Sterling Partners Equity Advisors Portfolio Commentary – Fall 2021
Productivity to the Rescue!
There’s still a lot of unusual events going on, at least from the myopic view of someone who did not personally live through the World Wars, the Great Depression, the Plague, the fall of the Roman Empire and numerous historic horrible calamities. Despite that lack of experience, we are managing our strategies much as we have for the past twenty years, which is based on our best predictions of the future. There is a discussion of our best and worst contributors last quarter and our recent performance later in this letter, so you can see how we’ve been doing. The future does feel harder to predict these days, but that view may just be hindsight.
Our main job continues to be to make our best predictions for the future and dial those into estimates of the underlying intrinsic value of our candidates for investment. The future is always uncertain, but at a time when almost all historic patterns of commerce are changing at once, the near term is more uncertain than usual. It’s unlikely many corporate finance types are just extending last year’s growth rates into next year’s forecast. While this approach was simple and not terrible in a lot of “steady as she goes” kind of years, now it’s just horrible.
It’s easy to blame the pandemic for the massive dislocation of resources that is disrupting world economies, but in fact, the benefit is that owners of capital have been alerted that moving billions of workers dozens of miles a day to work at maximum productivity may not be the highest and best use of time and resources. It has become apparent that maintaining offices of information workers in a central hub is not quite as necessary for productivity as we thought, which was the purpose of the central hub in the first place. The advent of digital banking and digital signatures leaves even fewer reasons to go downtown.
So, we are in a period of rapid adaptation in which all global suppliers and customers need everything shipped to a new address at the same time. They also need something slightly different than they needed at the old address or a different quantity. This shift naturally creates logistics excesses and shortages. Prior patterns of commerce have been disrupted and, like gravity, seek the most efficient new pathways.
The world is working hard to move to a more productive model. The evolution of the internet and its use is reminiscent of other big productivity enhancing technologies like the road system or air travel, or still the mother lode, electricity, where it took decades to fully realize the full productivity potential of the innovation. If the interstate can bring us the suburbs can the internet take away the cities? Many of the consumer and business needs that downtown hubs were built to serve, and in the process generate an ROI, can now be satisfied with a smart phone – no real estate or travel required. Because of the need to work and shop remotely, the pandemic has lurched big swaths of the world into a more productive approach to almost everything at once, and we are beginning to see this in the data.
We speculated about this a year ago when the effects of the pandemic were just becoming discernible. But now we are seeing some data. When the future is unknown, it’s good to know what people who think about ROA for a living are doing with their checkbooks. The best source for this is the Bureau of the Census, Manufacturers’ Shipments and New Orders. For our money, and this is free, this is some of the best lumination into the road ahead so it’s worth looking at.
Granted, a fair amount of the recently strong GDP numbers can be attributed to the pouring of trillions of dollars into business and consumer wallets, and clearly a good bit of that has found its way into the equity markets, but there are clues in the new order data about the future.
In August 2021, orders for all new manufactured goods were up 18.0% and new orders for durable goods were up 24.7% from a year earlier. These are the highest numbers reported in these series, aside from earlier this year when the comparisons were even easier, since 2010. New orders rose more than shipments, which posted up 12.9% for August 2021 for all manufacturing and up 14.1% for all durable goods.
More interesting than the top line numbers are those categories at the top of the list. New orders for industrial machinery were up 48.0% in August! New orders for transportation equipment were up 45.7%. Shipments were up 41.0% for industrial machinery, up 37.3% for Light Truck and Utility Vehicles, and up 32.9% for computer storage. In most cases these are the best numbers since 2010.
There is another useful big picture statistic we like, growth in real GDP per capita. At the core, until you get higher into Maslow’s Hierchy of Needs pyramid, real GDP per capita is a pretty good measure of a nation’s wellbeing, as it correlates with self-reported happiness, but more specifically, it measures total production per citizen, and roughly speaking the average goods and services available per person in the U.S.
Sustained growth in productivity per capita has delivered modern civilization as we know it so it’s interesting to note that the posted number for 2Q 2021 of 11.78% is the highest recorded since the late 1940’s, beating the second highest of 11.52% posted in 4Q 1950, as the nation began benefitting from the post WW2 reallocation of resources, and beating the third highest 7.63% spurred by the onset of Reagan realignment of tax incentives. Much of this current gain is of course a recovery from last year’s decline, but there is always a bit of that after steep declines. Despite an environment stoked by free money, the orders and shipments of capital goods will drive real productivity gains, as the nations’ businesses and consumers adapt, re-allocating resources to maximize productivity. If we manage to grow productivity fast enough, we can stay ahead of inflation, and the data suggests that may happening now.
It’s worth noting that the 11.78% growth was posted to reach a record U.S. annualized GDP per capita of $69,904. This was the fastest GDP recovery on record. In the chart below we show Real GDP per capita, which in 2012 dollars reached a new high of $58,478, beating the prior high posted in 4Q 2019 of $58,333.
As an aside the U.S. is way ahead of the pack of large nations with this metric. In 2019, the IMF estimated U.S. $GDP per capita of $63,544. Next, 18.5% lower, was Germany at $45,724, the U.K. at $40,285, Japan at $40,113, France at $38,625. The U.S. has been an engine of productivity for a long time, the country is good at it, and it seems we may be in store for a few years of good gains as the world redeploys resources and capital.
Thinking about this is what makes our job to manage small equities fun. Please keep reading to see our thoughts about our best and worst contributors to our performance in the quarter. Thank you for your interest in Sterling Partners Equity Advisors and our small-cap value strategies.
See PDF below for a discussion of our top and bottom contributors to performance.
Kevin E. Silverman, CFA
Chief Investment Officer
John A. Schattenfield
Head of Distribution
Lara M. Compton
Director of Platform Marketing
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