Paper Portfolio – September 2021 Update

The Paper Portfolio performed well during the month of August. The Paper Portfolio returned 6.00% vs the S&P500’s 2.98%.

This brings the Paper Portfolio’s YTD performance up to 16.52%, still slightly lagging the S&P500’s 21.57%.

The capital markets are currently in a tricky place. “Investors” have likely never been more risk-seeking than they are now compared to any other time in the last decade. “Investors” are currently willing to put money behind almost anything including invisible rocks. While some of this risk-seeking behavior stems from structural changes in the market (e.g. fractional shares, no-fee trading), a lot of the risk-seeking behavior is likely a side-effect of the unprecedented monetary and fiscal stimulus unleashed last year.

It’s unclear whether this risk-seeking behavior can sustain itself, especially as monetary stimulus gets pared back within the next few months as the Fed begins to taper its QE program (market is currently expecting taper signal beginning in September with official program initiation in November / December).

In conjunction with taper, the world’s two largest economies (US and China) are heading into an uncertain period. The US is likely facing near-term economic headwinds as COVID-19 Delta variant ravages certain parts of the US. At the same time, China has also been combating its own virus outbreak while trying to carry out an unusually active regulatory agenda.

Capital Flywheels is not a fan of picking up pennies in front of bulldozers.

Capital Flywheels is not suggesting there is a bulldozer coming (other than in China…but arguably the regulatory bulldozer has already rolled over quite a good amount of investor money). But Capital Flywheels believes it makes sense to run cautiously for the next month or two as the situation clarifies itself.

We live in a non-linear world. Small, unexpected shocks can often lead to large dislocations in markets and investor sentiment. I don’t see the conditions for massive upside at the moment, but potential meaningful downside if shocks materialize. As a result, the Paper Portfolio will position a bit more conservatively for the September update by raising cash levels a bit, while rebalancing towards names where there is potential for company-specific drivers for performance. More details on all of these below.

Moving on to the winners and losers.

Winners:

1/ SE (+22.5%) – Sea performed strongly as the company reported very strong results across all 3 segments (gaming, e-commerce, and fintech). Free Fire continues to gain traction around the world (including US, which is one of the largest gaming markets in the world) despite a very, very high base. Shopee continues to gain momentum in Southeast Asia, outcompeting local peers. In addition, Shopee seems to have also become one of the largest e-commerce apps in Latin America in under 2 years of operations.

2/ NVDA (+14.8%) – Nvidia performed strongly on the back of record earnings. Not only is Nvidia continuing to deliver unbelievably strong gaming results, the datacenter segment also seems to be reaccelerating above expectations. Nvidia’s latest announcements around Omniverse / metaverse, autonomous vehicles, and other areas continue to hint at immense long-term potential that have yet to factor into investor expectations.

3/ U (+18.3%) – Unity also performed strongly on the back of stronger-than-expected results. The company continues to grow above conservative expectations, despite feared headwinds from Apple’s IDFA changes. Not only has Apple’s IDFA changes not affected Unity, Unity appears to be benefitting from the changes. Similar to Nvidia, Unity’s recent announcements continue to highlight the company’s efforts in building out the long-term runway as the world becomes more digitized and more real-time 3D.

4/ ZI (+21.3%) – ZoomInfo also delivered incredibly strong results. ZoomInfo is a highly, highly under-appreciated company, in my opinion. People think it is a phonebook, but it’s a sales intelligence platform that I believe has the potential to be bigger than CRM in the long-run. On the contrary, CRM is likely the phonebook…ZoomInfo’s results continue to show how the company can grow revenues at ~50% CAGR, which is above investor expectations.

5/ Likewise, MELI (+19.0%) and Adyen (+17.4%) also delivered very strong results.

6/ AFTPY (+37.4%) – Afterpay performed very strongly during August because Square announced an acquisition of the company at a significant premium. While this bumped the stock up significantly during the month, it will ultimately lead to a very average outcome for the Paper Portfolio. Unfortunately, Square announced its acquisition of Afterpay during a period where Afterpay’s stock had been performing quite poorly. As a result, Afterpay’s long-term potential will no longer be captured directly by the company and its shareholders.

7/ ETHE (+46.7%) – Grayscale Ethereum Trust performed strongly as demand for crypto revived. I don’t have much more insight beyond that.

Losers:

1/ PINS (-5.7%) – Pinterest continues to perform poorly following last month’s disappointing earnings release.

2/ SDGR (-11.8%) – Schrodinger reported weak results that continue to leave investors a bit uncertain about its future. While the business appears to be doing fine, there is limited visibility into the pace of business value creation. The core software business has been lumpier than expected, while progress with the internal drug development programs is hard to predict.

3/ Z (-9.9%), UBER (-10.0%), and FSLY (-9.3%) all continue to be a bit weak as investors likely reposition away from these names due to near-term headwinds on their businesses.

Overall the Paper Portfolio did decently well during August.

For the September rebalancing, the Paper Portfolio will continue to lean in – at the margin – into higher conviction names that have company-specific catalysts coming up.

At the same time, the Paper Portfolio will completely sell out of Afterpay and Apple.

Afterpay is currently trading at a slight discount vs its acquisition value…but close enough. Since the acquisition is likely to close, it is effectively quasi-Square stock. Since I view Square stock as only somewhat attractive at its current level, I think it makes sense to sell down this stake.

Apple has performed very well since we added it to the Paper Portfolio at the beginning of March 2020. Since then, Apple has returned 124.6% vs the S&P500’s 56.4%. While Apple remains an incredible business, the risk / reward is much less attractive than before. Apple’s multiple has expanded dramatically, placing its market cap at >$2.5 trillion. While it remains an incredible business, it is likely just an average / good stock from here.

With that…let’s see what September brings!

Disclosures: I own shares in NET, PINS, SE, MRNA, SDGR, U, SQ, UBER, PLAN, AYX. I have no intention to transact in any shares mentioned in the next 48 hours.