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.
During March, the Paper Portfolio returned 9.76% vs 3.66% for the SPY. This brings YTD performance to 26.35% vs 7.46%, respectively. Despite the strong relative performance YTD, the Paper Portfolio still needs to make up some lost ground before the since-inception returns catch back up to the SPY. Since inception, the Paper Portfolio still remains behind at +31.25% vs +46.50%, respectively, though the gap has narrowed substantially over the last few months.
The market appears to be increasingly coming around to the views we have laid out over the last few months: Inflation has already peaked. The number of pending Fed rate hikes are few and declining. And as economic growth slows, growth stocks will become more attractive than cyclical / value stocks.
By June of 2022, Capital Flywheels believed that many stocks were starting to look quite attractive. With the rapid reset of valuations due to the dramatic sell-off between Dec 2021 and May 2022, many stocks were starting to look quite attractive over a multi-year horizon.
By late July 2022, Capital Flywheels believed that inflation was potentially peaking, and growth stocks looked particularly attractive in the low growth environment ahead of us.
Subsequent data later in the year further helped support these views and were key reasons Capital Flywheels believed market weakness in October and December were likely attractive opportunities to position more aggressively.
And as the market increasingly comes around to our view, the Paper Portfolio is likely to benefit.
One thing Capital Flywheels has firmly believed and continue to believe is that long duration / growth stocks do not need Fed rate cuts to do well. There is a whole debate about whether the equity market is wrong since futures market is pricing in rate cuts…leaving aside the fact that these are two separate markets with different investors, Capital Flywheels does not believe we need to square the circle because it is besides the point.
Long duration / growth stocks do not need rate cuts. They simply need the Fed to stop hiking and applying pressure on the margin. With the reset in valuation experienced over the past year, many long duration / growth stocks are no longer trading at unpalatable premiums. Except for a few rare exceptions (like Cloudflare and Snowflake), many long duration / growth stocks command much more acceptable premiums than before. And for investors with a meaningful investment horizon, these premiums are more than reasonable. Interestingly enough, there are actually a number of long duration / growth stocks that are trading at a discount to the market. With Fed hikes out of the way, growth stocks that can continue to put up decent growth will look particularly attractive, especially as overall economic growth slows. Barring a deep recession (which Capital Flywheels does not currently anticipate), growth stocks should perform well the moment it is clear that Fed hikes are coming to an end.
The market now believes that that is the case, which drove significant strength in growth stocks during March.
The way it happened was not expected, though. Capital Flywheels did not have “minor banking crisis” on the bingo card, but a minor banking crisis we did experience…
The environment is rapidly evolving so it is hard to fully know the outcome of all of this, but the market likely currently believes the minor banking crisis roiling the US is likely to signal a peaking of interest rates, potential further slowing in inflation as credit tightens, and further slowing of growth.
In other words, all aligned with what we seek for the Paper Portfolio.
Turning to contributors, many names contributed positively to March performance.
Nvidia – Nvidia continued its rapid YTD ascent as AI and ChatGPT fervor continues to gain momentum. Nvidia is undeniably the most important (perhaps only) arms dealer to the entire industry. With competition in AI ramping rapidly, not only are downstream customers investing aggressively to compete, many customers are likely refocusing attention towards competing with each other rather than waste time trying to design Nvidia out with their own internal silicon efforts.
During March, Nvidia also held its GTC conference where the company unveiled a full portfolio of updates. One of the most important themes is the building out of new software revenue streams with significant potential including the launch of cloud services. Capital Flywheels has been anticipating the shift towards software and continue to believe that this shift could lead to a higher long-term multiple for the business.
Sea – Sea performed well after reporting positive profits a full year ahead of prior guidance. Sea has been a very poor performing stock over the last 18 months as the capital environment shifted (despite the poor performance, Sea remains a long-term winner since the Paper Portfolio added Sea at 2019 inception at ~$30 / share vs current share price at ~$90 / share and down from >$350 at its peak). Investors likely took a negative view on the business due to significant cash burn and lack of profits. While Capital Flywheels believed that Sea had a robust enough balance sheet to support investments for several years, the market took a dimmer view. However, with Sea now profitable, this removes a significant overhang. Despite only just turning profitable, Sea already has quite a lot of profits at ~$2 billion net income run-rate. This makes it look quite attractive against ~$50 billion market cap (was ~$35 billion a few weeks ago pre-earnings). Although not likely to be a straight line up, Sea’s profits and margins are likely to continue to move up from here over time.
Okta – Okta reported results in early March that were better than feared. Okta has had significant operation and execution issues over the last 12 months. However, the valuation became quite cheap (<5x revenues just a few months ago…which is very reasonable for a software business that remains very important in its niche). Okta appears to be regaining operating momentum, which should help lift sentiment.
There weren’t too many detractors since most stocks performed well. The only major callout is Match.
Match – Match continues to underperform due to weak growth at key asset, Tinder. Investors appear to be increasingly concerned about the company’s ability to reaccelerate growth in Tinder. However, given that the company is trading at a low multiple and high FCF yield (almost 10% FCF yield on consensus numbers for 2023), a lot of bad news is likely baked in. If Tinder does not reaccelerate, we are still likely to achieve an okay outcome. But if it does, the stock is likely to be a winner from here, especially given the stellar performance at Hinge.
For the April rebalance, the Paper Portfolio will completely sell AYX. While AYX remains fairly attractive and is seeing upward business momentum, there are other more attractive opportunities for that capital.
We are also somewhat pairing back our Nvidia position. Nvidia ended the month at 7.9% of the portfolio. We will pair back to 6.0%. The Paper Portfolio added Nvidia during the Covid bottom in March 2020, and the stock has more than quadrupled in the last 3 years. While the long-term story remains very attractive, the stock is up 90% YTD and is almost back to all-time-highs. It seems like a good time to reallocate some towards other opportunities.
The Paper Portfolio will add a 3% position in ATVI (Activision Blizzard). The Paper Portfolio previously sold ATVI in Jan 2021 at ~$90. Now two years later, ATVI is still slightly below that price at ~$85. However, Microsoft is currently in the process of acquiring the company for $95 / share and is awaiting regulatory approval. The deal is expected to close (or break) by the end of June. Capital Flywheels anticipates a closure of the deal, but even if the deal does not close, ATVI looks attractive as they continue to execute across their gaming portfolio. ATVI is about to launch Diablo 4. Diablo 4 is currently seeing significant interest in beta testing.
Alright, let’s see what April brings. Onwards.
Disclosures: Of the stocks mentioned, I own shares in NET, PINS, SE, KIND, MRNA, UBER, OKTA, U, SDGR, and SNAP. I have no intention to transact in any shares mentioned in the next 48 hours.