Second Quarter of 2021

“Our expectation is that these high inflation readings that we’re seeing now will start to abate.” Jerome Powell, Federal Reserve Chairman, June 16, 2021

The US economy continued its rapid rebound in the 2nd quarter as we quickly transitioned from lockdown to a strong economy. The Atlanta Federal Reserve estimates that Q2 GDP will be 7.8%, which would be the highest quarterly GDP number in over 30 years. Inflation is probably the most discussed topic in financial markets today. You can see it in lumber prices, oil prices, used car prices, home prices, the labor market and more. The chart below shows the annual change in the Consumer Price Index, which is one of the key indicators of inflation. Inflation has recently spiked. The Federal Reserve believes this is transitory, but we are not as confident. We have made adjustments to the portfolios to position them for an inflationary environment that lasts somewhat longer than what the Fed is thinking.

Some inflationary pressures are likely temporary due to supply shortages as a result of the pandemic. For example, used car prices are at unusually high levels because auto manufacturers cannot produce enough new cars to meet demand. Unfinished new cars are sitting in lots awaiting semiconductors that control things like the engine and even less complex parts such as automatic wipers. The shortage of semiconductors is a result of auto companies canceling orders at the beginning of the pandemic and computer manufacturers demanding more chips as many white collar workers shifted to a work-from-home setup. As demand came back, auto companies placed orders for semiconductors, but were relegated to the back of the line. Semiconductor manufacturers should create enough supply for the auto sector in the next few months, however the lead time from chip to car is very long as a typical car part is shipped several times between countries who provide the lowest cost of manufacture for each individual component. We expect this bottleneck to dissipate early next year, and used car prices should begin to decline later in 2022. It’s possible that there will be sustained inflation in other areas such as wage growth. Job openings are at an unusually high level. Many employers are struggling to re-hire former employees as the economy reopens and companies are having to pay more to fill job openings. As the economy continues to strengthen, wages could continue to move higher.

Meanwhile, the Federal Reserve continues to fuel the economic recovery with their purchase of $120 billion of treasuries and mortgage backed securities each month. They are also keeping short term interest rates at 0%. These quantitative easing measures have been in place since the pandemic began. At some point the Fed will have to reduce asset purchases and raise rates. There is a debate within the Fed on the timing, but for now there is no change. If the Fed waits too long, they risk fueling a bubble. We are of the belief that the Fed needs to move sooner rather than later. The economy is clearly recovering and interest rates
at these levels are not healthy long term.

Our estimated composite returns year-to-date, net-of-fees, are as follows:

Brasada US Equity: +18.2%
Friedberg Dividend Growth: +12.7%
Friedberg Focused Equity: +12.1%
Friedberg Equity Income: +11.4%

This compares to +15.2% for the S&P 500 and -2.4% for the Barclays Aggregate Bond Index.

Brasada US Equity has been our best performing strategy since the beginning of 2020. Secular growers such as Generac and IDEXX Labs along with large cap technology companies including Microsoft, Paypal, and Google have led to market-beating returns.

Focused Equity has beaten the S&P 500 in each year going back to 2017. The strategy has an eclectic mix of stocks that we are optimistic about for the long term. Entegris is one of the companies that we are most excited about. The company will benefit from increasing demand for semiconductors along with increased manufacturing complexity. Our analyst, Daniel Prather, presented this idea at the Sohn Investment Conference in May. You can view the presentation by clicking here.

Dividend Growth has performed well this year and the returns have already eclipsed those of last year. The REITs we own have done very well this year, as they are benefiting from a recovering economy and REITs are a good hedge against inflation. We reduced our weight in utilities, which tend to lag markets when economies recover, and we reinvested the proceeds in companies such as Home Depot, Invitation Homes, and Union Pacific, which we believe will benefit from a recovering economy.

After a lackluster year in 2020, Equity Income has had a nice rebound and has outperformed the bond market by a wide margin. It’s hard to generate a decent return in bonds at these levels. Treasury bills yield close to zero, and the 30-year Treasury bond yields only 2%. The yield on our Equity Income strategy is about 3.3% and while bond payments are fixed, we expect the dividends from the companies in this strategy to grow annually.

We are very confident in our strategies over the long term. The members of our investment team have significant investments in the same securities as you. We hope you enjoy the summer and that you are able to see family and friends that you have not seen in a while. Our office is open if you would like to stop by or schedule a meeting.

Sincerely,

Jonathan Reichek, CFA

This quarterly update is being furnished by Brasada Capital Management, LP (“Brasada”) on a confidential basis and is intended solely for the use of the person to whom it is provided. It may not be modified, reproduced or redistributed in whole or in part without the prior written consent of Brasada. This document does not constitute an offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment advisory services or to participate in any trading strategy.

The net performance results are stated net of all management fees and expenses and are estimated and unaudited. These returns reflect the reinvestment of any dividends and interest and include returns on any uninvested cash. In addition to management fees, the managed accounts will also bear its share of expenses and fees charged by underlying investments. The fees deducted herein represent the highest fee incurred by any managed account during the relevant period. Past performance is no guarantee of future results. Certain market and economic events having a positive impact on performance may not repeat themselves. The actual performance results experienced by an investor may vary significantly from the results shown or contemplated for a number of reasons, including, without limitation, changes in economic and market conditions.

References to indices or benchmarks are for informational and general comparative purposes only. There are significant differences between such indices and the investment program of the managed accounts. The managed accounts do not necessarily invest in all or any significant portion of the securities, industries or strategies represented by such indices and performance calculation may not be entirely comparable. Indices are unmanaged and have no fees or expenses. An investment cannot be made directly in an index and such index may reinvest dividends and income. References to indices do not suggest that the managed accounts will, or is likely to achieve returns, volatility or other results similar to such indices. Accordingly, comparing results shown to those of an index or
benchmark are subject to inherent limitations and may be of limited use.

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