Too Much Good News

We were often reminded during the recent challenging economic period that the market climbs the wall of worry.  The inverse proposition might caution that the market can slide down the chute of good cheer.

Following up on our most recent commentary, the vectors on the economy, the pandemic, and government policies all pointed up the arc of optimism. Initial claims for unemployment fell sharply, while personal income and spending skyrocketed. COVID-19 active cases, new cases, and deaths all trended lower, as the vaccine rollout accelerated. Equally importantly, the single-shot Johnson & Johnson vaccine was approved for emergency use over the weekend, and the Company has indicated that 3-4 million doses are ready for immediate shipment. To state the obvious, controlling the pandemic is the cornerstone of building economic recovery. Congress moved closer towards passing the roughly $1.9 trillion pending relief bill, while Fed Chair Jerome Powell doubled (tripled? quadrupled?) down on the ultra-supportive monetary policy.

All this good news led to another rise in interest rates and a sell-off in the stock market. On Tuesday the yield on the Ten-Year Treasury exceeded the dividend yield on the S&P 500, alarming the TINATE (There Is No Alternative To Equities) rationale for elevated P/E multiples. Chairman Powell’s assurances calmed the markets; nevertheless, the S&P posted a 2.45% decline for the week. Tech stocks continued their recent underperformance, as the Nasdaq dropped 4.95%. The Ten-Year yield finished up 11 basis points to 1.46%, after reaching 1.61% on Thursday, equaling its pre-pandemic yield.

With all due respect to Chairman Powell, whom we believe is doing a fantastic job, we think that inflation is likely going to force the Fed to reconsider policy sooner than currently envisioned. As part of our ongoing research work at North Star, we monitor approximately 40 macroeconomic statistical series, many of which we obtain from the Fed database. Approximately a dozen of these statistical series tracks Producer Price Indexes, or “PPIs,” which historically have been a useful forward indicator of retail prices because PPI measures the cost of providing goods and services, which ultimately must be paid for by end-users. While these PPI statistics generally ‘wiggle upward’ over time with some of the data we track falling at times and others rising at the same time, for the first time in memory almost all of the approximately dozen PPI data series we follow rose in December and January. We don’t see this as a dire indicator regarding inflation, but rather view the data as useful to shape our views on opportunities. Specifically, a consistently inflationary economic environment is likely supportive of banking earnings growth (higher interest rates and yield spreads) and credit trends (rising nominal asset prices allow for easier repayment of existing loans). If PPI and other inflation indicators continue to rise, we also would expect an increase in mergers-and-acquisition activity as corporations seek to use current historically low borrowing costs to acquire attractive businesses before the bond market increases interest rates to account for rising inflationary pressures. Perhaps the recent “merger Monday” announcements of the past few weeks will continue into the Spring. We hope so since small-cap companies are usually the targets of such activity. On the other hand, the prices of long-term bonds and high P/E multiple growth stocks are vulnerable in this inflationary scenario. Additionally, the Fed would likely need to become more restrictive which could dampen future economic growth.

On Friday the U.S. jobs report will be released, with forecasts for nonfarm payroll growth of +225K after an increase of 49K in January. Too strong a number might drive interest rates higher and challenge the Fed’s stated monetary policies.

Trading in the “meme” stocks, internet currencies, and other speculative securities will likely continue to be in fashion. Most notably, the upcoming direct listing of Coinbase, the largest crypto exchange in the United States, will be in focus.

The oil market could be volatile as OPEC+ holds a committee meeting, with a decision expected on Thursday relating to production quotas that would likely take effect in April. Rising energy prices could contribute to the inflationary pressures that are forming.

To state the obvious, the twin narrative of pandemic and fiscal stimulus developments will continue to be of the utmost importance. The combination over the weekend of the positive vaccine news from Johnson & Johnson, the approval of the stimulus plan by the House, and a decline of 5 basis points in the yield on the Ten-Year Treasury set the tone for a very strong opening in the stock market. As the week progresses, let’s hope we avoid sliding down the chute of good news.

-15.0% Orion Energy Systems Inc (OESX) designs, manufactures and implements energy management systems for commercial and industrial customers. The Company’s management system is comprised of high-intensity fluorescent lighting systems, InteLite intelligent lighting controls, and Apollo Light Pipes. Last week, Orion announced Tim Rooney had been appointed to the new role of Executive Vice President of Sales. “Mr. Rooney…is a highly respected industry leader who brings an ideal mix of sales experience, industry knowledge, customer relationships, and career accomplishments to our company,” said Mike Altschaefl, CEO and Board Chair. OESX is a 3.9% position in the North Star Micro Cap Fund and a 4.5% position in the North Star Opportunity Fund.

+10.9% Bar Harbor Bankshares (BHB) operates as a bank in Maine. The Bank offers education funding, retirement, investment planning, insurance, risk management, and online banking services. There was no significant company news last week. BHB is a 1.2% position in the North Star Micro Cap Fund and a 2.5% position in the North Star Dividend Fund.

+22.3% Rocky Brands Inc (RCKY) designs, develops, manufactures, and markets men’s and women’s footwear. Its footwear brands, which are sold in retail sporting goods and outdoor stores, include Rocky, Georgia Boot, Creative Recreation, Durango, Lehigh, and licensed brand Michelin. Last week, Rocky Brands announced its Q4-2020 results of $1.33 per share. Net sales for the period increased 16.3% and the Company experienced record revenue and profitability. RCKY is a 5.2% position in the North Star Dividend Fund and a 3.7% position in the North Star Micro Cap Fund.

-10.5% 1-800-Flowers.Com Inc (FLWS) is an e-commerce provider of floral products and gifts. The Company’s product offerings include fresh-cut and seasonal flowers, plants, floral arrangements, home, and garden merchandise, and gift baskets. There was no significant company news last week.

-17.3% ARC Document Solutions Inc (ARC) provides large format document reproduction and printing services, mainly to architectural, engineering, building operator, and construction firms. Last week, ARC reported the Company’s Q4-2020 results of $0.02/share and revenue of $64.3M. ARC is a 0.5% position in the North Star Micro Cap Fund.

+17.2% Blue Bird Corporation (BLBD) designs and manufactures school buses and commercial buses for school districts, large national fleets, businesses, government agencies, and non-profit organizations. Last week, school bus stocks — particularly Electric Vehicle bus stocks — rallied on the news that the Los Angeles Unified School District made an all-electric school bus order. BLBD is a 2.0% position in the North Star Micro Cap Fund.

+18.4% Build-A-Bear Workshop Inc (BBW) is an interactive and entertainment mall-based retailer that invites guests of all ages to create their own customized stuffed animals with clothing, shoes, and accessories through a bear-making process. There was no significant company news last week. BBW is a 1.2% in the North Star Micro Cap Fund.

-11.1% Lakeland Industries Inc (LAKE) manufactures and distributes protective work clothing. The Company offers disposable, chemical, cleanroom, hand, arm, fire, and heat-protective clothing for on-the-job hazards, toxic-waste cleanup, and industrial work. Last week, LAKE announced the appointment of Nikki Hamblin to its Board of Directors. Ms. Hamblin has more than 20 years of experience in the investment industry. LAKE is a 1.2% position in the North Star Micro Cap Fund.