Apr 10, 2023

Investment Update

As a new member of the Meritage Investment Team, I will take the opportunity of composing the quarterly Investment Update and to introduce myself. You may recall from our December holiday note that I recently joined the firm in the dual role of Co-CIO along with one of our Founders, Mark Eveans, and Co-Manager with Len Mitchell on the Growth Equity strategy.

I am a Kansas City native and a career investment professional, most recently having spent over 30 years with Waddell and Reed/Ivy Funds. I am excited to be a part of Meritage and to work with a team of like-minded professionals. I look forward to meeting you in the coming months, as well as helping to further develop and strengthen the relationships you have with Meritage.

In the meantime, I will be contributing to the investment strategies and client correspondence on behalf of the Investment Team. You will also continue to hear views and perspectives from other team members as you have in the past.

A Positive Start

The first quarter finished with a strong showing for growth stocks, with significant help from the mega cap tech stocks, and a generally positive showing for the rest of the equity and fixed income markets in general. That said, a lot sure happened during the quarter. The list is long so here are a few items, not in order of importance but rather to highlight a critically important point later.

• Signature Bank and Silicon Valley Bank FAILED. Bad management, poor government oversight, the Federal Reserve, the Silicon Valley venture capital community – they are all getting blamed. Who’s at fault? Lots of finger pointing going on. It matters so we can work to make certain to avoid future failures. The point here is, two large, well known, U.S. financial institutions that were seemingly not an issue, read “healthy”, FAILED.
• As Federal Reserve Chairman Jerome Powell said at Jackson Hole in August of last year “without price stability, the economy does not work for anyone”. We saw the Fed Funds rate increased twice by a quarter point to the 4.75% to 5.00% range. Remember, as recently as the first quarter of last year the Federal Funds Rate was around 0.00% (yes, ZERO), FREE money. Always sounds good, usually does not end well. And this has been going on for a decade or more. While the rate of inflation is slowing, costs and prices are generally still on the rise. Inflation is still with us.
• We are just over a year into the Ukraine War. China is finally reopening post pandemic and continues in its global efforts to get other nations to look east for bilateral trade. At the same time, the United States and Europe look to strengthen and diversify global supply chains to lessen their reliance on China. Thinking this will continue to be disruptive.
• And how can we not say something about AI, artificial intelligence. You might think this all started in November of last year when ChatGPT was introduced. Here we are in April, some six months later, already having access to ChatGPT-4. We know this did not start just six months ago. Back in the 1950’s the idea that computers will be able to THINK, say maybe beat a human at a game of chess, was already in the works. More recently, we’ve seen the ability to automate customer service and other routine tasks with certain words and phrases; opportunities to accelerate drug development, send robots instead of humans into high risk, read DANGEROUS situations, accomplish all sorts of tasks better, faster, cheaper. It was not that many years ago when we were all so very impressed when a GOOGLE search yielded over a million answers in 0.13 seconds. Personally, I was always just wanting a couple of really relevant and helpful answers, even at the expense of a few seconds.
• With the advent of ChatGPT from Open AI and other AI engines, the ability to intelligently go through MASSIVE amounts of data almost instantly (thank you, semiconductors) and to now create thoughtful, relevant, and helpful information and insights, will change life as we know it. While we are in the midst of the hype cycle now, there will be many long-term opportunities for investors to participate in this revolution. We are on the front end of this.

Outlook 

So, where does that leave us, and more importantly, how do we suggest moving forward? With inflation driven by a still tight labor market, higher raw material costs, and rising interest rates, the cost of doing business is going higher.

Our macro process, despite the recent market strength, continues to strike a cautious tone suggesting a weaker economic environment. This, and higher costs, are two of a number of factors contributing to what we believe will be downward earnings revisions and lower P/E’s (price to earnings ratios) for stocks. This suggests more downside risks for stocks before the cycle is over. An inverted yield curve, where short term interest rates are higher than long term interest rates, will continue to create issues for some while at the same time provides a safe place for monies not dedicated to the equity markets in the near term.

Many market, macroeconomic and geopolitical pundits alike, ourselves included, have used words and phrases like gradual transition, evolution, and trending, all suggesting a metered and measured tone to things in the world. A nice cadence if you will. Recent history has made a strong case that this is not the roadmap going forward. More likely is a world characterized by constant change and heightened volatility. People and institutions alike, generally, do not do change well.

While there is good reason to be cautious, our bottom up quantitative investment process continues to selectively find some compelling equity investments in the areas of growth, value, and yield. And of equal importance is identifying the kind of investments we want to avoid. Despite all the uncertainty and volatility, the Fixed Income team is excited to have interest rates above zero and are selectively finding their own compelling investments in the treasury, corporate, and municipal markets. We believe the discipline of our process-driven methodology gives us the best opportunity to manage through what promises to be a more complex environment ahead.