Paper Portfolio – May 2022 Update

As always, this is not investment advice! Please do your own due diligence and take your own financial situation into account. Everyone has a different financial situation, which means different tolerances for risk and ability to take risk. What is appropriate for me may not be appropriate for you.

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Since the inception of the Paper Portfolio, April was the single most challenging month. Although there have been other months that have experienced equivalently sharp contractions (e.g. March 2020 and March 2022), previous episodes have seen some intra-month bounce-backs.

Not this time.

For the month of April, the Paper Portfolio declined 22.0% vs -8.7% for the S&P500. Despite raising cash since sensing trouble in late November and further aggressively raising it to nearly 10% last month, it has not been enough to offset the significant pressure across anything but commodities and certain mega caps (e.g. Apple, Microsoft).

This brings YTD returns to an incredibly poor -37.4% vs -12.9% for the S&P500.

Over the past 5 months, the Paper Portfolio has given back effectively all of its outperformance since inception. As of month end, the Paper Portfolio has only returned 45.1% since inception vs 45.0% for the S&P500.

That’s quite disappointing given the significant volatility we have lived through.

We are living through quite an unusual sell-off. Nobody alive has ever experienced a pandemic collapse, an unprecedented level of fiscal stimulus since the end of World War 2, and now an unprecedented plan to contract the monetary base / system liquidity to combat the highest inflation ever seen since the early 1980s.

There are no guides across this river. We can only feel our way through.

Still, with many, many stocks now down anywhere between 50-90%, some of these names will eventually recover (potentially aggressively).

But we must be selective. We do not know how long the challenges now facing the world will last. It is incredibly important that a company can survive (and thrive) on its own terms. Any company that is not the master of its own destiny is probably too hard. Any company that has a weak balance sheet or needs access to capital is probably too hard (though if they survive, these kinds of turnarounds could be where legends are made).

The good thing is that many companies that have strong balance sheets and decent cash flows have all sold off as well. We don’t need to take excessive risk. We just need to wait.

That’s approximately the philosophy behind the changes to the Paper Portfolio this month.

Not too many major changes.

We will sell Zillow. Zillow has been an unfortunately disappointing investment for the Paper Portfolio. The company’s initial plans to transform the house buying process has faced significant headwinds. Although the company is now shifting its strategy to something more sustainable (with a desire to remain a platform rather than own and control assets), the end market is now potentially facing a dramatic slowdown as mortgage rates rise. Zillow can likely manage through the challenges, but it’s less of a master of its own destiny than I would like. It has no ability to control or influence the direction of the housing market. Their fortunes are purely in the Fed’s hands now. One day it may make sense to revisit, but not now.

We will re-establish a 3% position in Match. When the Paper Portfolio first launched, we had a 4% position in Match given it’s long-term potential in a very interesting (but large) niche – online dating. Despite the growing demand for online dating with each passing generation, online dating is a fairly consolidated industry with Match and Bumble controlling most of the market. We sold it last summer at the onset of Delta since it was unclear how disruptive the fast-spreading Delta variant (and further eclipsed by the even-faster-spreading Omicron variant) would be for their business. The stock has since fallen 60%, but we are probably approaching dawn. Most of the world is now reopening very quickly and putting Omicron behind us. And after the 60% selloff since last summer, Match now trades at a decently attractive valuation ~25x forward P/E for a mid-to-high teens revenue grower (and 20%+ for earnings). In addition, Match is a very cashflow generative business.

Let’s see what May brings. I anticipate significant volatility around the Fed meeting next week, but it could be a clearing event once we have a better sense of how aggressive of a path the Fed will take in terms of rate hikes and balance sheet reduction.

Disclosures: Of the stocks mentioned, I own shares in NET, SE, PINS, U, MRNA, OKTA, SDGR, KIND, UBER, and AYX. I have no intention to transact in any shares mentioned in the next 48 hours.