Preparing for Inflation

 
Asset Management, Companies and Industries, Investment Themes, The Economy October 21, 2021

Preparing for Inflation

In the third quarter, Nelson Capital made several changes to our portfolio amidst the choppiness of the post-pandemic recovery. (See our blog post Inflation… Not So Transitory? for more information)

Within the Consumer Discretionary sector, we initiated a position in D.R. Horton (tkr: DHI), a leading homebuilder in the U.S. that constructs and sells primarily single-family homes. The recent all-time highs for home prices are driven by record-low home inventory combined with the trend of millennials forming households and entering the home-buying market. We believe D.R. Horton will benefit from the more dramatic scarcity of entry-level homes (per data from Freddie Mac and the Harvard State of the Nation’s Housing 2021 study), as nearly 90% of its homes sold are designed for entry-level and move-up buyers.

We also purchased a position in Equity Residential (tkr: EQR), one of the largest residential REITs, which owns primarily luxury apartments in urban, coastal markets. Residential REITs in these regions were hit exceptionally hard by the pandemic, with rent prices plummeting and concessions rising to attract new tenants as people left big cities for inland and suburban areas. Though an urban exodus was a concern early in the pandemic as remote work became the new norm, it is not likely as sticky as initially anticipated as more companies announce their plans to return to the office and people flock back to large cities. Additionally, the surge in home prices has made homeownership less attainable for many people and subsequently has driven the demand for apartments higher. Importantly, residential REITs typically hold up well in inflationary environments given their annual price resets.

In the Materials sector, we sold our position in Danimer Scientific, (tkr: DNMR), a newly public biodegradable plastics company, after a series of short-seller reports led to a significant fall in the stock price. Given the volatility in the stock, we decided to use this as a tax loss opportunity to offset some of the significant gains taken in client portfolios this year.

With the reopening of the economy, we chose to reduce our overweight in the Consumer Staples sector by trimming our position in Costco (tkr: COST). Costco’s execution throughout the pandemic was impressive, especially as paper goods and other household staples flew off the shelves. However, given its outperformance over the past several quarters coupled with supply chain issues that are depressing margins, Costco may be challenged by tough comparable earnings metrics over the next year or two.

Looking ahead, we are keeping a close eye on supply chain issues, tightness in the labor market, and other inflationary pressures that may impact the markets as well as seeking out new opportunities that will complement our existing portfolio.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Capital Management, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.

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