Sometimes investors focus on the long view; other times, events, real or imagined, cause views to compress dramatically. It’s always easy to reflect through the rearview mirror once the pendulum swings, but the difficulty in doing so as events are unfolding is sometimes obscured by emotion or by the sheer enormity of the information inputs which can affect market direction. Warren Buffet sold his airlines last Spring, at the bottom. Masa Son (of Softbank, the Berkshire Hathaway of technology, having funded Alibaba, DoorDash, and Uber, among many others), missed Snowflake and AirBNB .
2020 was about COVID and themes like work from home and the future of biotechnology, with the incredible creation of a vaccine in a matter of days. It was about free money, with the adjusted monetary base growing to 25% of GDP (2 ½ times what it was in 2009 after the financial crisis). FED Chairman Jay Powell famously said he, “wasn’t even thinking about, thinking about, raising rates”.
Now, as we face the reopening, some investors are wondering why the FED continues to buy billions of mortgage bonds each month, as the housing market booms. Market interest rates on the ten year US Treasury bond, which is not directly controlled by the FED, have essentially doubled this year. Inflation, which we see not only in the statistics, but also in the register tape at the grocery, is jumping dramatically. Yet it is important to note that though prices are showing spikes since last Spring, they are still well below pre-Covid levels.
So what does all of this mean for our portfolios? Our January letter referenced a pretty aggressive re-positioning of core account portfolios toward traditional industrials beginning late last summer. These companies were forced to cut costs during the Trump years as they were burdened by the Chinese tariffs, and then again as they dealt with the virus lockdowns. The resulting operating leverage in the businesses has exploded, with companies reporting 1Q profits 30-50% above expectations! The shares have responded accordingly.
Our growth account portfolios have recently (mostly after 1Q end) experienced the opposite side of that coin. Higher interest rates and inflation mean that the value of future potential earnings is lower. Though many of these companies also reported earnings beats, the stocks sold off, in some cases dramatically, on the news. And this was true not only for the Crisper Therapeutics (CRSP) of the world, but for massively profitable companies like Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN) too. Semiconductors (SWKS, AMD, QCOM) experienced similar punishment.
I believe this occurred for two reasons aside from rates and inflation (remembering that technology is the best antidote to inflation, as companies automate to eliminate costs). The first is the newfound celebrity of investment manager Cathie Woods, who specializes in investing only in what she calls “disruptive technology”. Her Ark funds are unlike traditional mutual funds. They are organized as ETF’s, which themselves trade as stocks on the exchange. This has the benefit of not requiring the manager to sell stocks directly when faced with client redemptions. But the corresponding negative is that it makes it easy to sell all the stocks in the fund short (ie. betting they will decline in price).
The second reason harkens back to a point from the January letter. Analyst “experts” of individual market segments are not institutionally conditioned to think across separate disciplines. And so they may be missing the key insight which makes this technology cycle different from previous ones. Those were centered around hardware, which by definition can be overbuilt; this one is centered around data, whose growth makes all previous data more valuable. Thus, the growth in this cycle is growing exponentially, rather than in a traditional linear fashion. To the extent this is true, growth stock valuations may not be as stretched as first appears.
Fortunately for us, in all but a couple of cases where position sizes were relatively small, we have stuck to our discipline of trims positions in these growth companies once they appreciate 25% or more. So though growth account balances have experienced a drawdown, in terms of individual positions we are playing with “house money”. We have cash in these accounts to allocate to the sector once selling subsides.
In the face of this turbulence, we need to keep our perspective on the possibilities for these companies. Any traditional attempt at valuation should be considered in light of the question, “what if….?”, in much the same way we looked at Moderna (MRNA) long before anyone had even heard of Covid. Indeed, Softbank (see above reference), invested during this past quarter $1B in each of two portfolio companies, Invitae (NVTA) and Pacific Biosciences (PACB); Vertex (VRTX), one of the largest bio-pharma companies, purchased 60% of Crisper’s (CRSP) sickle cell treatment for an unfront payment of $900MM, plus additional milestones.
All in all, our overall portfolio diversification has insulated overall client accounts from a nasty tech correction. As we look forward, we know that these companies will only grow in economic importance and we look for more heady returns over the coming few years.
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