​September 2022
 
Let’s cut right to the chase.  Ouch.  Tough month.  Tough quarter.  Tough year.  We keep hearing “lowest since….” in regard to the stock market and “highest since…” regarding interest rates.  Inflation has been the story of the year.  We have begun to see signs that inflation may be moderating.  Until it drops significantly though, we are going to see continued interest rate hikes. Just to remind you of where we are, the official measure of inflation topped out at 9.1% on an annualized basis in June.  We have seen a small tick down in the inflation rate to 8.5% in July and 8.3% in August.   That is still an inflation rate we have not seen since early-1982.  This has been the big disconnect that is driving much of the volatility in the markets. 
 
Many traders are saying – hoping, actually – that this small tick down in the rate of inflation will cause the Federal Reserve to pause interest rate hikes.  Some even go so far as to talk wistfully of the Fed “pivoting” – that is, actually cutting interest rates because they have gone too far.  Every member of the Federal Reserve Board has been clear that cutting interest rates is not even on the table for discussion.  At best, we can expect one or two more interest rate hikes and then a pause to see how all of this filters through the economic system.  In other words, once the Fed funds rate – the interest rate that banks pay to borrow money overnight and that largely determines other interest rates in the system – gets into a range of 4% - 4.5%, we can expect the Fed to perhaps stop raising rates for some brief period.
 
What does all this mean to us as investors?  I am firmly in the camp of “listen to the Fed”.  Fed Chairman Jerome Powell has been clear that inflation is their key problem, and they will not back off until the inflation rate is back down to something close to 2% on an annual basis.  My personal belief is that they might be okay with an inflation rate between 2% and 3% per year, but that is still a long way off from the current 8.3% annual rate.  This means we can expect interest rates to continue to rise.  The current Fed funds rate is currently around 3.25% per year.  I think we will see this at a 4.5% annual rate by the end of December.  Higher interest rates are generally not great for stocks for several reasons. 
 
The simplest reason higher interest rates are bad for stocks in general is that investors have an easier choice.  When it comes to investing, the goal is to earn a return on your investment.  When interest rates were essentially zero, there was no alternative.  Investors we forced to buy stocks either for their growth or their dividends or both.  When investors can earn a reasonable interest rate on a bond investment, they now have choices.  Do they buy a bond that pays a guaranteed interest rate of 4% or 4.5% or 5% or do they buy a stock that pays a dividend of 2% and may grow in value over the next year?  With choices like that many investors, especially more risk averse investors, will sell stocks and buy bonds.  This leads to stock prices falling. 
 
Another key reason for higher interest rates being bad for stocks is what we call the “discounted future value” of stocks.  Pardon me if I get a little math geeky for the next paragraph or two.  A share of stock represents ownership of a business and a claim on any current and future earnings of that business.  We invest in businesses that we anticipate will grow over time providing more cash to investors.  However, one dollar earned next year is not worth the same as one dollar today.  Why?  We can take the one dollar we have today and deposit it in a bank and earn interest on that dollar.  The more interest we can earn, the less one dollar one year from now is worth to us today.  For example, if we can earn 5% interest annually today, we could invest $100 today and end up with $105 in one year.  Conversely, if we wanted $100 one year from now, we would only need to invest about $95.24 today earning 5% interest to end up with $100 in one year. 
 
This is a concept called ‘discounted cash flow’ and is the basis for how many investors value a stock today.  These investors will estimate how much cash the company will generate per share into the future.  They will then discount those cash flows back to today to arrive at what is known as the ‘present value’ of these future anticipated cash flows.  This is where interest rates come into the picture.  The higher interest rates are on safer investments like Treasury bonds, the higher the interest rate an investor will demand on a stock to make the risk worth investing.  If I can earn 4% per year buying a Treasury bond which is backed by the U.S. government, I may decide that I need a 10% return to take more risk and buy a stock that may or may not continue to grow into the future.  Going back to the $100 above, if I determine a company is going to return $100 in the future and I discount that at 4%, I am willing to pay $96.15 today for that stock.  However, if I require an 10% return to entice me into buying a stock, I would only be willing to pay $90.91 for that stock today to have $100 in one year.  Apply this same concept across all stocks.  When interest rates were zero, stocks were worth just about anything you were willing to pay.  As interest rates increase, the “discounted” value falls. 
 
Given this set-up, stocks are likely to fall a bit further.  However, I am not expecting a dramatic tumble.  I truly think the worst is behind us.  In part, I believe some of the expectations for higher interest rates are already reflected in current stock prices.  What is not reflected is that investors really have no idea how far interest rates will increase.  I have been saying now for a while that the stock market is seemingly stuck in a range between 3,600 and 4,200 as levels of the S&P 500 Index.  The index closed just below this at the end of September.  I believe investors are expecting the Fed to cut interest rates by another 0.75% in November.  The big question is will they also cut in December and by how much.  This is what could portend some additional volatility and lower prices by the end of the year.  I think this would be short-lived, though as the likelihood is that the Fed will then pause interest rate hikes to see what effect all their work has had on reducing inflation.  That is part of the problem with these hikes.  They take a while to filter through the economic system and affect the inflation rate. 
 
How are we dealing with this volatility given our expectations?  We have already taken several steps and anticipate several more along the way.  In part, we are using the volatility and lower stock prices as a good buying opportunity.  We have added to a few current positions in addition to adding a few new positions and eliminating others.  We added to our holdings in two mutual funds.  One is the Applied Finance Explorer fund (ticker: AFDVX) which invests in smaller company stocks.  We also added a little bit to our Janus Henderson Contrarian fund holdings (ticker: JSVAX) which invests in mid-sized companies.  As the markets fell, we added a little bit to our holdings in Berkshire Hathaway class B shares (ticker: BRK.B) when the stock fell below $300 per share.  This stock may be classified as a “financial service” company based on its insurance businesses, but it almost qualifies as what used to be known as a conglomerate that touches everything from boots to ice cream to bricks and railroads.  In addition to the myriad private companies Berkshire owns, there is also an extensive stock portfolio as well making this holding a hybrid between an insurance company, a conglomerate or holding company and a mutual fund. 
 
We added several new positions this last quarter, several of which should take advantage of higher inflation and interest rates.  We added two stocks of companies that are primarily fertilizer companies.  We bought CF Industries (ticker: CF) and CVR Partners LP (ticker: UAN) to take advantage of elevated food prices and production.  We also added two new positions to take advantage of rising oil prices.  We shifted away from the oil ETF we had traded earlier in the year to a couple of individual oil company stocks.  The first we added was PDC Energy (ticker: PDCE) which is an oil and gas exploration and production firm.  We were starting to evaluate more oil companies as potential investment opportunities when we chose to simplify things and bought the SPDR Oil & Gas Exploration and Production ETF (ticker: XOP).  This is a mutual fund that invests relatively equally across all the stocks we were looking at for this space which simplified this investment for us.   While we readily acknowledge climate change is a real issue, it has become clear that we are not ready to flip a switch and turn off fossil fuels and turn on alternative energy.  We need time to get there and, in the interim, oil and natural gas will continue to be viable and profitable.  We also added another shipping company, Star Bulk Carriers (ticker: SBLK) to our holdings.  This company should continue to profit from the continuing supply chain disruptions though revenues may fall a bit should we have a global recession. 
 
We also added two investments that will take advantage of rising interest rates.  One is the Wisdom Tree Floating Rate Treasury ETF (ticker: USFR) which is a mutual fund that buys Treasury bonds with interest rates that adjust up or down based on the prevailing interest rates in the economy.  This is another safe place for us to park excess cash and still earn a little bit of a return on our money.  This fund has an annual dividend yield around 2.5% with dividends paid out monthly.  We also added shares of the Invesco DB U.S. Dollar Bullish fund (ticker: UUP) which is a mutual fund that trades foreign currencies.  When interest rates rise in the U.S., foreign investors will typically want to buy our government bonds which pay a higher interest rate then their own bonds.  In order to buy our bonds, foreigners need to sell their currencies and buy U.S. dollars.  This drives up the value of the U.S. dollar which is what this fund exploits. 
 
We eliminated a few positions over the quarter for various reasons.  We sold out of consulting company CRA International (ticker: CRAI) with just over a 10% return.  We eliminated Activision Blizzard (ticker: ATVI), which has an offer to be bought by Microsoft.  The merger seems to be running into some regulatory issues, and we chose to step back, taking a small 4% loss.  Should the regulatory picture become clearer, we may return to this stock.  We also sold out of two companies closely tied to the homebuilding industry.  We sold our shares of timber real estate company PotlatchDeltic Corp (ticker: PCH) as the price of lumber continues to fall.  We also closed out homebuilder Tri Point Group (ticker: TPH) as rising interest rates make this holding more of a “value trap” than a value currently.  The Tri Point Group still has value but rising interest rates will likely hamper growth for the next year or two.  We figured we could always revisit this stock when we think interest rates are going to start coming back down.
 
We are continuing to review new investment opportunities and have several new funds and individual investments that we are vetting for risk and potential returns.  These challenging times mean we have to seek out creative solutions.  Some of these solutions we have already implemented, such as the Wisdom Tree Floating Rate Treasury ETF.  This investment is a good short-term solution to rising interest rates but once interest rates peak, we will probably shift much of that investment to bond funds that offer a higher yield.  Rest assured we are doing our due diligence before committing client money to any new investment idea. 
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com

​July 2022
 
It would seem that everything old is new again.  We are back to inflation rates that we have not seen since 1982 which caused the Federal Reserve to hike interest rates in June by 0.75% which was the largest rate increase since 1994.  This has led to the worst first six months start to the stock market since 1970.  In addition to high inflation, there are signs that we may technically be in a recession currently.  Economists define a recession as at least two consecutive quarters of negative growth in an economy.  For the first quarter of this year, our GDP or gross domestic production, which is the measure of the growth of the U.S. economy, fell at a 1.6% annualized rate.  Early estimates for the second quarter, which will be released around the end of July, indicate the economy may have contracted at an annualized rate of 2.1%.  If that is the case, then we are technically in a recession. 
 
If we are in a recession, this could help the Federal Reserve out with taming the current high inflation rate.  There is an old maxim on Wall Street that the best cure for high prices are high prices.  This makes some sense as people will tend to cut back on spending when prices jump which eventually causes prices to come back down.  The expectation though, is that the Federal Reserve will continue to be aggressive in raising interest rates as their means to combat an inflation rate that is currently running around 8.6% annually.  However, if inflation drops off rapidly, which it could do from the combination of higher interest rates and a recession, the Federal Reserve won’t need to raise interest rates as much as had been expected.  In fact, the expectations for how far the Federal Reserve will raise their benchmark Fed funds rate has fallen from around 3.8% in early June to about 3.2% currently.  There are some that even expect rate cuts in 2023, should the recession continue, and inflation be reined in.
 
In looking at past recessions and how the Federal Reserve responded, the only period that correlates to our current environment is the mid-1970’s.  The U.S. economy went into a recession in the first quarter of 1974 that lasted for about a year through the first quarter of 1975.  During that period, the Fed funds rate started at around 9.75%, rose to just over 13.3% before being cut back to around 5.5% by the end of the recession.  This was also the era of the oil embargo by the OPEC nations which started in October 1973 and ended in March 1974 but saw the price of a barrel of oil rise four-fold from $2.90 per barrel to $11.65 per barrel.  It was this oil shock coupled with easy money and a lack of fiscal discipline, especially around spending to fund the Vietnam War that pushed the U.S. economy over the edge into a recession.  While $11.65 per barrel oil seems quaint now, that would be the equivalent of oil at over $200 per barrel today.  Mark Twain once said that history does not repeat itself, but it does often rhyme.  This would be one of those cases. 
 
The current environment we find ourselves in has echoes of the 1970’s oil supply shock in the pandemic-induced shortage of just about everything.  Add to that the easy money of zero interest rates and the three stimulus checks given out to spur the economy during and post-pandemic and we have a similar situation to the mid-1970’s.  Much of the reason for the current oil supply issues revolve around oil companies dramatically cutting back on what is known as “capital spending” – the money they would spend to explore for and drill new wells or to bring old wells back on-line.  The key reason oil companies are reluctant to spend that money is a long history of “boom-bust” cycles in the oil patch.  It would seem the companies have finally learned their lesson not to ramp up spending just because oil prices have jumped.  In addition, even if more wells were brought back on-line, there is an issue with a lack of refineries to turn the oil into gasoline.  Currently, the refineries we have in the U.S. are operating at about 94% capacity.  The capacity that is not being utilized is due to maintenance and repairs being done to the facilities.  In fact, no new refinery has been built in the U.S. since 1977.  There have been upgrades to some older refineries over the years, but we still lack a capacity to refine much more oil into gasoline.  And no oil company is going to commit to a years-long project and spend over $1 billion to build another refinery of any size with the pressures of investors bearing down on them to reduce their carbon footprint and shift to renewable energy. 
 
All of this has led to a very tough investing environment.  The broad stock market fell over 8% in June alone taking the market down just over 20% for the year-to-date period and putting us in what is generally regarded as a bear market.  Making things more challenging is the fact that many investments that should have done well this year have not performed as expected.  You would think that mutual funds that invest in bonds that take advantage of rising interest rates would be knocking the cover off the ball right now.  Most are down between 1.25% and 1.5% for the year despite three interest rate hikes so far this year.  Even the mutual fund that invests in TIPS – Treasury Inflation Protected Securities or bonds that automatically adjust their value to protect holders from high inflation – lost over 9% of its value for the year!  This has affected our current lone bond holding, the Janus Henderson AAA CLO ETF.  This mutual fund, which invests in the safest short-term loans, has seen its dividend yield increase from around 1% at the start of the year to 2% currently.  However, the share price has fallen a little over 2% since the start of the year, which has dragged down performance. 
 
One of the few areas that has done well has been oil and oil stocks.  While we don’t own any oil stocks (yet), we did make some money by trading in this space.  We sold an option that obligated us to buy shares of Continental Development for $6 per share which we closed early, earning a 4.54% return in a month.  We also obligated clients to buy shares of Occidental Petroleum at $50 per share just before news broke that Berkshire Hathaway had taken a large 7% interest in the company and the share price jumped to over $60 per share.  We still earned a 3.2% return in a month on our investment.  We also made some trades in the United States Oil Fund LP ETF, a fund that is tied to the price of oil using futures.  Over the five-month period that we traded options in this fund, we earned between a 36% and 47% return without risking more than 1% of a client’s account. 
 
We do currently have options outstanding obligating us to buy shares of PDC Energy Inc. (ticker: PDCE), formerly Petroleum Development Corporation.  We are currently obligated to buy shares at $59.50 but given the premium we have collected our cost would be about $57.80 per share.  In addition, we have earned a 3.32% return from selling a previous option that expired worthless.  As much as we as a country need to make a shift to clean, renewable energy, we are not ready to make that leap just yet and oil and some oil companies will continue to do well for the next few years. 
 
We did add two new funds to client accounts this quarter.  We have tiptoed into the Applied Finance Explorer fund (ticker: AFDVX).  We have been familiar with Applied Finance group since shortly after we started our firm.  The Applied Finance Group began as a company selling research on companies to portfolio managers.  They eventually branched out into managing money and then started mutual funds.  The Applied Finance group has what I think is a unique approach to calculating the value of a stock.  They do not use traditional “value” or “growth” metrics that most mutual fund managers box themselves into using.  Instead, they look at what they call the “economic value added”.  That is, does the company they are evaluating create or destroy shareholder value.  They are looking for companies creating shareholder value.  This sort of approach is one that appeals to me and is similar to my methodology.  This fund invests in small companies.  We only have a small position currently but expect us to add more shares on weakness in the markets. 
 
We sold out of the BlackRock Mid Cap Growth fund this past quarter. While we did well in that fund, notching a 40% gain while we held it, this fund was becoming too risky in the current environment.  We began to move to the Janus Henderson Contrarian fund (ticker: JSVAX) for exposure to midsized company stocks.  This fund marches to the beat of its own drummer.  What I mean by that is the fund is happy to find value wherever it can rather than following a particular benchmark.  This has proven to be successful, leading to smaller losses during tough times and better returns during good times.  Again, we have just a small position so far, but expect us to continue to add to this on market pullbacks.
 
We did eliminate three holdings from last year, selling out of Hillenbrand Inc. (ticker: HI) with a 13% loss on this stock.  The company has been showing more weakness lately which prompted the sale.  We also closed out our Hologic Inc. (ticker: HOLX) position for a small 2.32% gain.  Our biggest success came with Sanderson Farms, Inc. (ticker: SAFM), one of the largest producers of chicken.  A partnership of Cargill and Continental Grain agreed to purchase Sanderson Farms for $203 per share in cash.  We originally purchased shares for around $189.70 per share at the end of December.  We expected to lock in a 7% return once the deal closed later this year.  However, in late-June, shares of Sanderson Farms were trading above the $203 merger price, so we sold our shares for just over $210 per share, notching an almost 12% return in six months.  Likely, the market is expecting the merger deal to be modified with additional funds from private equity to get around some governmental concerns regarding too much concentration but in the absence of a definitive deal, we will take the sure thing now. 
 
In addition to the PDC Energy stock mentioned above, we have sold options against several other stocks that we want to buy.  Why are we selling options rather than just buying the stocks outright?  The key reason is that we are taking advantage of the increased level of volatility in the market.  This increased volatility which arises from the uncertainty about what the market will do allows us to earn large premiums from selling an option that obligates us to buy the stock at a set price.  If the stock falls, we end up buying the stock but at a more favorable price.  If the stock doesn’t fall, we still make money from waiting – usually 2% - 3% on the amount we are setting aside for the purchase within a 30-day period. 
 
In our last quarterly letter, we suggested that, if you had excess cash that you could “lock up” for at least one year, you should look into buying a Series I Treasury bond.  This can be done by going to http://treasurydirect.gov and setting up an account to have money drafted from your checking or savings account to make the purchase.  You are limited to $10,000 in purchases per person per year for these bonds.  When we made this suggestion back in February, the I-bonds were paying a little over 7% interest on an annualized basis.  These bonds have their interest rate adjusted twice per year and a portion of the interest rate is based on the current inflation rate.  If you have not taken advantage of these bonds yet, now is a good time to consider them.  The current interest rate on these bonds will be about 9.62% per year.  For those of you that did take advantage of them earlier, you will get this same rate, so you are not missing out on anything.  Again, let me reiterate that you cannot redeem these bonds within the first year of purchase.  After one year and before five years, you can redeem them, but you will lose the previous three months’ worth of interest.  After five years, you can redeem them for their then current value, and they fully mature in thirty years.  We will continue to update you on these bonds.
 
We are currently holding more cash in client accounts than we normally would but much of that cash backs up many of the options we have sold. For example, we sold options that obligate us to buy shares of agricultural chemical company American Vanguard Corp. (ticker: AVD) at $20 per share.  For every 100 shares that we want to purchase (each option represents 100 shares), $2,000 is set aside to make sure we can buy the shares should the stock price drop to $20 or less.  In the interim, we have earned a premium of $31.25 for taking on this obligation.  That may not sound like a lot but that equates to 1.56% in just 24 days.  While I hope to purchase the shares, should we not have to when the option expires in mid-July, we will simply try this same strategy again.  You can expect that we will gradually add more equity names – both individual stocks and additions to mutual fund holdings on weakness in the markets as we do not expect this downturn to be a long-term event.  Unless we are exceedingly lucky, we won’t buy at the exact bottom, but we will generally buy at favorable prices.  You can also expect us to gradually add more exposure to bonds to client accounts, especially as interest rates finally offer a more attractive return than zero percent.
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com

If you go back to my last client quarterly letter, you will note that I managed to nail what we have seen so far this year.  Increased volatility in the stock market?  Check.  A ten percent correction?  Check.  Higher interest rates?  Check.  Lower stock prices?  Check.  While I did not mention war, anyone who did not seriously think Russia was going to invade Ukraine was fooling themselves.  In early-February, I wrote a note that was posted on our website which addressed some of these issues.  In that blog post (https://www.aeriecapitalmgmt.com/blog), I tried to explain why we had more volatility this year.  Let me address this briefly here.  The answer started with explaining how rising interest rates affected the value of stocks. 
 
How do rising interest rates affect investors?  Let’s start with the fact that stocks represent ownership in a business.  These businesses earn a profit.  Let us look at a very simple problem.  Suppose we own a business that earns $1,000 per year.  We anticipate it will earn this same amount every year until the end of time.  Suppose further someone wants to buy our business from us.  What would we be willing to accept to sell this business?  If we expect to earn the same thing every year and if interest rates are 1% and we do not expect that to change, it turns out we would be indifferent between earning $1,000 each year or receiving $100,000 up front.  These two amounts would provide the same outcome.  In finance lingo, this $100,000 is the “present value of all future cash flows”. 
 
What happens if interest rates go up?  Suppose we can now earn 2% interest on any money we invest today.  As you might suspect, doubling the interest rate cuts in half the amount of money we would need to accept today to earn the same set of cash flows.  In other words, we would be equally happy with $50,000 in hand today or $1,000 per year forever.  Rising interest rates reduce the “present value” of future cash flows.  The value of our business has fallen in half.  The price a stock trades at represents what investors think the present value of future cash flows are worth.  The cash flows, of course, are the future earnings of the companies.  This raises two key questions.  The first is when the Fed is all said and done raising interest rates, what will be the prevailing interest rate?  3%?  5%?  6%?  No one knows.  The second question is what will companies earn?  If Apple earned $6.00 per share last year, is that sustainable?  Might it continue to grow?  Could it shrink if we have a recession?  These two questions – the level of interest rates and the future earnings of companies – are leading to the current levels of volatility.  In other words, if you think Apple will earn $7 next year and interest rates will settle around 3.5%, then you are willing to pay up to $200 per share to purchase Apple stock.  Meanwhile, I may think Apple has stalled out and earnings will not grow but will remain at that $6 per share level.  Further, I think interest rates will climb to 4% when all is done, so I am only willing to pay $150 for a share of Apple.  The disparity between investors beliefs is what leads to volatility.
 
Besides the increased volatility, the other two key issues – both linked to each other – are inflation and oil prices and gasoline prices.  Oil is a key component of the basket of goods that determine the inflation rate so when that spikes, inflation spikes, too.  So when can we expect some relief from this inflation and how will that happen?  Pardon me while I get just a little bit wonky and discuss economics for a bit. 
 
Let me explain just exactly what inflation is and how it is measured.  Inflation is when prices are rising in an economy.  This is measured by what we call the consumer price index or CPI for short.  This index is based on a market basket of goods and services that most Americans use on a regular basis.  Key items, of course, are food, gasoline, housing costs and normal consumer purchases.  The value of each item is measured and compared over time and the change in the value of this basket of goods and services reflects the inflation rate.  Currently, energy costs comprise almost 25% of the value of the index, so a change in the price of oil would have a large impact on the CPI and thus inflation.   Through February, the CPI rose 7.9% on a year-over-year basis.  Energy (fuel oil and gasoline) was up 25.6% and was obviously a major component of the current inflation rate.   
 
Up until the end of last year, I was of the opinion the inflation rate we were seeing last year was “transitory”.  That is, I thought it was an anomaly that would quickly pass as we returned our economy to a more normal state.  Sadly, this is not the case and energy costs are a big reason for this and a major source of controversy.  There are several reasons for the spike in price for oil and gasoline.  Most have little to do with the memes you see on Facebook or hear about from some politicians.  They all want to blame President Biden for canceling the Keystone XL pipeline or for not allowing oil drilling on Federal lands.  Neither of these have anything to do with the current spike in oil prices.  The Keystone pipeline, which brings oil from the tar sands region of Canada down to the Gulf Coast, has been operational since 2010.  The Keystone XL pipeline was to be a shorter route that connected the starting point in Canada to the existing pipeline in Nebraska.  TC Energy, the company that operates the pipeline, touted that the XL pipeline would carry “up to 800,000 barrels of oil per day” but failed to mention that most of that oil would come from the Bakken region in Montana and North Dakota as it ran through that area – oil that is already being shipped anyway.  In other words, the pipeline would not have added 800,000 barrels of additional oil to the U.S. economy contrary to what politicians and memes claim.  There might have been some incremental increase but certainly not to that level. 
 
Congress recently took the oil companies to task for making billions in profits and using this money to buy back their own stock rather than reinvesting in more oil wells.  There is some legitimacy to this claim, but it is a gross over exaggeration.  Yes, oil companies did earn a tremendous profit in the past year.  However, over the past two decades they have had a boom-bust cycle.  When oil prices would climb, oil companies would rush to drill new wells to capitalize on the high oil prices.  This led to more oil on the market and lower oil prices and losses forcing cuts in production which eventually led to less oil production and eventually higher oil prices.  Oil companies may have learned from their past mistakes and are slower to bring new oil wells on-line.  Add to this the loss of over 12,000 jobs in the oil patch from the pre-pandemic high and that adds to the difficulty in restarting old wells or drilling new ones.  The money the oil companies are spending to buy back their own stock is being done because they really have no other place to spend the money that brings added value to shareholders. 
 
Another issue impacting oil production is a shift in sentiment among primarily institutional investors (think mutual funds, large college endowment funds and large pension plans) that encourage a shift to greener energy and less focus on industries that cause greenhouse gas emissions to rise.  This can make it hard for oil companies to raise additional capital for drilling more oil wells.  That may be counterintuitive in light of the fact I just said oil companies earned record profits.  Oil companies will try to spread the risk of drilling new wells by attracting outside investors who share both the expense and some of the profits for drilling these new wells.  Oil companies could do this all themselves but prefer to spread the risk around. 
 
Lastly, we have the war in the Ukraine also impacting the price of oil.  Due to Russia’s invasion of Ukraine, stiff sanctions have been imposed on Russia including on Russian oil.  Russia is the sixth largest producer of oil in the world and currently no one is buying their oil to punish them for invading another sovereign nation.  This has taken about 11 million barrels of oil per day off the market, driving up the price of the oil that is still out there.  Should the war end soon with Russia’s complete withdrawal, the sanctions would likely end, and Russian oil would flood the market driving down the price of oil in the short run.  However, oil would likely settle in the $80 - $85 range (oil is currently around $96 per barrel as I write this) which is where it was before the Russian-Ukraine situation. 
 
With all of this being said, what are we doing about this either to protect clients or to take advantage of the situation?  We made several moves that were designed to protect us from some potential losses.  For example, in early January with inflation being universally acknowledged as an issue, retail stocks were starting to suffer losses.  This makes sense.  Costs for the goods they sell go up.  The stores may not be able to pass along all the cost increases.  That would be a drag on their earnings.  We purchased options that would benefit from a drop in the price of a group of retail stocks.  This proved successful as we generally netted a 25% gain in client accounts in the span of about three weeks.  We also sold options on two separate occasions that obligated us to buy an ETF (exchange-traded fund) tied to U.S. oil as a bet that oil prices were going to continue to move higher.  This is, of course, what happened, allowing us to net 9% the first time and 9.2% the second time we made these trades. 
 
As stock prices fell, more companies became values to us, and we added several new positions this quarter.  We bought shares of Activision Blizzard (ticker: ATVI) for around $80 per share.  Currently, Microsoft has offered to buy the company for $95 per share.  There are a few in Congress who are saber rattling against the merger (Elizabeth Warren and Bernie Saunders, for example) but my expectation is this is a lot of noise and hot air and will come to naught.  We also added shares of consulting company CRA International (ticker: CRAI), industrial company Hillenbrand Inc. (ticker: HI), medical diagnostic equipment manufacturer Hologic Inc. (ticker: HOLX), container shipper Matson Inc. (ticker: MATX), interior electrical wiring company Encore Wire (ticker: WIRE), and residential homebuilder Tri Pointe Homes, Inc. (ticker: TPH) to client accounts.  We also bought shares of Ford (ticker: F) as we viewed this stock as a reasonable way to invest in electric vehicles without taking the risk of the many new entrants into that space. 
 
In addition to these new equity investments, we made some major adjustments to client fixed income (bond) investments.  We eliminated the two bond funds we held as they not only were lagging but promised to be more of a drag as interest rates start rising.  We shifted most of our fixed income investment to the Janus Henderson AAA CLO exchange traded fund.  This mutual fund invests in CLOs or collateralized loan obligations – bank loans – but only those with the highest credit rating.  This results in a slightly lower yield relative to other funds that invest in bank loan debt but more safety.  When we started buying shares, the fund sported a dividend yield around 1.13% but we expect that to increase dramatically this month.  The loans the fund holds are floating rate loans, meaning the interest rates paid on the loans adjusts periodically.  These CLOs reset their interest rates quarterly and are set to adjust in April.  In our conversations with the portfolio managers, he expects the dividend yield to increase to around 2% for the fund.  In addition to this fund, we have found a solid “core plus” bond fund that will be our “go to” bond fund.  We have started with a small allocation of around 1% of client accounts to this fund and expect to gradually scale into this fund as interest rates continue to climb, and we can add shares on periodic price drops. 
 
We weren’t just busy adding new investments this quarter.  We also eliminated a few holdings and trimmed several others.  We sold out of our Atlas Air Worldwide stock earning a 30% return in about a year, eliminated retailer Citi Trends with a small gain in some accounts and a small loss in other accounts.  We trimmed several growth-oriented mutual funds including the BlackRock Mid Cap Growth fund, the Putnam Small Cap Growth fund, and the Putnam Growth Opportunities fund.  We eliminated our holding in the Virtus KAR Mid-Cap Growth fund.  That fund had been a stellar performer for us but had become quite the anchor in the first quarter of the year.  In retrospect, we probably should have trimmed or eliminated these funds sooner and faster as the values of these funds fell, dragging down our performance a little more than we would have liked for the quarter. 
 
At quarter-end, we are in a reasonable position with our stock and bond holdings.  We are being a bit more aggressive in hedging client portfolios with options as well as using option strategies to add income to client accounts.  I would expect to see a few more equity positions coming into client accounts as stock prices continue to be volatile providing opportunities to add good companies at great prices.  As a last note, we recommended to many of you a direct investment in Series I Treasury bonds.  These bonds, which can only be purchased through the website http://treasurydirect.gov , are currently paying a little over 7% interest through May.  The interest rate on these bonds is reset semiannually and is based on the inflation rate.  As the inflation rate is expected to remain above 7% for now, we can expect these bonds to continue to pay at this rate through November.  We will keep you informed on what to do with your I Bond holdings.
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com

​We turned the page to a new year, and it seems an entirely new market, as well.  Until January, the stock market was buoyed by the knowledge that the Federal Reserve would continue to pump money into the economy.  What this most often meant was shallow pullbacks of around 5% followed by “buying the dip” mentality that quickly drove stock prices back to new highs. Even when we had the pandemic shutdown in 2020, the market recovered most of the 35% drop within two months and all the loss within five months.  This relentless push upward is what investors have been conditioned to expect. 
 
So what changed and what does it all mean?  For one thing, inflation has become a more serious problem.  Inflation first appeared in the second quarter of last year, but everyone (including me) thought it was “transitory”.  That is, everyone seemed to think the spike in inflation was largely due to comparing a year in which we were returning to normal to a year in which the economy was shut down.  The idea was that as we got further into the year, comparisons would moderate, and inflation would come down.  That has not happened.  The inflation rate has remained at a stubbornly high level for the remainder of the year.  This has forced the Federal Reserve to dramatically shift their policy from one of “easy money” – that is, keeping interest rates low and buying bonds from the public to add additional dollars to the economy – to one of tightening.  This tightening is a two-step process.  The first step involves ending the QE or bond buying program, which is already happening and should be over by March.  The second step will be to raise the Fed funds interest rate.
 
It is the rising interest rates that are directly affecting the markets even though the Fed has not acted yet.  How do rising interest rates affect investors?  Let’s start with the fact that stocks represent ownership in a business.  These businesses earn a profit (or we anticipate they will at some point).  Let us look at a very simple problem.  Suppose we own a business that earns $1,000 per year.  We anticipate it will earn this same amount every year until the end of time.  Suppose further someone wants to buy our business from us.  What would we be willing to accept to sell this business?  Flipping this question on its head, if we could earn 1% interest on an investment, how much would we need to invest today to end up with that same $1,000 in a year?  The answer is $990.10 invested today earning 1% gives us the same $1,000 in one year.  We could make this same calculation of how much we need to invest to end up with that same $1,000 for the second year and the third year and so on and add them together to get a figure for the value of the company.  Simply put, we are discounting the cash flow we expect to earn from our business back to present day.  If interest rates are 1% and we expect to earn this amount forever and ever, it turns out we would be indifferent between earning $1,000 each year or receiving $100,000 up front.  These two amounts would provide the same outcome. 
 
What happens if interest rates go up?  Suppose we can now earn 2% interest on any money we invest today.  As you might suspect, doubling the interest rate cuts in half the amount of money we would need to accept today to earn the same set of cash flows.  In other words, we would be equally happy with $50,000 in hand today or $1,000 per year forever.  Rising interest rates reduce the “present value” of future cash flows.  Stock prices represent this “present value” of future cash flows.  The cash flows we are discounting are the earnings of the companies.  This raises two key questions.  The first is when the Fed is all said and done raising interest rates, what will be the prevailing interest rate?  3%?  5%?  6%?  No one knows.  The second question is what will companies earn?  If Apple earned $6.00 per share last year, is that sustainable?  Might it continue to grow?  Could it shrink if we have a recession?  These two questions – the level of interest rates and the future earnings of companies – are leading to the current levels of volatility.
 
Investors are confused by both the continued growth rates of the companies they own and of the prevailing interest rates we are going to see in the economy.  The one thing all investors agree upon is that with interest rates likely to start rising in March, stocks are worth less today than they were in December.  The volatility arises from the debate over what stocks will earn and what interest rate is appropriate.  If interest rates go up too quickly or too far, stocks will tumble dramatically.  If inflation is less severe, interest rates may not rise dramatically, and stocks may have more value.  The trouble is, no one knows exactly what a company will earn next quarter, let alone next year or three years or ten years down the road.  This means we have no idea what number to use to discount back to today.  In addition, no one really knows how far the Fed will raise interest rates.  There have been guesses of anywhere between three interest rate hikes this year and seven(!) hikes.  The answer to this question depends upon how the rate of inflation responds to the first rounds of interest rate hikes as well as how company earnings respond. 
 
We have not been sitting idle during this volatile time.  We have already taken several steps for our clients.  Over the past couple of years, we have been a bit more focused on growth largely utilizing mutual funds.  These funds typically had a high allocation to tech stocks.  Tech stocks will likely be impacted by rising interest rates.  To counter that, we have greatly reduced or eliminated our exposure to these mutual funds and will continue to trim as appropriate.  This does not mean we are giving up on growth altogether – just that we are paring back significantly to focus on areas that are likely to do better.  In addition, we have started dipping our toes in the water or, more appropriately, oil.  Oil has been on the rise lately and is a key component of the inflation calculation.  There is an ETF, the United States Oil Fund L.P (ticker: USO) that is tied to the price of oil.  We have a couple of trades around this security and expect to do more to take advantage of higher inflation. 
 
Another change we have made is to invest excess cash in a bond fund that will benefit from rising interest rates.  We view this largely as a short-term place to park cash and less as an investment or a trade.  The fund, the Janus Henderson AAA CLO ETF (ticker: JAAA) sports a current dividend yield around 1.10% per year and the price is relatively stable.  It is important to note that this is not a money market fund and stable prices are not guaranteed.  The fact that the bonds it owns are high quality gives us some level of assurance for the safety of our investment.  Further, these bonds are backed by corporate loans that have adjustable interest rates.  As interest rates rise over time, so will the payouts on these bonds and our dividend yield should increase comparably.  We are not looking to hit home runs here.  We are trying to enhance our returns a bit without taking undue risk.  All of this is designed to help shelter us during these volatile times.  We may have losses on paper as stocks rise and fall, but if we do our job correctly, we will have smaller losses which gives us the chance for quicker return to profitability.    

Another quarter and year have ended.  If we had to sum up the year in one word, it might be “inflation”.  Inflation seemed to be on everyone’s mind for most of the year.  We debated whether it was “transitory” or not, whether President Biden could reign it in (hint:  Presidents have very little control over the economy, especially in their first year in office), and whether we were headed for that old 1970’s hit, stagflation or not.  As I looked back at quarterly letters I sent this past year, I was pleasantly surprised at how prescient I was about things.  Of course, that is part of my job – to be able to read the tea leaves of the economy so I can better position us for what may come. 
 
I will reiterate what I said last quarter.  This world is often random and chaotic and only makes sense in retrospect.  Proof of this is in the stock market.  On the next-to-last trading day of the year, the market as measured by the S&P 500 index notched its 70th record high close for the year.  On the last trading day of the year, the index was in new record territory until literally the last 14 minutes of the day, when it fell 0.26% for the day.  Did anything of significance happen to cause this?  Likely, it was simply investors trying to lock in gains exacerbated by low trading volume.  In other words, there were not a lot of investors trading which created more risk and wider moves in stock prices.  As investors sold, the lack of buyers allowed prices to fall.
 
While many random events can occur, putting a frame around what could or is likely to happen helps.  The problem is always the unknowns that we don’t know but we can speculate on the things we do know.  We do know the Federal Reserve is tapering their bond buying.  Since the start of the pandemic, the Federal Reserve has been buying bonds from the public.  This has the effect of putting more cash into our financial system (the Fed pays cash for the bonds they buy).  The Federal Reserve owned about $4.2 trillion in bonds just prior to the pandemic shutdown at the end of February 2020 and today has about $8.8 trillion in bonds.  This means the Fed has added $4.6 trillion in cash to our financial system.  This cash had to go somewhere, and much of it likely ended up in the stock market.  In fact, this cash accounts for about a third of the growth in the value of the U.S. stock market over the period from the end of 2019 through the third quarter of 2021. 
 
Does this lack of further cash infusions have any implications for us as investors?  I believe we are likely to see more volatility, larger pullbacks, and longer recovery times from these corrections.  Investor sentiment lately has been to “buy the dip”.  This has proven to be a winning strategy keeping drops in the market relatively shallow essentially since the Great Recession.  Even with the large drawdown during the pandemic last year, the market recovered amazingly quickly.  The only other significant drawdown occurred in November and December 2018 when the Federal Reserve was raising interest rates during a serious trade dispute with China.  This all combined to make investors very nervous.  Since there was no end in sight to the potential problems, investors could not figure out when to buy.  The turning point was when Fed Chair Jay Powell capitulated and reversed course on more rate hikes the following year. 
 
I suspect we are going to see more volatility this year, and at least one pullback of more than 10% in the market.  I want to be clear that I am not advocating for selling and going to cash.  Quite the contrary.  I think any pullback of 10% or more will create some good buying opportunities.  I am more likely to sell into strength, so we have some cash sitting on the sidelines for these potential market fluctuations. 
 
We also know the Federal Reserve is going to raise interest rates.  Jay Powell has told us so and the Fed really needs to keep inflation in check.  The market is anticipating at least three rate hikes over this next year.  The first one is not likely to occur until the Fed ends their quantitative easing (bond buying) which is likely to occur by March.  If the Fed sticks to the script, we will probably see the first interest rate hike by June.  What could turn the markets on its head is if we get a larger than expected hike or if we get more than three hikes this year. 
 
The biggest change we are likely to see is in the types of stocks that lead the market.  As interest rates increase, this will make the high growth stocks that have been the market leaders over the past few years less attractive.  We have already started seeing this changeover in leadership.  When you look at the best performing stocks for 2021, the top of the list is littered with oil companies and basic industries like Devon Energy, Marathon Oil, Old Dominion Freight Line and fertilizer company CF Industries.  We have already started seeing a shift in companies fitting our criteria that align with this shift in focus.  If you recall, in the third quarter of the year we added timberland REIT PotlacthDeltic Corp (ticker: PCH) which we purchased back in August.  This quarter, we added shipping company Matson Inc. (ticker: MATX) in early December.  We also added shares of Hillenbrand Inc. (ticker: HI), an industrial company that is probably more famous for starting life as Bates Casket Company which they still own.  We are starting to see more signs of “value” stocks in our lists and expect this trend to continue over time. 
 
The two biggest questions – and the biggest unknown – is how quickly interest rates will rise and how far.  The latter answer depends upon your view of inflation.  Many have been in the “transitory” camp meaning they think the high inflation rate we are seeing will resolve itself as Covid fades and the supply chain fixes itself.  If this is the case, interest rates will not rise significantly.  Others are not so sanguine on this scenario.  I have been gradually moving from the former camp to the latter though I am not worried about a permanent high inflation rate as are some pundits.  I see some things – higher wages required to entice people back to work and a permanent labor shortage due to a lack of people with the necessary skills – that will drive higher prices for a long time to come.  This pandemic has sped up some trends that were inevitably coming.  I think we will end up with a semi-permanent modestly higher inflation rate than we have been used to over the past decade.  In other words, a return to normal.  I would not be surprised to see interest rates top out around 4 – 5% annually on a 10-year Treasury bond.  The yield on this bond has been the measure everyone is paying attention to currently.  As I write this, the bond is paying about 1.66% annually.
 
The toughest part of navigating the inflation and rising interest rates issue is balancing off stocks versus bonds.  I have been saying for a number of years that we are in a “TINA” world – there is no alternative to investing in stocks.  That will change as interest rates rise.  At some point, bonds will be a viable investment alternative.  In the interim, bond investments are merely a place to park cash and a bit of an anchor for a portfolio.  We recently made a small change in the fixed income allocation in client accounts.  We eliminated the SPDR Bloomberg Investment Grade Floating Rate ETF (ticker: FLRN) in favor of the Janus Henderson AAA CLO ETF (ticker: JAAA).  This fund invests in debt instruments called “collateralized loan obligations”.  These are large, first-lien senior corporate loans.  These loans have adjustable interest rates which means that as prevailing interest rates in the economy rise, so does the interest paid on these loans.  The loans this Janus fund holds tend to be very high quality, yet the fund offers a much better dividend yield than the SPDR fund we held without compromising safety. 
 
After many months of intensive research, I have finally found a “go anywhere” bond fund that I think will provide the safety our clients need and deserve without compromising returns.  You can expect to see the T. Rowe Price Total Return fund showing up in accounts soon.  This fund had the singular distinction of having a positive return last year when most other broadly diversified bond funds did not.  So with the addition of the Janus Henderson fund to help us in a rising interest rate environment and as a place to “park cash” and the soon-to-be-added T. Rowe Price broadly diversified fund, we have the fixed income piece of the puzzle covered for client accounts. 
 
Hopefully, despite my expectations for increased volatility, we can settle down to a more comfortable buy-and-hold strategy versus the amount of trading we did over the past year.  While this trading did play out in our favor for the most part, I am just not a big fan of trading too much.  During the fourth quarter, we eliminated several stocks including Clearwater Paper earning between a 10% and 20% return, Camping World Holdings with a small loss, Quest Diagnostics for a small 5% profit and Williams-Sonoma with gains between 35% and 40% on our investment.  We also cut back on the Virtus KAR Mid-Cap Growth fund due to the level of risk in that fund and its holdings.  Upon further review, we will likely eliminate this fund from the lineup this year.  Thankfully we have one or two other funds already in client accounts that can take up where this fund left off.
 
We did add a few new positions this quarter.  I mentioned earlier adding shares of shipping company Matson and industrial company Hillenbrand.  We also added shares of chicken producer Sanderson Farms Inc. (ticker: SAFM) which is in the process of being acquired.  There is some risk from the new Biden administration that the acquisition will not go through which gave us the opportunity to acquire the shares at a discount.  Should the merger be completed, we will earn a 7% return in a reasonably short period of time.  If the merger is not consummated, Sanderson Farms still represents a great bargain at the price we paid so this is a win-win either way. 
 
Finally, towards the end November, we dipped our toes into the EV, or electronic vehicle, space by obligating clients to purchase shares of Ford for $17 per share.  We wrote (sold) a put option and collected a premium for this obligation that is paying us a 2.76% return over the 52 days the obligation is outstanding.  Likely, this option will expire worthless, and we will simply write (sell) another put option to again collect more premium.  Part of the reason for doing this is that I really think the price we are seeking to pay is a fair price.  Ford currently makes one of the most popular vehicles of all time, the Ford F-150 pickup truck.  They have now introduced an EV version of this truck that has proven so popular, they are having to double production in the first year of manufacture.  This type of news has caused the stock to pop to a value that is, in my opinion, excessive and I refuse to chase this stock or pay too much just to gain access to what is a “hot” sector of the market currently.  I would rather be patient and continue to collect premiums and let the stock come back to us.  As I mentioned earlier, I fully expect more volatility and at least one larger pullback this year and I think we will be able to get shares of Ford at that point at a fair price. 
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com 

I have been reading a great book recently that touches on much of the psychology behind many of the investing decisions and errors that investors make.  The book, Thinking, Fast and Slow by Nobel prize winner Danial Kahneman, is a user-friendly narrative behind his thinking and research that led to the development of the field of behavioral economics.  One of the things Dr. Kahneman points out – and something I have been saying for a long time – is that we as investors are hard-wired to put a narrative to events.  This is an attempt to put order to an often random and chaotic world. 
 
We have had a volatile stock market since mid-September with any number of narratives to help explain what is going on and why investors are selling.  No, buying.  No, selling again.  First it was Chinese real estate developer Evergrande’s potential bankruptcy.  Then the Federal Reserve calmed fears by confirming what they have been saying all along – they will start tapering sooner rather than later and will follow that up with interest rate hikes.  Next it was hotter than expected inflation numbers.  So many headlines and so much confusion.  Let us try to sort this out a bit.
 
There are really two emotions that drive the market – fear and greed.  When fear is high enough, people will sell anything and everything.  Oftentimes financial advisors will talk about owning “uncorrelated assets”.  The idea is to own two different investments that will move in different directions when things get rough.  A simple example would be owning an airline stock and an oil company.  Since one of the major costs for an airline is their fuel costs if the price of oil increases this will hurt the airline’s profitability and presumably the stock price.  However, the oil company obviously benefits from this price increase as should their stock price.  The stock prices should move in opposite directions when the price of oil changes.  However, when fear rises, investors tend to ignore fundamentals and sell stocks indiscriminately.  We often see investors selling both their airline stocks and their oil stocks at the same time.  In “finance-speak” we would say that all assets have become highly correlated. 
 
The opposite effect occurs when greed is high.  Investors tend to rush out and buy regardless of the outlook or underlying fundamentals.  Oftentimes investors will create a narrative that justifies outrageous valuations.  Sometimes investors have no other choice.  This would explain the world of investing since the Great Recession.  The Federal Reserve lowered interest rates to effectively zero.  This was done to prod businesses to borrow money to invest in building new plants and buying new equipment to spur growth in the economy.  The economy did grow but never at the rate that anyone wanted nor expected though this should not have been a surprise.  Of course, one side effect of low interest rates is that people who rely on earning interest on their investments effectively earn nothing.  This forces investors to seek returns elsewhere. The only alternative has been to invest in stocks for growth and dividends and growth is what investors got. 
 
Since the 2009 post-Recession low, we have seen the stock market pull back on a few occasions.  There were often external forces or headlines at work, but the reality is that investors were just more fearful.  The first instance was in 2011 when Greece faced a debt crisis with the threat of bankruptcy and investors feared another 2008-like debt crisis.  This was also the first time the U.S. balked on raising the debt ceiling and credit rating agencies downgraded U.S. Government debt from an almost risk-free AAA bond rating to AA+ debt rating.  As a side note, as I write this, we are currently facing this very cliff again.
 
We again faced down fear in late-2015 through early-2016 when China’s growth rate was slowing, and oil prices were falling.  This proved to be a short-lived “crisis” as greed again soon took over and by March we were back to where we started.  Fear was stoked again in the fourth quarter of 2018 as we were embroiled in a damaging trade war with China and the Jerome Powell-led Fed raised interest rates for a fourth time for the year and indicated more was to come the following year.  Just a few days into January 2019, Powell was speaking to the American Economic Association and walked back the interest rate hike just a month earlier and indicated he was inclined to cut rates rather than raise them again.  Fear was erased, and greed took over again.  Lastly, there was, of course, the 35% losses sustained in March 2020 when the COVID-19 pandemic shut our economy down completely but by July all losses had been completely recouped as fear of an extended economic shutdown disappeared, replaced by hope life could return to normal sooner rather than later.
 
While the stories that have been spun during these corrections have all been different, the outcomes have been the same.  Fear in the short-term drives markets down until greed takes over and we are quickly at previous levels and higher.  There may also be a hint of “FOMO” – fear of missing out on gains.  In our current economic environment with very low interest rates, we remain in a “TINA” world – there is no alternative.  Investors who want any kind of return are forced to take higher levels of risk than might otherwise be prudent in a more normal world.  This is likely to remain the case until the Fed raises interest rates significantly.  Since the end of the Great Recession, investors have always been rewarded for “buying the dips”.  After one of the more recent pullbacks, I was chatting with a client about his worries over the markets.  He mentioned to me conversations he had recently with his son who actively trades options.  His son, my client told me, had urged his father to sell everything and “go to cash” until the market bottomed.  “That’s perfect!” I replied.  “And just when will the market bottom?”  His son had apparently not given him any figure for how far down he expected the market to tumble.  Our fear leads us to think that every time the market starts to tumble that it is different this time and the start of the financial apocalypse.  At some point, greed kicks in, we are afraid of missing out on future gains, we convince ourselves that stocks are ‘cheap’ again and markets correct themselves.    
 
What could raise the fear factor for investors enough to make a difference?  The biggest boogey monster currently is inflation.  The inflation rate is measured by what is known as the consumer price index or CPI.  The CPI measures the change in the price of a basket of goods and services typically used by a normal household.  The CPI is measured on a year-over-year basis.  Since we are now comparing prices this year to the same time last year when we were just emerging from the pandemic economic shutdown, you can imagine that prices have climbed dramatically as we return to a more normalized setting.  The inflation rate has been running “hot” as the economists say, with the CPI growing at an annualized rate of 5.4% per year.  This is the highest level since around 1990.  There are two questions about the current level of inflation.  The first question is how real this rate is and the second is how long this higher inflation rate last. 
 
There is some question about how realistic this current inflation rate is given that we are essentially comparing apples to oranges.  Of course inflation is higher this year.  Everything was shut down most of last year.  Oil, for example, is a component of the CPI and comparing the October 2021 price of oil to the October 2020 price of oil, the price is up almost 87% year over year.  If you go back a year and compare the current price of oil to the same period in 2019, however, the current price is up about 39% over the same 2019 period.  While that is a jump, it is not as significant a jump.  Personally I think inflation is higher than the Fed would like but lower than what the CPI indicates.
 
As for the question about how long this higher inflation could last, that question is a bit trickier.  Part of the reason for the higher inflation rate is the increased costs to businesses as shelves are restocked.  We have a supply chain issue, and this is driving both the inflation rate and the potential length of time for inflation to remain elevated.  When the pandemic hit, businesses around the world shut their doors to slow or halt the spread of the virus.  This led to empty store shelves as people panicked and bought a year’s supply of toilet paper and soup.  Most goods are now manufactured overseas, largely in China.  Now, as manufacturers attempt to increase production to get things back to normal, they are running into a shortage of enough workers to run the lines.  Assuming the goods get made and out the door, there can be a delay loading containers on the ships for export.  Once the ships arrive in the U.S., there is a backup of ships waiting to dock to unload and even if they get to dock, there is a lack of people to unload the ships.  Once unloaded, the goods are shipped out via railroad to be later transferred to trucks to be hauled to the stores.  Railyards are backed up with containers to be unloaded from trains and put on a trailer.  There is a lack of trailers and even if we had enough trailers, there is a lack of truck drivers.  All along the way, costs are added by shippers to cover these additional costs.
 
There is also a shortage of the materials used in production.  Auto manufacturers, for example, cannot get the microchips they need to build cars, forcing them to idle some assembly lines.  This has led to a shortage of new cars which drove up the prices for used cars as well as the cost for car rentals.  Businesses are having to pay higher wages to find workers for everything from the manufacturing line to the cash registers all of which will translate into higher costs.  Businesses will either have to accept lower profits or raise prices leading to contributing to the inflation picture.
 
Most economists thought the blip in inflation this year would be a relatively short-lived phenomenon.  Many, including Fed Chair Jay Powell, are now saying this higher inflation rate could last longer than first anticipated.  Some economists are arguing higher inflation is here to stay based on the increasing wages and unfilled jobs.  A few economists are evoking a blast from the ‘70’s – stagflation.  Stagflation is an economy in which growth is low or stagnant and prices are increasing at high rates.  Frankly, I am not worried about this scenario but just the very thought of the potential for stagflation to return raises a certain fear level among some investors. 
 
The more likely scenario is one in which the inflation rate continues at a relatively high level above the Federal Reserve’s target rate.  Chairman Powell has always maintained that he thinks an inflation rate of 2% per year is reasonable and healthy but he is willing to let the inflation rate “run hot” – that is to have an inflation rate above the 2% per year level – for a short span of time.  His view is that the rate should moderate over time.  The danger is that inflation runs hotter for longer.  If that were to happen, the Federal Reserve would want to reign this in.  The chief method the Federal Reserve uses to control high inflation is to raise interest rates. 
 
This scenario of higher inflation for longer should be the biggest fear for investors.  If inflation does continue at this hot pace, the Federal Reserve will be forced to raise interest rates both sooner and faster than they have intended or indicated.  As interest rates increase, this does two things.  First, it increases costs for businesses.  Second, it begins to create investment alternatives to stocks that may be more attractive.  If an investor is asked to choose between a stock paying a 2.5% dividend or a bond that matures in ten years paying 1.5% interest per year, the stock wins.  If I have the choice of a bond that is paying 3.5%, interest per year now I have a tougher choice.  Ultimately, many investors will abandon the volatility and risk of stocks for the relative safety of bonds, and this will drive the price of stocks down. 
 
This is a scenario that I am paying close attention to for client portfolios.  Across all client accounts, most of the mutual funds we own have been focused on “growth” stocks.  This has served us well as these are the stocks that have benefitted the most from this current environment.  These will also be the stocks that may suffer should this environment change.  Let me be clear.  I am not expecting an imminent or immediate meltdown in stock prices.  I do think we could see the S&P 500 Index eventually retreat from their current levels.  If the Fed is raising rates, this retreat would last longer.  With this expectation in mind, you will see me gradually cut back on our exposure to these growth mutual funds and reallocate to investments that are better positioned to weather the storm and continue to grow. 
 
This past quarter, we made a few changes across client accounts.  We sold off our holdings in homebuilder Lennar Corp. as valuations of some homebuilders are starting to get a bit stretched.  We also sold our holdings in food distributor SpartanNash, earning just over 6% return in about four months.  On the flip side, we bought shares in medical products and imaging supplier Hologic, Inc. (NASD: HOLX), diagnostics and testing company Quest Diagnostics Inc. (NYSE: DGX), regional supermarket chain Ingles Markets Inc. (NASD: IMKTA), and timberland REIT (real estate investment trust) PotlatchDeltic Corp. (NASD: PCH) which comes with a 3% dividend yield.  We were able to find more bargains during this more volatile quarter.  We also continued to make extensive use of options to enhance our returns – either by selling call options that obligate us to sell a stock in exchange for a premium or by selling a put option that obligated us to buy the underlying stock at the stated price.  Both strategies served us well during the quarter. 
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com
​

The operating watchword for this past quarter was “inflation”.  We were preparing to hear from the Federal government on their measure of inflation and the only question was “how high”.  Prices have been steadily increasing as we slowly return to a more normal post-pandemic economy.  Everyone knew inflation for the first quarter of this year would be high.  After all, we were comparing current prices to the first quarter of last year when the economy was shut down.  We were comparing apples to oranges. 
 
The inflation rate for April came in a 4.2% and then rose to 5.0% for May, significantly above the 2.6% rate for March and the 1.2% average for all of 2020.  When the quarter started, the interest rate on a 10-year U.S. Treasury bond was 1.746% which was significantly above its pandemic low of a 0.538% interest rate.  This interest rate reflected investors’ fears that inflation was imminent, and the Fed might raise interest rates to combat this problem.  The key question argued between economists and investors was whether this high inflation rate was real and sustainable or, in the words of most economists “transitory”.  Federal Reserve Chairman Jay Powell is in the latter camp, which has led him to not react to these high inflation numbers.  Let me explain.
 
During a recession, no one is spending any money.  There is no incentive to spend now as prices are likely to fall tomorrow making the goods or services you want cheaper.  To spur spending, the Federal Reserve would lower interest rates.  The chief idea would be for businesses to see a low enough interest rate to incentivize them to borrow money to buy land, build new plants, buy new equipment, and hire more workers to “jump start” the economy.  This has been one of the main tactics during the past two recessions – the 2008 housing bubble and the recent pandemic economic shutdown.  The Federal Reserve lowered interest rates to basically zero on the shortest-term loans to drive investment.  It has not worked exactly as planned, but that is another story.    
 
On the flip side, when there is inflation in an economy, prices are rising, often rapidly.  When inflation exists, the incentive is to spend money now before it loses its value.  Inflation also drives people to borrow money now to buy big ticket items now (houses, cars, appliances) before their prices are out of reach.  If things get out of control, we have what is called hyperinflation.  The poster child for this phenomenon was Germany post World War I.  There are several stories out of this time about how quickly prices could change, even over lunch.  There is the story of a student at Freiburg University who ordered a cup of coffee at a café.  The price on the menu was 5,000 Marks.  He had two cups.  When the bill came, it was for 14,000 Marks.  He was told that if he wanted to save money and have two cups of coffee, he should have ordered them at the same time (from Paper Money by “Adam Smith”).  To stop inflation, the Federal Reserve would raise interest rates charged to banks, forcing banks to raise interest rates they charge their borrowers.  If interest rates reach a high enough point, it will “choke off” this borrowing and sanity will be restored to the economy. 
 
For anyone that lived through the high inflation of the late-1970’s and early 1980’s, the fear of high inflation is very real.  Let me be clear here.  I do not expect a return to those inflationary rates.  That was largely caused by the oil supply shock which dramatically and unexpectedly increased the price of oil very quickly.  This sent shockwaves through our economy which was largely built on using oil for everything from gas-guzzling cars to plastics.  And, to the point that I made earlier, this bout of inflation was finally reigned in when Fed Chairman Paul Volker dramatically raised interest rates and within three years brought inflation from over 13.5% down to around 3% annually. 
 
Circling back to the question at hand, are we facing increasing inflation or is it just transitory as many economists and the Federal Reserve seem to think.  Frankly, I believe that it is transitory.  We are already seeing the prices of many commodities that had soared in value coming back down to earth again.  We need only look to the futures markets to see this.  For example, lumber traded as low as $282.10 per 1,000 board feet in early-April 2020 during the pandemic, climbed as high as $1,733.50 in mid-May this year before falling back to $737.40 at the end of June.  We have seen similar moves in corn, wheat, copper, and most other commodities as well.  All these commodities are well off their recent highs set in mid-May.  If this is truly indicative of transitory inflation, the Fed is correct not to raise interest rates now as that could potentially choke off the recovery from the pandemic.  In fact, the Federal Reserve, in their most recent meeting, indicated they would most likely not be raising interest rates until 2023.  I am cautious on this expectation and would not be surprised to see a late-2022 rate hike.  I believe data may force them to move sooner than they want but, regardless, we still have at least a year of continued low interest rates fueling continued money flows into the stock market.  The key reason for this, as I have been saying for a while, is that this is a TINA world – as in ‘there is no alternative’ to stocks if you want to earn any return at all. 
 
All this fascination with inflation led to an interesting rotation in stocks for the quarter.  Many stocks that have been beneficiaries of the re-opening of the economy such as the airlines fell the hardest.  Stocks that gained for the quarter were heavily tilted to oil companies and industrial names, both of which tend to benefit from inflationary pressures.  I suspect the staying power of these oil and basic industrial stocks is as transitory as commodity prices have been.  Trying to time the markets by picking and choosing the ‘hot’ sector is a fool’s errand and something we avoid.  I prefer to find stocks that meet strict criteria and stick with them provided they continue to meet our standards for growth, quality, and potential long-term returns. 
 
We did a lot more trading this quarter than we normally like to do but most trades worked out in our favor.  During the quarter, we sold out of Beazer Homes USA (ticker: BZH) for a 23.73% gain, eliminated Cardinal Health, Inc. (ticker: CAH) with a small 4.17% gain, sold sporting goods retailer Hibbett, Inc. (ticker: HIBB) for a 53% gain, exited boating retailer MarineMax, Inc. (ticker: HZO) with a 60% profit and closed our position in construction firm Primoris Services Corp (ticker: PRIM) with a small 13% loss.  We sold either because the quality of the company had slipped in their recent earnings report, they were trading well above our estimate of a fair price, or their growth prospects were falling. 
 
On the flip side, we put some profits back to work, adding to our existing holdings in Atlas Air Worldwide (ticker: AAWW) as well as several new positions.  These new holdings include paper products company Clearwater Paper Corp. (ticker: CLW), two home décor stores, At Home Group (ticker: HOME) and Williams-Sonoma Inc. (ticker: WSM), apparel retailer Citi Trends, Inc. (ticker: CTRN) and RV dealer Camping World Holdings, Inc. (ticker: CWH). 
 
We also recognized that we had too much idle cash just sitting around collecting dust in many accounts.  Rather than let that continue to sit idle earning 0.01%, we bought an exchange-trade fund, the SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (ticker: FLRN) that invests in short-term corporate bonds that have adjustable interest rates.  This will be beneficial when interest rates do finally start going up as the interest rates paid on these bonds will also increase resulting in higher dividend yields on this fund.  In the interim, the fund is paying a dividend of 0.21% on a “cash-like” investment.  It is important to note that this is not a guaranteed investment, and the value can and will change.  Typically speaking, the price of this fund will remain reasonably stable over the short-term.  This is not an investment in which we are looking for large capital gains.  We were looking for an investment that is reasonably safe, liquid, and earning something more than leaving the money in cash.  This fund fit that bill well. 
 
One last point on the cash management front.  One additional tool we have been using up until recently has been an options strategy called a “bull put spread” in client accounts.  This has often offered us a 10 – 11% return on the amount we were risking over the course of a month.  Basically, we were acting as an insurance company for people who thought the market might fall.  They might purchase insurance on their portfolios in the form of put options that would pay them cash if the market fell below a certain level.  We took the other side of that trade but to offset our risk, we would purchase insurance ourselves just a little bit lower in value.  For example, with the S&P 500 Index trading around 4,369, we might sell an option that obligates us to pay the holder if the index fell in value to 3,995 at expiration.  To offset this risk, we would turn around and purchase an option that would pay us if the index fell to 3,990, limiting our risk to the $5 difference between these two values or $500 in total.  To further mitigate risk, I typically limit the number of option contracts to only 1% of any individual’s account size, though some clients can afford to take a bit more risk.  This ensures that, even in the event of a market blowup, we won’t lose more than we can easily recover in a short time.  This strategy typically added over 2% or more to account performance over the first half of this year in those account where we have actively traded.  The key reason we have stopped doing this for now is that, with the complacency that seems to have settled over the markets, we cannot get enough premium to make this strategy worthwhile for now.  I am sure this will change again in time, and we will return to this strategy. 
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com
​

What a difference a year makes!  This time last year, we were at the bottom of a long slide down though we didn’t know we had bottomed at that point.  Things looked pretty bleak, with millions out of work and businesses closed or closing.  Today we are in an entirely different place.  Vaccines are rolling out at a furious pace and over 51 million people have been fully vaccinated according to the most recent CDC data.  The most recent jobs report rose by over 900,000 which was well beyond expectations.  Job growth was strongest in leisure and hospitality, showing the “re-opening” trade is still very much alive and well.  The S&P 500 Index, a popular measure of the stock market, closed near its all time high and the first day of the second quarter closed above the 4,000 level for the first time ever.  The Federal Reserve is vowing to maintain interest rates at near zero levels and continues to pump about $120 billion into the economy each month.  Add to that the $1.9 trillion stimulus package Congress passed and the pending $1.2 trillion in infrastructure spending that is being negotiated and the economy is awash in money seeking investments.
 
Despite all these good numbers, there are a few caution signs flashing.  There are still about 8 million Americans unemployed relative to where we were in February 2020 before the pandemic hit and about 3.9 million fewer people in the labor force.  These folks that are out of the labor force are people that essentially lost their jobs during the pandemic and have indicated they have ceased to continue looking for a job.  As the economy continues to rebound, it will be important to note whether these folks attempt to return to the labor market.  In addition, it is not clear that we will be able to get the 8 million people still seeking jobs employment.  The pandemic did a lot to change the way we work.  Businesses have learned they can survive with fewer employees.  In addition, it is not clear that the jobs that are needed line up with the skills of those who are out of work, making the jobs recovery more challenging. 
 
We have seen interest rates climb rather steeply since the start of the year.  This has taken a little bit of wind out of stocks’ sails and has raised fears of inflation and even higher interest rates.  Before we start panicking, let me address this issue.  During the pandemic, interest rates hit historical lows, largely because no one was borrowing for any reason.  One of the key benchmark rates has been the interest rate on the 10-year Treasury bond – that is, a bond issued by the U.S. Government that matures in ten years.  Before the start of the pandemic, the interest rate on these bonds ranged between 1.65% and 1.95% before plunging to an historical low of 0.53% in July.  We are now back around the 1.65 – 1.70% range so this is not anything to either be surprised about nor alarmed at either.  This is just another sign of markets returning to pre-pandemic normality.  The big worry will be if this rate continues to creep up well past 2%, making bonds more attractive than stocks. 
 
The rise in interest rates and with a focus on the vaccine rollout and the economy getting back to normal, we saw a shift in investors mindset.  This led to a change in investor sentiment from what many pundits described as moving from “growth” to “value”.  A better way to explain the shift in investor sentiment would be to say it moved from technology and high growth to infrastructure and lower growth.  When you look at the best performing stocks in the S&P 500 Index for the first quarter it is filled with energy (ExxonMobile Corp), materials (Nucor Corp) and industrials (Deere & Co.) while the worst performing stocks included a lot of information technology stocks (Apple Inc), health care (DaVita Inc.) and consumer discretionary (NIKE Inc.).  This shift in sentiment both hurt and helped us during the quarter. 
 
Many of the mutual funds we hold across client accounts are very tilted towards ‘growth’ which typically means a higher allocation to technology names and the stocks that have done well through the pandemic.  With the change in sentiment recently, many of these funds have stalled and lagged the broader stock market over the quarter.  We have still done very well over the past year and I expect these funds to continue to perform well providing they continue to find sectors that are growing.  We did make one change right at quarter-end, paring back dramatically on the Putnam Growth Opportunities fund (POGAX) in many client accounts.  The accounts we trimmed also held the Janus Henderson Balanced Fund (JABAX) as our “core” holding.  As it turns out, the Putnam fund and the Janus fund duplicated each other across most of their top holdings.  This exposed us to too much risk especially in the tech sector.  We chose to cut the allocation to the Putnam fund in half, which dramatically lowers the risk we are taking in client accounts.  Please note that I am not saying that either fund was “bad”, just that having both funds in the same account meant we were too exposed to some stocks.  The other mutual funds we hold continue to do well and we will continue to monitor them and make changes as appropriate.
 
We benefitted from the shift in sentiment through many of our individual equity holdings.  Most of the individual stocks we own are in far less glamorous industries.  We do have a reasonably large bet on the housing market given our exposure to Tri Pointe Homes (ticker: TPH), Lennar Corp (ticker: LEN) and Beazer Homes USA Inc (ticker: BZH) which we added this past quarter.  Other new purchases we made this quarter were also in rather mundane industries.  We added Primoris Services Corp. (ticker: PRIM) which is involved in building and maintaining pipelines, gas, water and sewer systems for cities and infrastructure construction.  Another new purchase for the quarter was Atlas Air Worldwide Holdings (ticker: AAWW) which buys and leases aircraft for everything from charter flights for tours to freight forwarders and e-commerce retailers (think Amazon here). 
 
The key question at the end of a quarter is always “what comes next?”.  At the risk of being redundant, I am still cautiously optimistic.  I know I say this seemingly every single quarter, but it remains true.  I believe many of the more popular stocks are overvalued, but I also think we are still in a TINA world – there is no alternative.  Much of the stimulus money from last year already found its way into the markets and I suspect much of the recent $1.9 trillion stimulus package will soon find its way into stocks.  I remain convinced the market is essentially in a “liquidity bubble”.  The only reason for the current stock market valuation is the extreme amount of liquidity due to stimulus money and the Federal Reserve.  The Federal Reserve is contributing to this bubble by purchasing $120 billion worth of bonds every month.  I am convinced this will continue as long as the Fed continues down its current path.
 
We have already seen a couple of attempts in past years by the Federal Reserve to either cut back on buying bonds or to raise interest rates.  The first attempt to cut back on the bond buying in 2013 did not end well.  When the Federal Reserve finally stopped the program in October 2014, the market largely ignored the event.  Many pundits compare ending this bond buying program, officially referred to as “quantitative easing” or QE, as taking away the punch bowl in the middle of the party.  The most recent round of QE was begun in September 2019 and ramped up in March 2020 in response to the COVID pandemic.  The only time interest rate hikes have not gone over well was when current Fed Chair Jerome Powell raised interest rates for the fourth time in December 2018 and indicated he expected two or three more hikes in 2019 which was not what the markets wanted to hear.  After markets fell precipitously, Chairman Powell quickly reversed course. 
 
With this background, I would not anticipate Fed Chair Powell stopping the bond buying or raising interest rates at any point before 2022 at the earliest.  In some recent testimony before Congress, he has gone so far as to indicate he is unlikely to do anything until 2023 based on his current projections.  Frankly, the artificial inflation of our economy is not sustainable.  As much as I understand the underlying principles involved, the diehard Keynesian in me says that enough is enough and as we get back to normal, we need to run balanced budgets and pay off debts.  How this situation ends remains to be seen but that is likely some time down the road.  For the short to intermediate term, our best course is to stay focused and not panic when we have small market corrections.  For just over the past decade, the best course of action has been to “buy the dips” and until mindsets change in Washington, this will continue. 
 
As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com

This year has certainly been one for the books.  I think that many of us will be glad to see 2020 in our rearview mirror.  I looked back at my quarterly letters starting with last January’s letter.  At that time, I was ‘cautiously optimistic’ but for all the wrong reasons.  By March, I was justifiably worried and repositioning client accounts.  In June, I was noting the rapid recovery at least at the top and the speculative excesses taking place in the market.  By September, the markets were back to normal, but we were on the verge of another big surge in coronavirus cases and I was worried about another nationwide lockdown.  So far, a nationwide lockdown seems to be off the table, but things continue to get worse.  Many hospital systems across the nation are reaching critical capacity with COVID patients.  The coronavirus that dominated our headlines has been unrelenting.  According to the latest numbers from Johns Hopkins, as I write this note on January 3, there have been 20,451,310 confirmed cases in the U.S. and 350,357 deaths.  This means that 1.71% of everyone that contracts COVID will die.  By comparison, for the 2018-19 flu season, the death rate was estimated to be 34,200 deaths out of 35.5 million cases or 0.10% mortality. 
 
When the coronavirus exploded on the scene in March, the Federal government embarked on an ambitious plan to develop a vaccine very quickly.  Prior vaccines used a weakened or inactivated germ to create an immune response.  However, developing that vaccine often took years.  Now, using relatively recent technology called messenger RNA or mRNA, a vaccine – actually three different vaccines – has been developed and put through rigorous trials and shown to be 95% effective in a matter of months not years.  The rollout of these vaccines is beginning now with front-line healthcare workers and those most vulnerable to the disease starting to receive the first of the two doses of the vaccines. 
 
Despite a year of heartache and death, the markets were relentlessly focused on the future, not the present.  We saw the S&P 500 Index hit 20 new record closes this year, closing the year on the last one.  The index went from 3,397.16 on August 21 to 3,508.01 on August 28, blowing through the entire 3,400 level in one week.  For the year, the S&P 500 Index gained 16.26% which is quite a performance.  However, if you will recall my second quarter email, I warned about not equating the S&P 500 Index with “the market”.  I pointed out the difference between the S&P 500 Index everyone is familiar with and the equal-weight version of the index.  To review, one of the key reasons for the difference in performance between the two indexes is how these securities are “weighted” in the index.  In the equal-weight index, as the name implies, each stock starts out at 0.20% of the total account.  This is rebalanced on a periodic basis to bring this back into line.  The more popular version of the index uses the market capitalization which is the number of shares of the stock that are outstanding multiplied by the price per share.  As a stock’s price increases, so does the market capitalization (or market cap for short).  I noted the market-cap weighted index had recovered almost all their losses by the end of June while the equal weight index was still down by 12% at that point. 
 
It is a bit instructive to return to these two slightly different indexes again.  While the S&P 500 Index was back to new all-time highs by mid-August, the equal-weight version – the one that is more influenced by smaller and mid-sized stocks – did not hit new highs until mid-November.  The equal-weight index only hit nine new highs for the year, half of the number of the market-cap weighted index.  The equal-weight version was up a respectable 10.42% for the year but this significantly lagged the market-cap weighted version.  Where does this leave us at now and where are we heading?  Stock prices are still at relatively elevated levels.  There are many brokers and investment advisors that will try to bend and manipulate the data to justify the high current prices and valuations.  I believe the reasons for the current bull market are twofold – FOMO and TINA.  Let me explain. 
 
The first acronym, FOMO, is short for ‘fear of missing out’.  This is the greed factor that drives investors to take greater risk, especially when they are following a crowd.  This prompts investors to put money into the markets often in the wrong places as they try for that “get rich quick” idea.  This can often lead to speculative excesses.  Two good examples of this are Robinhood and Tesla. 
 
Robinhood is a financial app that is extremely popular nowadays.  It offers access to trade stocks at no cost.  Because of the way Robinhood presents itself, it makes investing very “game-like” with confetti and emojis to entice younger investors.  This has led to a lot of devastating results with novice investors getting in well over their heads and pouring good money after bad.  From an article in the Denver Post it was pointed out that Robinhood traders bought and sold 40 times as many shares of stock and 88 times as many option contracts as their peers at Charles Schwab or E-Trade.  Robinhood saw 3 million new users sign up in 2020 and was the fourth most downloaded app on the Apple platform and the seventh most downloaded app on Android phones.  With many people working from home or out of work, the 13 million total users had a lot more time on their hands to trade stocks and options on the app.  And trade, they did.  The revenue Robinhood earned in the second quarter of 2020 – their revenue is driven by the company getting paid based on the number of orders generated by individuals trading – eclipsed all Robinhood revenue earned between 2015 and 2018. 
 
Tesla, as you are probably aware, makes electric cars or EVs (short for electric vehicles).  Tesla has been on the leading edge of the EV market and its founder and CEO, Elon Musk is either a genius or crazy, depending upon whom you ask.   Tesla, the company is finally starting to do well, having turned a profit in each of its last four quarters.  This led to the stock being added to the S&P 500 Index in mid-December, entering as the sixth largest company in the index.  While the company is making strides, the stock has been on fire.  The stock price moved from a split-adjusted price of $83.67 per share at 2019 year-end to close just over $700 per share at 2020 year-end for a 743% gain for the year.  The total market value of Tesla’s stock is more than the next eight largest car companies in the world!  Never mind that Tesla only has just over 1% of the total vehicle sales in the U.S.  Yes, it can be argued that Tesla’s 54% of the EV market is worth some premium, but the other car companies are not sitting still and their EV sales will eventually cut into Tesla’s sales and market share.  Investors seem to be assuming infinite growth forever for Tesla.  The bottom line is that Tesla is probably a speculative bubble but remains popular with individual investors because it just continues to increase in price.  For now. 
 
FOMO explains much of the speculative excess lately but what is TINA and how does that affect us?  TINA is short for “there is no alternative.  In a nutshell, with interest rates near historic lows, if investors want any kind of return, their only alternative is to invest in the stock market.  As you know, Congress passed the CARES Act back in March in the wake of the shutdown of our economy.  This $1.8 trillion stimulus package was designed to soften the blow of the shutdown and get the economy over this hurdle.  In late December, another $900 stimulus bill was passed as part of a budget package.  In addition, the Federal Reserve has spent nearly $6 trillion in buying bonds.  All this money has to go somewhere, and the biggest beneficiary is the stock market. 
 
I know many of you are worried about the speculative excesses I outlined above.  At the risk of sounding like a broken record, let me repeat what I said at this time last year.  I am cautiously optimistic.  The optimism arises from expectations for continued fiscal and monetary stimulus.  In other words, I continue to think both the Federal Reserve and the incoming Biden administration will attempt to stimulate growth in the economy and get people back to work through additional spending packages.  This may come in the form of more “free money” or it could come in more responsible ways.  Ideally, we could finally see spending on our infrastructure – rebuilding our bridges and highway system that is crumbling.  This would be a productive way to spur growth but would not be as immediate as a third stimulus check.  Regardless of how stimulus comes to us, I fully expect we will see more money from the government to support the economy and to encourage and promote business and employment growth. 
 
On the cautious side of things, I want to again return to what is fast becoming my favorite metric – the ratio of the value of the stock market to the value of our economy.  Just to remind you, this metric measures the value of the Wilshire 5000 stock index, the broadest measure of stock values encompassing virtually every publicly traded corporation, to the value of the output of our economy.  As of the end of the third quarter 2020, which is the last measure we have available, this ratio stood at 2.01, which is a new record.  In other words, the value of the stock market is currently twice the value of all of goods and services our economy produces.  I asked last January when the index was much lower if this overvaluation was sustainable and answered affirmatively.  I will echo that thought.  As long as interest rates remain low and inflation benign, we will continue to see stock prices at these inflated levels. 
 
And speaking of interest rates….  Last January, the interest rate on a 10-year Treasury bond was just above 1.84% but that was still low relative to the 3% yield it hit in October 2018.    The recent changes in interest rates have much more to do with market forces than economic issues.  During the summer, interest rates hit new lows as investors were seeking the safety of bonds during the uncertainty of the pandemic.  The interest rate on a 10-year Treasury bond fell to 0.54% in July before rebounding to about 1.10% today.  Much of this increase in yield is due to optimism on the vaccine front and the expectation for more stimulus financed by bond sales.  As investors have gotten more optimistic about the economy returning to normal, they have sold bonds and bought stocks.  When investors sell bonds, the price of the bond falls which increases the interest rate yield.  This is because the interest rate paid on a bond is fixed so the lower the price, the higher the yield you will earn and vice versa.
 
The interest rate situation is one that I am paying particularly close attention to these days.  This is largely because we have a couple of investments that are a bit interest rate sensitive.  The two are TRI Point Group, Inc. (ticker: TPH) and Lennar Corp. (ticker: LEN), both of which are homebuilders.  Low interest rates obviously help sales but there are other factors that I believe will continue to drive increased sales for these two companies.  One key metric is the availability of new homes for sale.  This inventory is currently at the lowest level since this data has been tracked.  Couple that with a strong demand by buyers and this is a potential long-term winner.  We added both names in the third quarter of the year.  Changes to client accounts included two new names.  We have added exposure to medical supplies distributor Cardinal Health (ticker: CAH) as well as sports retailer Hibbett Sports, Inc. (ticker: HIBB).  In both cases, we continued to use options to gain exposure.  However, our use of options seems to be diminishing as volatility – one key factor that allows us to earn great returns – is falling and this lowers our profit opportunities.  You can expect to see a return to a more normal “buy a stock and hold” strategy. 
 
Of course, if the fundamentals change on something we own, we will not be shy about selling.  This past quarter, we eliminated our holdings in ACCO Brands at a small loss as the company’s cash flow fell significantly, raising the risk on our investment.  We also eliminated our exposure to construction company Great Lakes Dredge & Dock Co with a nice profit.  We earned between 13% - 16.5% return on this investment in a matter of six months depending upon the account.  This one was eliminated for falling cash flow, as well.  In addition, we have continued to “roll” options we have on a few other securities such as MarineMax Inc (ticker: HZO), SpartanNash Company (ticker: SPTN) and Weis Markets, Inc. (ticker: WMK).  By rolling, I mean we bought back an option we originally sold, obligating us to buy the underlying stock and selling another option that is another month down the road.  This is adding to our long-term profits by adding additional cash without taking any additional risk.
 
We continue to seek out new investment opportunities but there are not many that have caught our attention.  Perhaps this speaks to the elevated nature of stock prices. The mutual funds we added in the second quarter of the year continue to perform admirably.  We continue to research new ideas as they come along, and we encourage you to bring ideas to us as they occur.  We know we do not have a corner on investment ideas.  We are always willing to look at new ideas you may come across.  While we are always open to short-term trade ideas, we much prefer to find good, long-term investments.  Boring companies that continue to mint money for us allow us to rest easy at night.
 
I hope this is the last time I have to say this, but I will again not be traveling to see clients this quarter.  With the vaccines now available, I am just awaiting my turn for my two shots.  Once I have the vaccine, I will feel far more comfortable traveling.  Just because we do not all have the vaccinations yet does not mean we cannot meet face-to-face.  I mentioned last quarter that I have added GoToMeeting, a video conferencing software, to my repertoire.  If you would like to schedule a meeting with me, please feel free to either email me or call me and I will set this up and send you the invite to the meeting.  As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com
​

​This has been the longest month of March ever.  Oh… wait…. It’s October now isn’t it which means another quarter has just ended.  In many respects this was a normal quarter with not a lot of excitement.  The market continued its relentless climb out of the depths of the recession in March peaking in early September at new all-time highs before sliding over the next three weeks in what, so far, has been a garden variety correction.   Most investors consider a fall of around 10% to be a correction.  The broad S&P 500 index fell 9.6% between September 2 at its peak and September 23 when it hit its lowest point. 
 
If you recall last quarter’s letter, I mentioned that the S&P 500 Index is greatly influenced by a few large tech names such as Apple, Alphabet (Google) and Facebook.  That continues to be the case.  As evidence of this while the widely followed S&P 500 Index fell about 10% in September, the equal-weight version of the index only fell 8% for the same period.  By contrast the very tech-heavy NASDAQ Index fell almost 12% over those three weeks.  While some of the funds we hold across client accounts do tilt towards these large tech names we still did a good job of controlling risk.  Across all accounts we were only down a little over 6% during this correction. 
 
As interesting as these numbers are the one thing to keep in mind is that the stock market is not the economy.  This is oftentimes difficult for many to understand.  What is worse is when members of this administration, who should know better, continue to equate the stock market’s recovery with the economic recovery.  This is simply not the case.  Normally, the stock market will reflect expectations for the broad economy, but there are times when the two can become divorced from each other.  This is likely one of those times.  While the stock market oftentimes looks ahead and anticipates changes in the economy there are times when the market and reality can diverge.  The stock market has essentially gone through a “V” shaped correction and recovery.  We had the economy essentially shut down in March as the coronavirus pandemic hit us.  Stock prices and stock index averages plunged.  However, as soon as stimulus money started pouring into the financial system the stock market turned and headed north again.  Even discounting the recent 10% correction – not an unreasonable expectation given the 60% rise from the bottom in March to the most recent new high in September – the stock market is well ahead of the overall economy in terms of recovery. 
 
To put the economy in context, at the height of the great recession, unemployment hit a peak of 10.0% in October 2009 with 15.7 million people out of a job.  This past April, when the pandemic closed our economy, the unemployment rate hit its highest point in recorded history at 14.7% as 23.1 million people were out of work.  As stimulus money designed to keep people employed started flowing and states began gradually reopening, the unemployment rate started falling.  By September, the number of unemployed had fallen to just under 13 million.  This is the point where the stock market and the economy seem to diverge.  The stock market seems to be pricing in a continued recovery and a continued reduction in the unemployment rate.  While I am confident we will recover from this pandemic, I am so sanguine on the rapidity of that recovery.  I would argue that things are likely to get worse before they get better, especially in light of recent news and events.  Please allow me to explain. 
 
One of the key stimulus items that helped reduce the unemployment rate was the PPP or paycheck protection plan loan program.  Companies were able to borrow money from the government at a favorable interest rate.  If the loan was used strictly for payroll to keep employees on the books or rehire those that had been furloughed and the employees were still there at the end of September, the loans would be forgiven.  We are now past the end of September and companies are having loans forgiven but business has not necessarily picked up yet.  This is leading to layoffs again. 
 
In fact, we have seen quite a number of announcements of coming corporate layoffs in the past few weeks.  Disney announced a 28,000 reduction in their workforce.  Cineworld, the owner of Regal Theaters, has closed all their theaters in the U.S. and the U.K., laying off about 40,000 workers here.  MGM Resorts is cutting 18,000 workers.  Kohl’s is cutting 15% of their workforce as more shoppers move to buying on-line.  The beleaguered airline industry has announced that 32,000 or more employees may be let go and Southwest Airlines, in an attempt to keep from having to lay off anyone, is negotiating to cut salaries of all employees 10% across the board.  These are a few of the largest companies and speak nothing of the small Mom and Pop restaurants, bars, and retailers that are closing every day.  The online review company, Yelp Inc. has data to show that between March 1 and July 25, more than 80,000 business permanently shuttered. 
 
If you recall I mentioned that I was not terribly worried about a major stock market meltdown because I was confident the Federal Reserve would step up with some sort of stimulus package to provide a floor if possible.  I still believe that to be true but there is a limited amount the Federal Reserve can do to deal with more structural issues such as all these layoffs.  In recent testimony before Congress, Fed Chair Jay Powell called on Congress to provide more stimulus money to help ease the burdens.  Chair Powell essentially said that even if Congress spent too much money on stimulus it would not be wasted as it would contribute to a faster recovery.  I tend to agree with Chair Powell.  I am not a fan of wracking up deficits that we never pay back.  I have long said that I am a diehard Keynesian when it comes to economics.  As such, I believe we need to spend during times of crisis even if it means borrowing to do so.  However, I believe that once we recover from this pandemic – and we will recover – we need to pay these debts back and run a balanced budget. 
 
In addition to the threat of massive layoffs, for many people unemployment benefits fell dramatically as of the end of July.  As part of the stimulus package passed in March unemployment benefits included an extra $600 per week.  This expired at the end of July.  The President did issue an Executive Order that temporarily extended additional unemployment benefits at a reduced rate but that money was taken from the FEMA budget – the funds that are typically used for Federal emergencies such as hurricane relief – and those funds dried up by late August.  Add to this the high probability that many businesses may have to close down again as winter comes on and coronavirus cases almost inevitably surge again and there is a compelling argument for additional stimulus money to get us through this pandemic.  However, the Republicans in the Senate seem loathe to want to do anything more, counting on the money they have already spent to be enough.  Further confusing the situation, you have a President who changes his mind on whether to go through with a stimulus package seemingly by the minute.  On October 3, the President tweeted to the Republicans that he wanted a stimulus deal.  By mid-afternoon on October 6, he tweeted out that he was no longer going to negotiate on stimulus.  The stock market quickly lost about 600 points to close down for the day.  Now, it seems stimulus is back on the agenda as the President has announced that he is willing to come close to the $2.2 trillion package the Democrats in the House passed recently.  Whether or not the Senate is willing to take this up before the election remains to be seen.    
 
The bottom line is that without additional stimulus funds, any recovery is going to be glacial at best.  In fact, if we don’t get any additional stimulus given the number of potential layoffs and the greatly reduced unemployment benefits the recovery could turn south again.  This is likely to give us what some had feared would be a “W” type of recession.  That is the economy fell dramatically in March.  We had a gradual recovery through September but now we take another sharp leg down before finally turning back up as the coronavirus eventually is brought under control next year.  Additional stimulus could get us over the hump of the winter and into the spring when businesses can again focus on reopening and we will hopefully have a viable vaccine coming available.  It could help prevent that second leg down of the “W” which would benefit everyone.  I am paying close attention to what happens in Congress so we don’t get caught in a second sell-off should that happen. 
 
With all of that out of my system, how did we do this past quarter?  By most measures this was a good quarter for us.  We added a several new positions this quarter.  We have been very selective in our purchases sticking with quality companies that are showing solid revenue growth and high free cash flow.  New names to client portfolios include Great Lakes Dredge & Dock (ticker: GLDD), recreational boat retailer MarineMax Inc. (ticker: HZO), homebuilder Lennar Corp. (ticker: LEN), semiconductor equipment company Photronics Inc, (ticker: PLAB), grocery distributor SpartanNash Co. (ticker: SPTN) and homebuilder TRI Pointe Group Inc (ticker: TPH).  
 
In many accounts rather than buying shares of the stocks we liked directly we instead chose to use options strategically.   We sold put options which obligated our clients to buy these underlying stocks.  For example, in August we sold an option that obligated our clients to buy 100 shares of Great Lakes Dredge & Dock for $9 per share.  We collected $29.33 for taking on this obligation.  Our total risk was $900 should we have to purchase this stock even if it was priced at zero.  The premium we earned may not sound like a lot, but that equates to earning 3.26% in a month and a half.  We were able to repeat this process again earning a little bit more the second time.  We will continue this strategy as long as we are able to earn good premiums.  In the current market environment of volatility and uncertainty, selling (writing) options has proven to be very profitable.  In this quarter alone, we have earned 3.3% and 3.4% from options on Great Lakes Dredge & Dock, 4% on options on Lennar, 6% on Photronics options, 6.2% on SpartanNash options, 9.5% on Weis Markets options and a healthy 12.4% on TRI Pointe options.  I would like to believe we can continue this strategy indefinitely, but the reality is that, at some point, there will be less uncertainty and we will revert to simply buying and holding good stocks.  This does not mean we are stopping this strategy.  It simply means we probably will not have as many lucrative opportunities. 
 
On the sell side, we eliminated our holding in Canadian insurance giant Manulife Financial Corp. (ticker:  MFC) taking a small loss in the process.  This investment was starting to become too risky.  The Parker Drilling (ticker: PKDC) that we held in several client accounts was finally bought back by the company at $30 per share.  This gave us a tremendous return for the quarter since the stock was selling for around $6 per share at the end of June.  Based on our $20.50 original cost, it was worth waiting for the nifty 46% return on that investment.  We remain pleased with the mutual fund lineup we have in place now and are merely “tweaking” client allocations to deal with this success.  The Virstus KAR Mid-Cap Growth fund that we started buying in early-April around $37 per share closed the quarter at $58 per share for a 55% gain.  We have been trimming a little bit in client accounts to reduce the amount of risk we are taking with this fund though it remains a great fund and a key allocation for clients. 
 
What can we expect for the rest of the year?  With a potentially contentious election process already signaled we can expect continued volatility.  Regardless of who wins the election stocks will continue to do well.  Certain sectors will do well under a continuing Trump administration while different sectors would benefit from a Biden election.  In fact, as long as the Federal Reserve continues to provide stimulus money by continuing to buy bonds this money will continue to flow into the stock market.  If we do not get any fiscal stimulus from Congress before the election, we will likely remain in a narrow trading range.  Clarity on the election results will dictate the direction of the markets in the short term.  Over the long term I continue to be optimistic.
 
As you know the coronavirus is still a major issue.  Cases are rising in many states so there is still a significant risk.  The recent “super spreader” event at the White House which led to most of the senior staff being infected shows just how vulnerable we still are as a nation.  I will again not be traveling to see clients this quarter.  However, that does not mean we cannot meet face-to-face.  I mentioned last quarter that I have added GoToMeeting, a video conferencing software, to my repertoire.  If you would like to schedule a meeting with me, please feel free to either email me or call me and I will set this up and send you the invite to the meeting.  As always, we truly appreciate the trust you have placed in us, and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.
 
Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(866) 857-4095
www.aeriecapitalmgmt.com