Following the challenging month of March, April turned out to be a nice reprieve.
Our decision to lean into the March weakness for last month’s Paper Portfolio update also helped support performance.
During the month of April, the Paper Portfolio returned 7.44% against the S&P500’s 5.29%. This returns the Paper Portfolio to positive YTD performance, coming in at 3.74%. However, this remains below the S&P500’s YTD performance of 11.98%.
Although the monthly performance was good, April was another month of relatively high volatility for the Paper Portfolio. As a result, I would not assign a high grade for the performance achieved because it came with significantly higher volatility than the S&P500.
Near-term, the market continues to lack strong narrative. There is a tug-of-war between a lot of different investors trying to pull the market in different ways. This is leading to significant back-and-forth. On some days, narrative X may dominate. On other days, narrative Y may dominate. And every few days, this is further punctuated by unexpected narrative Z’s.
There are those (like us) that focus on strong, secular businesses that believe economic reopening and normalization should not overwhelm the secular growth profiles of these businesses. Some days, investors like us dominate the market (though we should be careful because there are a lot of speculators that also traffic in our stocks that do not necessarily invest for the long-term and may only be fair-weather friends).
Then there are those that believe reopening makes reopening / value plays much more attractive because of the (likely) faster near-term cyclical growth and lower starting valuations. Both of these elements are indeed true. If Capital Flywheels were more of a momentum or short-term investor, making these swaps could make sense. However, many of these businesses are unlikely to be good businesses over the long-run after the near-term cyclical recoveries have played out…
Then on some days, the world simply drops unexpected information that cause investors to scramble, reminding them that the world is not one-dimensional…and the things we focus on are not the only things that matter.
For example, interest rate movements continue to impact the market every now and then.
Investors have also been reminded that sometimes stocks simply go up (or down) depending on supply and demand. And sometimes demand is not sustainable because it is driven by unsustainable leverage (like the recent Archegos blow-up).
And still, other days investors are reminded that governments and policy matter. Changing government tax rules (like the recent proposals to increase global corporate tax rates as well as the US’ governments’ interest in raising capital gains taxes) matter. This should be no surprise since any objective investor should also willingly admit that a lot of the strong market performance over the past 12 months likely had a lot more to do with strong government fiscal and monetary stimulus than anything your favorite company likely did on their own.
Because the market currently lacks narrative, it makes stock picking even more valuable and important.
When there is strong market narrative, it is almost never a good idea to go against it. It’s fine to sit it out if the markets is driven by something that makes you uncomfortable, but it is often extremely painful (and likely unproductive) to move against an irreversible current. God can try. But others should not.
However, when there is no strong market narrative, most stocks will lack direction.
What matters then is picking the stocks that can create their own narrative.
Every stock has its own narrative. Always.
But most of the time, no company’s individual narrative is (likely) ever larger than the narrative of the market. Or the narrative of the country. Or the narrative of the geopolitical world.
But in moments like this when the market does not have a strong narrative, the narrative of some companies can rise to the top.
And it pays to listen closely for these faint voices amidst the white noise of the market.
The solid performance of the Paper Portfolio in April was largely driven by this very dynamic.
While the portfolio mostly holds secular growing companies, there was a lot of dispersion during April. Some went up a lot. But many were also relatively flat. The ones that powered the portfolio were really companies that had strong individual narratives that were able to shine during this period.
The best performer was Moderna, coming in at +36.56%. After a brief sell-off in recent months due to fears of reopening / normalization (potentially leading to declining COVID-19 vaccine business), Moderna has now largely recovered. Recently, Moderna held a “Vaccine Day” to discuss its future. And, as you can hopefully guess from Capital Flywheels’ rising optimism, Moderna’s future is extremely bright. COVID-19 may go away one day (or not), but there is so much more to Moderna than COVID-19. Moderna reminded investors that they are a technology company. And the technology they have is fundamentally transforming how vaccines and treatments work. Moderna can potentially tackle even cancer with a vaccine. What Moderna is doing to the healthcare industry is not unlike what software did to computing hardware industry. And this narrative is taking hold. We are by no means early to Moderna, but there’s a lot more future ahead of us.
Similarly, the 2nd best performer was Okta, coming in at +22.35%. Okta also held an investor day. And it reminded investors why Okta’s positioning is not only powerful and relevant, but also showed investors how its market positioning will allow it to expand and expand into adjacent areas now and into the future. Capital Flywheels was particularly taken aback by their vision for the future of identity. Okta is but one company vying for the future of identity, but the narrative that Okta is the default identity option is starting to take hold.
The 3rd best performer was Cloudflare, coming in at +20.61%. Cloudflare’s strong performance was mostly due to the announced collaboration with Nvidia to bring AI to the edge. Nvidia is the de facto industry leader in AI hardware. This tie-up adds significant credibility to what Cloudflare has been saying for a long time – Computing is moving to the edge, and Cloudflare is one of the best positioned to be the computing platform of the future.
Beyond that, Afterpay (+16.32%) Sea (+13.13%), and Nvidia (+12.45%) all performed well as the prevailing narratives for their businesses strengthened.
Outside of these names, Match (+13.28%) and Anaplan (+10.77%) also delivered strong performance. However, these two names are among the few in the portfolio that are more levered to economic reopening. As a result, these two names likely benefited from the improving vaccine situation.
On the negative side, there are very few names to mention.
The key name to call out is Pinterest (-10.35%). Pinterest delivered extremely strong quarterly results as well as provided very strong financial guidance. However, investors are a bit hung-up over the company’s forecast for sequentially falling US active users (due to reopening and people spending less time at home / online). This is disappointing because Capital Flywheels believes Pinterest’s future has never been brighter. The e-commerce opportunity for Pinterest is starting to shape up really well, and this will likely become more and more apparent later this year as we head into the holiday season.
Overall, the portfolio delivered solid results. However, this came with elevated volatility as well as meaningful dispersion within the portfolio.
In terms of rebalancing, the Paper Portfolio will continue to lean into high conviction names, while marginally pulling back on a handful of smaller names.
The Paper Portfolio will also swap GBTC for ETHE, the Grayscale Ethereum Trust. The most interesting things happening in crypto space is mostly driven by Ethereum and not Bitcoin. For years (sadly, Capital Flywheels did nothing but watch even though Capital Flywheels has been bullish on the ecosystem development in Ethereum while leaning quite cautious on Bitcoin due to, quite clear to me, the near impossibility of Bitcoin becoming a currency), ETHE used to trade at a significant premium to the underlying Ethereum assets held in the trust, but recently this premium has disappeared. It used to trade at a premium because many institutional investors cannot hold crypto assets outright. Many institutions that wanted to own Ethereum bought ETHE instead, which led to a significant premium / disconnect vs the actual underlying assets due to the way the trust is structured. However, many institutions now have other options when they want to invest in Ethereum. As a result, the premium has now evaporated. The combination of the removal of the premium in addition to all the interesting things happening in the Ethereum ecosystem makes it a good time to swap from GBTC to ETHE. Still, given that there is meaningful possibility that crypto assets could collapse in price very quickly, it makes sense to keep this position small.
Disclosures: I own shares in NET, PINS, SE, SDGR, SQ, U, UBER, PLAN, and AYX. I have no plans to transact in any shares mentioned in the next 48 hours.