Hello, friends. 👋🏻👋🏻
Before I dive in, just wanted to remind everyone that I originally started the Paper Portfolio only to be a writing device. I wanted something that would force me to write more frequently.
This is not intended to be investment advice. I am not a registered investment advisor. I am not qualified to give you investment advice. And you should always do your own work and thinking before making any investment decision.
Thought I would put that upfront given how social media is increasingly becoming a relevant driver of market activity as evidenced by WallStreetBets. This blog is by no means anywhere near relevant in terms of traffic and reach, but there are real people out there that have lost money based on poor advice. I do not want that on my hands. Anything I write here should not be viewed as advice because everyone’s investing and financial situation is different. What makes sense to me may not make sense for you and your own financial situation. So please do your own work and consider your own financial situation before making any investment decisions.
As always, thanks for reading, and I sincerely hope for the best outcomes for all of you. I care, and I don’t want anyone to get into a situation they did not expect simply because they have a different financial situation that would warrant different decisions than what I write about.
February turned out to be another volatile month. While the first two weeks of February saw a strong market recovery following the (temporary?) conclusion of the GameStop / WallStreetBets saga, markets ended the month on heavy volatility as rapidly rising Treasury yields led to repricing of risk assets across the market.
The rise in Treasury yields and subsequent repricing of risk assets caused a bit of a vortex as many new investors to the market are likely not used to seeing stocks not go up 10% a month, let alone see stocks fall.
The market has experienced moments of volatility every few months over the past year. COVID-19 sell-off in March 2020. Retail speculation in bankrupt stocks between May and July of 2020. FANG mega-cap speculation in August through October of 2020. GameStop (+ AMC and others) in January 2021…every single episode ropes in new investors that believe stocks should only go up (by a lot).
And every time reality starts to collide with these expectations, it leads to a similarly strong and violent and opposite move down.
But at the end of the day, people learn. Expectations are reset, and the markets become healthier…at least temporarily…until new investors are roped into the markets with unreasonable expectations.
For example, GameStop might be going to the moon, again! 🚀🚀🚀 Or not…
We all know Reality tends to be cruel…and, unfortunately, Mr. Market does not possess the magic to suspend Reality indefinitely.
Capital Flywheels finds it a bit ironic that Treasuries and the USD are widely panned as “worthless” by many investors and crypto-currency enthusiasts, yet for something “totally worthless”, it sure has a way of forcing us to pay attention to it. The reality is that Treasuries and USD remain the single currency in which most of the world’s assets are priced against. Bitcoin has gone up a lot. It may continue to go up a lot. But it has limited effect on what other asset classes do because nothing is priced against Bitcoin (except, perhaps, other cryptocurrencies). For new-ish investors, I’m not sure it’s cool to quote Warren Buffett anymore so I may be reducing my own street credibility by doing so, but he’s right when he says interest rates (e.g. Treasuries) is equivalent to gravity for the financial markets. Gravity is not something you think about at all, but you most certainly are held captured by its power.
And we must respect its power. Very few high-flying stocks (or cryptocurrencies) would be heading to the moon 🚀🚀🚀 without the low gravity that the Fed has delivered to us. With low financial gravity dominating the markets, it’s becoming very easy to confuse real rockets 🚀 with 💩 that is floating off the Earth simply because gravity has gone to zero. Interest rates won’t stay at zero forever…”failing to prepare is preparing to fail”.
In any case…
For February, the Paper Portfolio slightly edged out the S&P500. The Paper Portfolio returned 3.95% vs the S&P500 at 2.76%. This brings YTD returns to 5.69% and 1.72%, respectively. While the Paper Portfolio outperformed the S&P500 during the month, the Paper Portfolio also delivered significantly higher volatility. At one point the Paper Portfolio was up more than 20%…and then ended the month up only 3.95%. For that level of volatility, the results should be viewed as quite disappointing.
Nonetheless, this is not unexpected given the level of performance many of these stocks have delivered over the past 12-18 months. Capital Flywheels anticipates that there will eventually be months-long periods where the Paper Portfolio will underperform significantly. For example, if ARK Invest, an extremely large ETF fund family that has significant exposure to many of the themes that the Paper Portfolio is also exposed to, underperforms, then the Paper Portfolio will likely also fall with it even if Capital Flywheels believes the Paper Portfolio is not exposed to the level of balance sheet and business model risks that ARK Invest has undertaken with a meaningful portion of their assets.
Due to the high level of volatility during the month, almost all individual stocks held in the Paper Portfolio experienced a greater than 5% move.
Pinterest, Square, Match, Nvidia, Zillow, ZoomInfo, Shopify, Twilio, Adyen, and PayPal all delivered very strong earnings. Many of these stocks rose heading into earnings. Many also rose further after the release of earnings, but a few did give back some gains.
Sea continues to benefit from rising optimism about the company’s prospects as they expand aggressively in Latin America as well as into food delivery in Southeast Asia.
Schrodinger likely rose in anticipation of strong upcoming results.
Bitcoin increased as a number of companies continue to buy Bitcoin for their own investment purposes including Square and Tesla. For the calculation of the results below, I have replaced Bitcoin with the Grayscale Bitcoin Trust (GBTC) as I was having trouble with my portfolio management software…the software has not been updated yet to include Bitcoin or any cryptocurrencies. However, this calculation is conservative because Bitcoin went up ~28% in the month of February but GBTC only went up 25%.
On the losing side, all of the biggest losers reported results that disappointed investors. This notably includes Fastly and Alteryx. Mercadolibre and Apple also went down a lot, but this is more likely due to market volatility (and perhaps competition with Sea for Mercadolibre).
For March, the Paper Portfolio has largely reduced weights across many names, while increasing the weights for the highest conviction names at the top.
Square is a notable reduction…while I am very bullish on the Cash App, Square recently bought an additional $170 million of Bitcoin in February at an average price of $51k. This is on top of the $50 million they bought last summer with an average cost closer to $10k. The purchase last summer made some sense. The expanded purchase at $51k makes less sense to me. There is potential that this tail will start to wag the dog since the accounting treatment of the purchase requires Square to write-down losses without any ability to write-up gains. Bitcoin has fallen quite a bit from their $51k purchase price, which means there could be as much as a $50 million write-down coming if the losses are sustained for a while.
The Paper Portfolio will completely sell out of Facebook and PayPal. While Facebook looks attractive with a lot of potential, the outlook is quite noisy with regulatory and advertising overhang and rising competition in terms of commerce. If it was just regulatory and advertising (e.g. Apple’s IDFA changes) overhang, then Capital Flywheels thinks it would have made sense to hang on, but competition is rapidly rising on the commerce side. Commerce is the one area that keeps me interested in this story, but Facebook risks moving too slowly, especially if Zuckerberg is wrapped up in these other concerns including regulations.
PayPal also remains very attractive, especially in light of the Investor Day presentation delivered recently. However, PayPal is not uniquely additive to this portfolio since we already have a lot of fintech exposure. Thought it would make sense to reallocate to other names that would be uniquely additive.
Which includes…
Unity and Okta.
The Paper Portfolio is adding a 4% position to Unity. The recent sell-off creates an excellent entry point. Unity is by no means cheap. And its business model (40% subscription revs, 50-60% advertising) is unlikely to deliver massively surprising revenue growth to bring the multiple down quickly. But Unity has the potential to deliver 30-40% revenue growth for many, many years. Although Unity is expensive, it is a near-unique asset (alongside Epic) with massive optionality as the world increasingly adopts gaming, 3D visualization technologies, and eventually AR / VR. Unity provides a rendering engine that makes it easy for game developers (and increasingly companies outside of gaming in areas like entertainment, architecture, autos, etc) to quickly create 3D models and 3D environments that can be manipulated in real-time. We, as a society, are very likely heading for a future where 3D digital worlds become much more prevalent in our own lives, and Unity is a foundational asset that will likely underpin that future.
The Paper Portfolio is adding a 3% position to Okta. Okta is an identity management company. Historically it was mostly used to manage identity / access management for enterprise employees. However, Okta has increasingly made progress in recent quarters to extend identity management to consumers / customers of the enterprises they work with. Okta has very interesting potential to become a neutral identity player across both consumer and business settings. Identity management is one of the most important problems facing the digital world today and our digital future…if Okta becomes anywhere close to the standard / default, its future will be very bright.
Let’s see what March brings.
Disclosures: I own shares in SE, PINS, SQ, NET, SDGR, MTCH, PLAN, UBER, SHOP, AYX, and U. I may transact in shares mentioned in the next 48 hours.
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