Cutler Commentary

Equity Income Commentary 1Q21

March 31, 2021

Market Commentary
The world largely breathed a sigh of relief to close the books on 2020, though the problems faced last year are certainly not all behind us now.  Still, with the tailwinds of vaccine implementation, yet another huge stimulus package, and general re-opening measures in place, stocks broadly provided upside in the quarter. The S&P 500 reached  a new all-time high mark in late March and a 6% gain for the full quarter, and crossed 4000 for the first time in early April.  This resurgence in economic activity has led to increased expectations for inflation, and that the possibility (along with generally very elevated valuations for bonds in this “no-rate” environment) led to considerable selling pressure for bonds at the onset of the year.  The Barclay’s Aggregate bond index finished down over 3% for the full period.

The low point for stocks in 2020 was officially reached on March 23rd, so during this quarter we saw some jaw dropping 1-year returns for various broad indexes following the rally that has led to multiple record highs.  We have also seen a notable rotation away from the concentrated leadership of “big Tech” names, with the large Value index having the biggest outperformance against Growth in 20 years, up 9.9%(1).  We have seen brief head fakes in that direction in recent years, but given the desire for yield, lower relative valuations, and the possibility for a huge infrastructure spending bill, the Value trend may indeed have both feet under it this time.

As noted above, a massive $1.9T stimulus package has been pushed through after some divisive debate.  This package will add to the already enormous stockpile of consumer cash, and this “dry powder” has been a large driver of ongoing trading in quite speculative stocks- with GameStop garnering attention as a prime example.  That stock became a focus of the “Reddit Army”, an internet chat room group that banded together to drive up prices for heavily shorted stocks.  The goal was both to disrupt hedge funds that held those short positions, and to benefit from the ensuing price increase as those short positions were “squeezed” and closed out.  As is often true in these cases, a few traders realized huge upside but far more got caught on the wrong end as the price of GameStop (and other similarly shorted stocks) whipsawed up and then right back down. This further validates Cutler’s long-held view that speculation and prudent investing are two very different approaches.

Even as stocks have rallied from those March 2020 lows, there remain some concerning indicators about heightened volatility and uncertainty.  The VIX Volatility indicator (the “fear gauge”) has significantly decreased from the record highs of March 2020, but still remains about double the readings for most of 2019.  Unemployment has come well down from the high mark of roughly 15% closer to 6%, but reaching the sub-4% level from 2019 will be difficult with several million service jobs still in flux.  Even the re-opening process itself has proven to have fits and starts, with some states well ahead of others in that process and unease in some portions of the populace about getting back to “normal”.
The Fed has continued its dovish stance and has reiterated the timeline to remain at/near 0% short rates out to at least 2023.  However, with the 10-year Treasury yield rising from 0.5% last March to 1.7% now, there is increased speculation that this timeline is untenable.  This push up in yield has come from significant bond selling pressure, leading to that 3% drop for the Aggregate bond index and over a 13% drop for the 20+ Year Treasury index as investors retract their duration risk.  High Yield bonds did provide some modest total return for the quarter as investors maintained a risk appetite for more income.

Looking ahead, scrutiny will remain elevated on the vaccine process, ongoing stimulus and spending package proposals, possible (and likely) tax rate changes, and the willingness of consumers to utilize this stockpile of cash.  We are already seeing huge jumps in year-over-year demand for air travel, hotels, and restaurants.  The next step will be to see if these levels are a temporary relief, or long-term trajectory that can bring us back to the economic pace prior to the lockdown measures.  In addition, the specter of inflation will loom both in headlines and likely in some practical level.  Inflationary pressures are normal and healthy, so some increase there is welcome to stave off a possible “stag-flation” scenario like Japan has experienced for decades.  However, if signals persist of accelerated price pressures, the Fed may need to step in and take actions to alleviate that condition.  If/when we do see tax policy changes, some areas of impact could include the corporate tax rate, income tax rates for “high earners”, capital gains rate again for higher income households, and the standard deduction and/or estate tax exemption.  The impact of such changes are specific to each household, and appropriate planning steps should be considered.

We have identified key data points in recent market commentaries. While these metrics can continue to be difficult to rationalize in this unusual environment, here is where they stand:

  • Valuations. Valuations have risen notably since the recent bottom of late-Q1 2020, but so have earnings as more companies are able to expand operations.  The average valuation is now around 22 times earnings(2).  This remains elevated versus typical levels, but with bonds still looking overpriced and earnings broadly rising, this level could remain sustainable. 
  • Economic growth. GDP measures remain somewhat difficult to rationalize following the shocking Q1 and Q2 2020 drop and ensuing rally back. The GDPNow Q1 2021 estimate is up to 6% growth (source: Atlanta Fed)(3), and some 2021 full-year estimates are rising to over 7% growth.  Note that these stats should be taken in full context with the massive 2020 drops.
  • Interest rates. The Federal Open Markets Committee has projected short-end rates to remain at/near 0% out to at least 2023.  However, as noted above the 10-year yield has already climbed back up to 1.7% as bonds have sold off. The yield curve has steepened, and if inflationary indicators climb, the Fed may be forced to accelerate any rate increases to help contain those pressures.
  • Currency. The USD continued its trend of general softening during most of the quarter, but did see some relative strength return near quarter end- and this had a notable impact on non-US security pricing.  The general trend of USD softening could continue, which would be a relative boost for those non-USD securities, but this will bear ongoing review.
Equity Income Review
Cutler’s Equity Income strategy followed the trend of the broader markets, with a very strong quarter on the heels of the outperformance of Value stocks. Through March 31st, the portfolio had a return of 11.1% (10.85% net) versus the S&P 500 return of 6.17%. This was also roughly in line with the Russell 1000 Value index which had a return of 11.26%. Energy stocks led the way, up over 30%, followed by Industrials up over 21%.

Cutler maintains a significant overweight in Industrial stocks, as well as the Financial sector, when compared to the S&P 500. We feel optimistic about this portfolio positioning, as Industrials have benefitted from the overall economic recovery, and a political priority for 2021 has been further investment into infrastructure bill. In our opinion, cyclical companies are well positioned for this economic growth. Financials should also benefit from a steepening yield curve, as well as increased pressure on short-term rates. With inflation once again at the forefront of investor concerns, financial institutions should benefit if this trend were to materialize. We have increased exposure to Financials in recent years, adding both JP Morgan and Charles Schwab to the strategy in 2020.

We made several portfolio changes during the first quarter. We trimmed Deere stock, which saw a rally of 39% in Q1. We also sold Otis, which was an orphaned position from the United Technologies split-up last year. We continue to hold Carrier and Raytheon Technologies, which were the other entities that emerged from this break up. We also sold Dominion Energy, which had cut its dividend. Per our policy, if position has a dividend-cut, we will remove it from the strategy for at least 10 years.

We purchased two positions in Q1 that well represent our current market views. We view many companies in the Technology sector as having expensive valuations- IBM was purchased as an exception to this general trend. Granted, execution over the past decade for IBM has lagged, but with new management and new initiatives, we felt that the valuation today was compelling. We also added Comcast Corporation, the nation’s leading cable and internet provider. Comcast has numerous threats, such as cord-cutting and 5G internet, but the cash flows are significant and stable, and we felt increasing our Communications sector exposure was prudent.

The S&P 500 Index is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
The Russell 1000 Value Index is a domestic stock index measuring the performance of large U.S. equities, which demonstrate value characteristics such as lower price-to-earnings ratios and other metrics. It consists of approximately 1000 securities.
The Barclay’s Aggregate bond Index is a broad base, market capitalization weighted bond market index 
representing intermediate term investment grade bonds traded in the United States.
The VIX Volatility indicator is Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options.

The Russell 2000 Index measures the performance of the bottom 2,000 stocks (small-cap) of the Russell 3000 index. It is the most common index to represent the overall performance of U.S. small-cap companies.
The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
The MSCI Emerging Markets Index captures large and mid-cap representation across 27 Emerging Markets (EM) countries. With 1,392 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
Past performance is not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be profitable or suitable for a particular investor's financial situation or risk tolerance. You cannot invest directly in an index. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses. Source: Morningstar

All opinions and data included in this commentary are as of March 31, 2021 and are subject to change.  The opinions and views expressed herein are of Cutler Investment Counsel, LLC and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This report is provided for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. This information should not be used as the sole basis to make any investment decision.  The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed.  Neither Cutler Investment Counsel, LLC nor its information providers are responsible for any damages or losses arising from any use of this information
(1) Russell 1000 Value TR vs Russell 1000 Growth
Please see full disclosures at the end of this presentation and for information on the indexes referenced.
Top 5 Portfolio Securities   Q1-2021
Company Weight Return
Deere & Co. 6.09% 39.39%
Exxon Mobil Corp. 2.00% 37.77%
Intel Corp. 3.14% 29.22%
Caterpillar Inc. 4.44% 28.06%
Chevron Corp. 2.08% 25.80%
Bottom 5 Portfolio Securities   Q1-2021
Company Weight Return
Walmart Inc. 3.70% -5.37%
Merck & Co. Inc. 2.52% -4.94%
PepsiCo Inc. 2.76% -3.86%
Becton, Dickisnon, and Co. 3.65% -2.49%
Procter & Gamble Co. 2.83% -2.08%
Source: Morningstar Direct    



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These blogs are provided for informational purposes only and represent Cutler Investment Group’s (“Cutler”) views as of the date of posting. Such views are subject to change at any point without notice. The information in the blogs should not be considered investment advice or a recommendation to buy or sell any types of securities.   Some of the information provided has been obtained from third party sources believed to be reliable but such information is not guaranteed.  Cutler has not taken into account the investment objectives, financial situation or particular needs of any individual investor. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor's financial situation or risk tolerance.  Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.


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