Jan 4, 2022
The story in 2021 was the rotation from growth to value, with the energy and banking industries in particular attracting investors. For Peattie Capital, returns were widely dispersed, with the best account gaining about 35%. However, dedicated growth/disruption portfolios fared relatively poorly and for them returns ranged anywhere from -2% to about +20%. The total return for the S&P 500 was approximately 28%.
Gains at Peattie Capital the past few years have been spectacular, with many accounts sitting on unrealized gains over $1mm, and a few over $2mm. One dilemma in 2021 was whether to take profits and join the market in rotating to “value” industries. This would be easy to do in IRAs but in taxable accounts it’s a different situation….especially in cases where there is still a long runway of growth and opportunity. Not only would selling generate enormous taxable gains, but it would also present a question of when to get back in. I think patience will be rewarded and absent any specific company (or client) issues, for now my intention is to continue owning several names that are well positioned for long-term growth, even though they were out of favor in 2021.
Reminder here that Peattie Capital manages separate accounts only and customizing portfolios based on specific client goals and preferences is a core tenet of Peattie Capital. Past performance is not a guarantee of future returns.
The biggest positions were winners
Across Peattie Capital portfolios the five most widely held names are Microsoft, Alphabet, Apple, Globant and Tesla, and last year they gained 51%, 65%, 31%, 44% and 52% respectively. I particularly like GLOB, which is a $12bn company and is not widely known or followed. I also like TSLA which is well ahead of all its competition, and electric vehicles are still only a 3% share of global auto sales.
The most concerning issue for me with any of these names is that they have been such strong performers recently. As far as fundamentals are concerned I like them all and expect to continue owning them.
But there were a number of losers too
The rotation out of growth/disruption hit a number of positions very hard, with several names off significantly and some ending the year in negative territory. The second half of the year was particularly difficult as the belief in entrenched inflation grew, accelerating the move away from growth. The rotation accelerated in November when Fed Chairman Powell removed the word “transitory” from his remarks, and as year-end approached many growth names became candidates for tax-loss selling as well.
Among these were Block (formerly Square “SQ”) and fellow payments company PayPal (“PYPL”). Twitter disappointed as well, as growth slowed and the company continued to tweak its model. For the year these three were down 25%, 18% and 19% respectively. I also held ROKU (“ROKU”) which dropped 54% from its high and ended the year down 31%.
While these names aren’t as widely held across PCM portfolios, they are in many portfolios and for the year had a significant and negative impact. I think these companies are worth holding, as they are executing well and still have significant growth opportunities. That said, both SQ and PYPL are facing increasing competition in the payments space and of these names they are the ones where I have least conviction.
Different year but same issues
It’s almost a repeat of last year’s letter as we continue to wrestle with potential rate hikes, lingering COVID issues, and an expensive and narrowing equity market. While I remain optimistic about the opportunities in the ongoing digital revolution, it’s important to remember that investing success is not linear. Many long term winners have had periods of moving sideways over a 12-24 month period and experienced 35% (or more) corrections.
As we enter 2022, the rotation into bank and energy stocks will probably continue as long as the markets at large believe in an improving economy and the onset of inflation. Banks benefit from higher rates and a steepening yield curve and oil/energy is viewed as a good inflation hedge. These two industries could be in long-term decline however as banks are being disintermediated by fintech and more oil can be brought to market to relieve supply/demand imbalances. Historically that takes a few months, but inevitably “price cures price” when it comes to commodities. In addition, many believe demand for oil is in long-term secular decline.
For some clients it may be appropriate to increase exposure to these areas.
A few other industries that look interesting are housing, and semiconductors and there may be opportunities in those. I also like companies with pricing power, and companies with specific catalysts on the horizon. Lately I’ve been adding an infrastructure company, which is planning to convert from an LP to a corporate structure, a formula that has been hugely successful for several private equity companies the past couple years.
For more conservative accounts portfolios tend towards larger, dividend paying and more recognizable names in defensive industries such as consumer staples, or utilities, among others.
January can be a difficult month as rebalancing dominates institutional behavior. We are still in a “TINA” world (“there is no alternative) as bonds continue to represent “return free risk” as far as I’m concerned. Even for income oriented accounts, I prefer dividend paying stocks with manageable payout ratios and a history of consistently increasing dividends rather than fixed income securities.
While the Federal Reserve recently announced an acceleration of tapering, at the moment their balance sheet is still growing, just at a slower pace. Eventually that support will end.
Higher rates would be a headwind for equities as well, and it looks like at least one or two rate hikes are coming in 2022. It’s noteworthy to me that so far the bond market is rejecting the inflation story, otherwise rates would be trending higher. More likely it is signaling weakness ahead and a greater risk of deflation than inflation.
Several commodities support this idea even though it is not widely believed by the market at large. For example, iron is down 36%, the Baltic Freight index is down 39%, US lumber prices are down 35% and oil is down 15% (source: Ark Research “Innovation Stocks Are Not in a Bubble” December 17, 2021).
I think Alan Binder’s Dec. 30 opinion in the WSJ (“When It Comes to Inflation, I’m Still on Team Transitory”) outlines how historically under-supply inevitably has led to over-supply and in so doing reduced inflation. Regardless, right now there’s a somewhat flat yield curve, which tends to be associated with a slowing economy.
In addition, I think it’s worth noting that even though the indexes had another sparkling return, under the surface many names have been much weaker, with more lows than highs and more companies trading below support levels.
According to the December 17 Financial Times (“Wall St. peaks mask treacherous currents beneath the surface”) on the day the S&P 500 first closed with a 25% 2021 gain, 210 companies were trading at least 10% below their 52 week highs. On the NASDAQ the disparity was even greater “with more than 1,300 stocks down 50% or more from their highest levels of the past year, and roughly 80% of the more than 3,000 stocks on the exchange off at least 10%.”
It’s a very expensive market too
According to David Rosenberg (“Early Morning with Dave” December 29) “We go into 2022 with the CAPE (cyclically adjusted p/e ratio) pressing against 40x….this last happened in 1999 heading into 2000. At this level, future returns, on a 1-year, 3-year and 5-year basis have been negative.”/FONT>
After such an extraordinary three-year run, with the S&P 500 gaining 29% (2019), 16% (2020) and now 28% (2021), the average for the following year is -2%, and on Thursday, 12/23, while the S&P 500 was making another new high, 334 stocks on the NYSE stocks were making new lows (Source: IBID).
A few final thoughts:
It’s also worth noting the extraordinary amount of algorithmic trading happening today. In the same December 17 article, Ark Research stated “By some estimates, algorithmic trading accounts for roughly 70% of all trading in the US, and even higher percentages during periods of higher volatility.” Momentum and algorithmic trading appear to drive stocks/markets faster and to great extremes, which creates an opportunity for anyone with patience and some fortitude. Most Peattie Capital clients are in it for the long term, which is the most likely route to investment success as far as I’m concerned.
To my way of thinking, interest rates will be the most critical factor. If we are through the worst of the supply shortages then inflation fears will (likely) abate, and there is a risk that the US economy goes from being under-supplied (broadly speaking) to over-supplied….the Alan Binder theory.
I pay very close attention to what’s happening in the bond markets. Low absolute rates underpin equity multiples and the shape of the yield curve tends to be a good indicator of the direction of the overall economy. Rising rates in an aging, narrowing and expensive market would be a challenging issue for the market overall.
While the conditions for a selloff might be in place, there’s no telling when any correction might happen, how long it would last or how deep it might be. Safe to say that it’s unusual for a market to be so strong for so long without a significant correction. People ask me all the time what the market will do and I can only say that I believe in a market of stocks, not a stock market. Regardless of the macro issues, and there are ALWAYS unsolved macro issues, owning the right names over time provides the best opportunity for long-term capital appreciation.
Peattie Capital portfolios are always based on meeting specific client goals and for some clients a more defensive position is warranted. However, left to my own devices I am still in favor of growth and disruption for long term success. Based on what I know today I expect to continue owning those kinds of names for most clients, and I think stock picking today is more critical than ever.Best wishes for a safe and healthy 2022, and please feel free to contact me with any questions or comments.