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The COVID/Quality Roller Coaster

The COVID/Quality Roller Coaster

Long Short Review of the Third Quarter of 2021 | KayneCast 168

November 2, 2021

Chris Wright, portfolio manager of KAR’s Long-Short strategy, believes that the low-quality rally that took hold last November, and continued into Q1, took a pause towards the end of Q2 and continued into Q3.

The recent resurgence of quality coincided with the spread of the Delta variant and the decline in longer-term Treasury yields that began at the end of Q2. Wright believes that declines in the yield and S&P Transport sector (usually considered a bellwether of an expanding economy) indicated a change in attitude among investors who, at that point with Delta looming, began to fear a more challenging road ahead for economic growth.

However, towards the end of Q3, Delta seemed to peak, and Transports and long-term yields began to rise again, reinforcing the KAR philosophy that investors should not overreact to current short-term conditions, but remain focused on owning quality businesses with long-term earnings power.

Key Contributors and Detractors in Long Short

Listen to the podcast above to learn about the top contributors and detractors in KAR’s Long Short strategy for Q3 2021.

2021 – Interest, Inflation and Consumer Demand

As we enter the last quarter of 2021, Wright is focused on interest rates, consumer spending, and the impact of inflation on profit margins.

“As the Fed begins to taper its bond purchases, it will be interesting to see how the longer-term end of the yield curve responds.” He believes the Fed is likely to keep short-term rates at their current low levels because of their position that current inflation is transitory.

Inflation certainly exists today, and anyone who has made a recent visit to the gas pump or bought items at the grocery store knows that prices are higher. While the ability of individual companies to maintain their profit margins through this inflationary environment varies, corporate profits, in general, have continued to increase due to sustained post-COVID consumer demand. According to Wright, “We will have to wait and see if continued inflation finally causes some demand destruction, which would be a negative to corporate profits.”

What does this mean for Wright’s long-short investment strategy?

  1. For the short side —gross exposure is lower than it has been historically due to exiting some positions and caution in adding new names during this time of favorable economics and capital market buoyancy.
  2. An enduring mantra for the long side — remain focused on seeking high-quality companies with competitive advantages at reasonable prices.
DISCLOSURE

This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. Information contained in this material is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation of a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented should it change. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information contained herein.

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