see "more hiring before pulling back on bond buying." He added that the Fed could reduce mortgage purchases more than treasuries initially, which is what we expect to happen. We have not altered our view that the Fed will announce this fall that it will begin tapering by early 2022 and conclude all bond-buying by the beginning of 2023. Remember that tapering is not tightening, and the Fed will continue to maintain its balance sheet by buying bonds as they roll-off. We do not expect to see the Fed hike its funds' rate until mid-2023 at the earliest, which is a long time away, so don't fret. The Fed will remain our friend for a long time.

The Senate voted on Wednesday to move ahead with a $550 billion traditional infrastructure plan by 67-32. Among the projects to get the most money are $110 billion for roads, bridges major ad projects; $73 billion for electric grid upgrades; $66 billion for rail and Amtrak; $65 billion for broadband expansion; $55 billion for drinking water; $39 billion for transit; $17 billion for ports and $25 billion for airports; and $7.5 billion for electric vehicle chargers. The package would be paid for by re-purposing $200 billion in unspent covid relief funds, strategic petroleum reserves, and fees. The key for passage hangs on whether the Dems hold this bill hostage to the $3.5 trillion social infrastructure bill and reconciliation. We see the moderate Dems pushing for social spending of around $2.5 trillion funded with a hike in top-end individual and capital gains rates but far less than initially proposed, plus an increase in corporate taxes to no more than 25%. There will be much more stimulus from D.C. in the years ahead, supporting higher than historic economic growth rates.

The U.S. economy continues to be very strong despite shortages and supply line issues. Second-quarter GNP fell short at 6.5% annualized even as consumer spending rose 11.8% as inventories reduced growth by 1.1 percentage points while residential purchases reduced growth by 0.5 points. Personal savings was $1.97 trillion In the quarter, with an individual savings rate that remains elevated at 10.9%. Other essential data points reported last week include a drop in jobless claims to 400,000; new home sales rose 6.6% in June; the NABE Business Conditions Survey remained very strong in July; durable goods orders rose 0.8% in June while unfilled orders increased 0.9%; inflationary expectations are falling; the Shiller price index for homes rose an astonishing 16.6% in May year over year, and consumer confidence remains elevated at 129.1. The dynamics of the U.S economy continue very strong and will only get better as more people get vaccinated, shortages are alleviated, supply line issues are solved, and additional stimulus is passed.

European growth rebounded sharply in the second quarter as businesses reopened. Output in the 19 nations increased by 2%, beating estimates. Interestingly Germany was the only country to disappoint, expanding by 1.5%. Shortages and supply line issues hamper growth here, too, but that should improve as we move into 2022. China's economy continued its stable pace of recovery in July, and officials are optimistic of hitting its 8% growth target for the year, especially after monetary conditions were recently eased. China's Politburo pledged more support for its economy yesterday as well as more IPO oversight.

Interestingly investors added nearly $4 billion into Chinese stocks last week despite all the negative press on increased oversight of the tech leaders. We found it interesting that China is looking to raise tariffs on its domestic steel supply to curb prices. That will undoubtedly help our steel companies.

We remain confident that the global economy is on the cusp of a synchronous economic expansion that will last many years as we put the coronavirus in the rear-view mirror. In addition, there will remain an unprecedented level of monetary and fiscal accommodation supporting above historical average growth rates.

Investment Conclusions

We continue to favor the economically sensitive areas of the market as we see the need worldwide to increase capacity after years of underspending to alleviate shortages and bring supply lines closer to home. All of this excludes the benefits of significant government-funded infrastructure spending plans over the next several years. Heightened technology spending will remain strong for many years to stay competitive and reduce costs. We remain impressed how well corporations have navigated the challenges due to the virus and are coming out more profitable and generating more free cash flow than ever before.

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