June 30, 2023

AI is for real…..and The Electrification of Everything .

What’s noteworthy to me about 2023 so far is how narrow the market is. Seven companies in the S&P 500 (Apple, Tesla, Alphabet, Nvidia, Meta, Microsoft, Amazon) collectively have gained 53% and the remaining 493 have gained 3% (source: FactSet, Goldman Sachs Global Investment Research). Overall, the S&P 500 is +15%. Lately, more names have begun participating, but broadly speaking this kind of concentration isn’t a healthy sign.

Many people think AI’s applications are limitless and are calling this period the advent of the next economic revolution, fundamentally changing the way we live our lives. According to the June 6 Financial Times (“AI buzz does not foretell another dotcom bubble” - John Plender) the “public facing version of ChatGPT reached 100mm users in just two months”, and “the data analytics firm GlobalData estimates the global AI market will be worth $383bn in 2030, a 21% compound annual growth rate over 2022.”

I also want to mention that it took me one minute to prompt ChatGPT to write a short summary of the first half of the year, and in less time than that the attached summary appeared. It is an amazing tool (!) and I agree that it is far more than a passing fad. Companies from numerous industries are already finding ways to use it to make their operations more efficient and profitable.

In addition to AI, the electrification of everything continues and Tesla’s dominant position in autos (and data collection) is only getting stronger after several competitors recently announced they would adapt Tesla’s charging station. In addition, Elon Musk is exploring ways to expand in India. Several analysts have downgraded TSLA from buy to neutral, but I think it remains a solid holding and will continue to reward patient investors.

These two areas present a wonderful investing opportunity and so far, the mega cap tech names which have long been Peattie Capital holdings have been beneficiaries. I expect to continue holding those names.

The Fed remains active

Chairman Powell recently testified that he expected two more rate hikes this year and I believe we are very near the end of this rate hike cycle. The Fed Funds rate is now above the inflation rate and many components of the inflation calculation are moving in the right direction. One exception is rent, which remains somewhat problematic. The CPI dropped to 4.5% in May, down from 5.0% in March and April, and down from 9.0% at its peak a year ago. M-2 money supply figures have been contracting as well, down for the fourth consecutive month in May, and this will also help.

On the other hand, China hasn’t grown as expected and has been cutting rates. Peattie Capital owns two Chinese companies in portfolios, Alibaba (“BABA”) and BYD (“BYD”). Most street price targets for BABA are in the $130 range, well above the current $84. It’s surprising to me that despite the low forward P/E ratio of approximately 9.5x, the announcement to break itself up, and the discount to the sum of its parts, BABA remains stuck in the $80-$85 range. This one may become a source of funds.

BYD is this generation’s Volkswagen, with a low-cost, high-volume operating model. BYD is expanding geographically and the only negative thing I can say about it is that Warren Buffett has been selling some of his position. I think it is well-positioned for more growth and will be the dominant EV company along with Tesla.

Some other international investments have done well, such as Mexico which has gained 25% this year, and Japan. Several portfolios own the ETFs for these countries also.

A couple other positions

The disaster that is Texas Pacific Holdings (“TPL”) continues, and I am ruing not selling all the shares. TPL has the single worst corporate management I’ve ever seen, with its new Board members and CEO attempting to re-invent a company that has been successfully operating and generating significant wealth for shareholders since 1888. Management spent $16mm in Q1 on legal fees suing its largest shareholder…. who is also on the Board. As Warren Buffett has said (paraphrasing) “it’s best to buy a company that even an idiot could run, because one day an idiot will.” The lawsuit is winding its way through the court, and there could be news any day. If current management prevails, I will sell the remaining shares in several portfolios but if they lose and have the good sense to resign I expect to buy more shares.

Enphase (“ENPH”) is a new (and very small) position for a few portfolios. I love seeing insiders open their checkbook to buy shares, and when ENPH sold off after its Q1 earnings report the CFO bought another 3,500 shares at about $156 bringing her total directly owned shares to about 100,000. I will be following this more closely.

A new position in several portfolios is Copart (“CPRT”), which operates in the automobile salvage and resale market. It was founded in 1982 with a single yard in California, and it now operates 200 locations and sells over two million vehicles every year, mostly through online auctions. I particularly like the “network effect” it has created by attracting both buyers and sellers and the fact that its extensive real estate holdings serve as a protective moat from competition. I hope to own CPRT for many years.

Conclusion: it’s still a favorable calendar

Earnings are always critical but in pre-election years when the market has been ahead through June it has gone on to close the year even higher 12 of 12 times. While there is always the possibility of an exogenous event, this precedent and the (nearing) end of rate hikes, suggests to me the odds favor a positive second half of the year. I wouldn’t know how to quantify this, but I suspect many institutional investors are underinvested, and will be compelled to chase this market, providing more support to it.

Regardless, I am pleased with the developments at PCM portfolio companies and look forward to their continued success.

Please feel free to contact me if you have questions or comments and best wishes to all for a safe and happy Fourth of July!

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April 2, 2023

2023 so far….

It’s been a bumpy ride, but the first quarter ended with a big bounce. January was strong; February was weak and March was tepid until the Federal Reserve expanded its balance sheet to deal with the banking crisis. In the second half of March, all three major indices gained ground, with the NASDAQ gaining the most, up 9.2% from the March 15 close.

For the year the NASDAQ has gained 16.8%, the S&P 500 has gained 7.0%, the Dow Industrials has gained 0.4%, the S&P 600 Small Cap index has gained 2.5%, and the Russell 200 Small and Mid Cap has gained 2.4%.

Somewhat ironically, the banking crisis has probably done some of the Fed’s work for it, and I believe the Federal Reserve is either finished hiking for this cycle or will only hike once more. I suspect that when the market believes the Fed is at/near a pausing point, markets, and particularly faster growing companies, will do well. That may have been a contributing factor to the strong performance of the NASDAQ the past two weeks.

The bigger issue right now is the possibility that earnings disappoint, and at 18 times the earnings projected for this year, the S&P 500 could be vulnerable to another leg down. Mike Wilson, Chief Market Strategist at Morgan Stanley has been cautioning about this. On the other hand, in a note to clients this week, Goldman Sachs’ Chief Economist characterized the current crisis as a “headwind, not a hurricane” and said he expected a stall, not a slide, in earnings.

Favorable seasonals

The pre-election year is usually the strongest year of the four-year election cycle, and pre-election year Aprils tend to be particularly strong. Since 1950, the average gain in those Aprils are: Dow +3.9%, S&P 500 +3.5%, and NASDAQ +3.6% (Source: Stock Trader’s Almanac 2023).

In addition, in the first quarter the S&P 500 held above its December low, and in the 36 first quarters since 1950 when that has happened, 94.4% of the time (34 of 36) the S&P 500 was positive for the full year. The only two years it wasn’t positive for the year were 2011 when the S&P was flat, and 2015, when it was -0.7%. Both the average and the mean return for those 36 years was approximately 18% (source: FactSet Research March 28).

A Directionless Market

I’m particularly curious about how earnings will unfold this quarter and what sort of guidance companies will provide because of the divergent messages from bonds (a recession is coming and the Fed will be forced to cut rates) and equities (earnings will be OK and even if there is a recession it will be brief and shallow).

The S&P 500 first broke above 4,000 in the spring of 2021 so effectively there’s been no progress for 24 months. In such a range-bound market individual sector and specific company selecting is critical, and more than ever, I believe in a “market of stocks” as opposed to a “stock market”.

A few company specifics:

The recent flight to the biggest and most liquid companies benefitted Peattie Capital portfolios which own an abundance of Microsoft (“MSFT”), Apple (”AAPL”) and Alphabet (“GOOG”) among others. Long-time clients have held each of these names for many years, and for now I don’t expect to sell any of them. That said, there are questions about whether GOOG’s BARD can effectively compete with ChatGPT as it is getting mediocre reviews so far.

Alibaba(“BABA”) is a way to participate in the re-opening of China, and the company’s announcement that it will split into six separate companies is triggering a re-rating upwards. Barron’s wrote that shares could double from today’s levels and I expect to continue holding BABA shares and may add more.

Meta(“META”), the renamed Facebook, peaked near $385 about 18 months ago and subsequently fell to $100. I’ve never been a fan of Mark Zuckerberg, but META has 2 billion users and has declared 2023 the “year of efficiency”. Long term I like a company that has so many users, gets its content for free, and has refocused with an eye on profitability. On March 21, Morgan Stanley put a $250 price target on the shares and various other Wall St. firms are increasing price targets, mostly to the $250-$270 range.

Sylvamo(“SLVM”) has been recommended in Barron’s roundtable twice by one of my favorite investors, Meryl Witmer of Eagle Capital. Witmer is also on Warren Buffet’s Berkshire Hathaway Board of Directors. SLVM was spun out of International Paper in 2022 and calls itself “the world’s paper company.” It is the industry’s low-cost producer and is an investor friendly cash generating machine. In its first year, SLVM generated $418mm of cash from operations, which the company has been using to repurchase both debt and equity. In addition, SLVM initiated, and then more than doubled, a dividend (currently $1 annually). Spinoffs sometimes present outstanding investment opportunities as they tend to be under owned and aren’t included in any indexes.

Gannett(“GCI”) GCI is another company that is owned by well-known billionaire investors: in this case Bill Miller, who owns over 5%, and Leon Cooperman, who owns roughly 3%. In addition, there have been a couple significant open market purchases by officers, and a couple directors have begun taking compensation in shares rather than cash. For good reason, the newspaper industry has been decimated, but GCI has been able to generate cash which they are using to pay down debt and expects the “crossover” in which digital subscriptions overtake print subscriptions, to happen in 2024. This is a highly speculative situation; however, it wouldn’t take much for shares to double or triple from today’s levels and at $1.80 they present a good risk/reward profile for aggressive accounts.

And a few where I’ve added/trimmed:

Texas Pacific Land Trust(“TPL”) has had a wonderful business model since its founding in 1888. The company leases, and sometimes sells, their acreage in Texas, most of which is in the Permian Basin, and with the proceeds retires shares. It’s a very simple and powerful business model. There have been some management changes the past couple years, and in a bizarre twist, the company is suing its largest shareholder, who is also a Board Member. Shares gained 90% in 2022 and peaked at $2700 in November. Subsequently they have dropped to roughly $1700, partly as oil prices have corrected but also because of the market’s lack of confidence in the changes that have been proposed by the new management…changes that would reverse the time-tested and successful existing model. The suit goes to trial in mid-April, and for some portfolios I have trimmed shares. For now, I still view TPL as a wonderful opportunity, but I will be watching the trial closely and after a verdict is returned may make more changes to the position.

Tesla(“TSLA”) TSLA is by far and away the leader in the EV industry and even with the recent price cuts will remain profitable, not something most the other EV manufacturers can say. On March 23, Ford revealed that they had lost $34k per delivery (61,575 vehicle in 2022) and in contrast TSLA made $10k per delivery. The size of the global EV market is estimated to be nearly 10mm units at year end 2022, and it is expected to grow at nearly 31% annually through 2030 to approximately 81mm units (Source: Research and Markets: “Electric Vehicles: Global Strategic Business Report” Feb. 28, 2023). For now, I expect to hold TSLA shares and add more opportunistically.

Final thoughts:

There are always numerous macro issues but over time buying and staying with the right companies has been a very successful way to protect and grow wealth. I can’t say with any certainty what will happen next, but I believe in the companies in Peattie Capital portfolios and am reminded of Warren Buffet’s saying that volatility is the friend of the long-term investor. Based on what I know today, I would view a material selloff as an opportunity to add to my favorite companies.

As always, I welcome questions and comments.

Best regards,

Bill

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Jan. 1, 2023

Very Happy to put 2022 in the rear-view mirror…

Bear markets are always out there and while they are stressful and difficult, history shows that the opportunities they create are truly astounding. This one is no different, and it’s important to keep in mind that when we get to the other side of it the opportunities will be extraordinary. I don’t think we are quite there yet.

As Warren Buffett has famously said, “volatility is the friend of the long-term investor.”

2022 was one of the worst years ever in financial markets and Peattie Capital is no exception. Not just in equities, but supposedly “safe” assets like government bonds were down across the board, and the prototypical 60/40 (bonds/equities) portfolio lost nearly 20%. The Nasdaq, usually more volatile than the S&P 500 and the Dow Jones Industrials, dropped 33.1% while the other two were down 19.4% and 8.8% respectively. In addition, the iShares Core U.S. Reit ETF (“USRT”) was down 26.8%, and the U.S. Government 30-yr. bond was down 30%.

For the past several years most portfolios have been overweight growth and “change” as that is where I believed (and still believe) the best long-term opportunities are. In 2022 however, that was the worst possible place to be invested, as many names dropped 40%-50% and in some instances much more.

IRAs are more flexible and can be a helpful hedge

In most non-taxable portfolios I sold long-term winners and, client depending, used the cash for tactical positioning and trading. As a result, performance in IRAs was better than in taxable portfolios, and the best overall client accounts are those where I have both taxable and non taxable portfolios.

As we start 2023, I have maintained healthy cash balances in most IRA portfolios, in some cases as much as 65%. That said, I am looking for places to put that cash to work.

The Federal Reserve is still the driving force as we enter 2023

Chairman Powell used the term “2% inflation” repeatedly in his December 14 press conference which suggests to me he doesn’t anticipate a “pivot” anytime soon. Despite the fastest tightening cycle in history, annual inflation is still running over 7% and the Chairman has emphasized there is more work to do. Any number of commodity prices have come down, but growth in wages, food costs, and many services remains elevated.

Given his posture, and a variety of economic news and indicators, many people are calling for a recession in 2023. Mike Wilson, lead equity strategist at Morgan Stanley, recently warned of a further drop in the S&P 500 to the 3000-3200 area, down roughly 20% from today, as lower earnings are looming.

The unanswerable question as we enter 2023 is how the Chairman will respond if we do have a recession. At the slightest hint that he intends to ease off on the relentless tightening, regardless of when that might happen, I would expect markets to find their footing and rally, possibly quite strongly.

Earnings season will begin late January and I’m looking forward to hearing what companies have to say about their prospects in 2023. In the meantime, I expect to be cautious as we work our way through the tightening process. It is a most difficult time, but the best opportunities come from bear market selloffs.

A changing of the guard?

Microsoft (“MSFT”) and Alphabet (“GOOG”), two long term market leaders and prominent Peattie Capital holdings, were down 29% and 39% respectively and are good examples of why most Peattie Capital portfolios were down significantly for the year.

Having owned these two (and a couple others) for nearly 10 years I am reluctant to sell them as I think they are deeply entrenched in all our lives and still generate enormous free cash. Selling them would create both significant capital gains for a number of clients and also the issue of when/if to buy back in.

They are both expected to grow earnings next year mid/high teens and are currently valued at roughly 21x and 17x respectively. To my way of thinking these are reasonable multiples and for now I expect to keep these two in most taxable portfolios. However, they are not cheap and, in a recession, earnings for them, and nearly all companies, will be under pressure.

One other consideration for these two is that market leaders of one era tend to underperform in the next market upturn, whenever that may happen (think nifty fifty stocks in the 60’s, or Japan in the 80’s for example).

The S&P 500 is trading at roughly 17x 2023 earnings estimate of $220, and many companies in defensive industries like consumer staples are trading at far higher multiples and have little growth. For example, Colgate-Palmolive (“CL”), Coca-Cola (“KO”) and Procter and Gamble (“PG”) trade at 35x, 28x and 27x earnings respectively (source: Yahoo Finance). Among Peattie Capital portfolios are several names trading at much lower trailing earnings multiples: Thor Industries (“THOR”), and Arrow Electronics (“ARW”) are both below 5x and Sylvamo (“SLVM”) and Nelnet (“NNI”) are roughly 5x and 6x respectively.

Maybe a few silver linings

1) A reasonable alternative to equities is available in short term Treasury bills, which currently yield about 4.40%. I have been parking funds there in anticipation of better buying opportunities.

2) The vast majority of the tightening could be behind us. The bond market is very clearly signaling as much, as the U.S. yield curve is deeply inverted, which historically has been a reliable indicator of recession. Most analysts believe that rate hikes will end in the first half of 2023 and some think that the Fed might even have to begin easing shortly thereafter.

3) Excepting consumer staples companies, multiples, overall, have come down significantly. For example, some hyper growth software names have dropped from above 50x sales to roughly 10x sales. Notable to me is that these companies continue to grow at scale and are trading above their mid-year lows, and for more aggressive accounts I own several hyper growth software companies.

4) Late in the year the merger business picked up. In December alone, Thomas Bravo offered to buy Coupa Software (“COUP”) at 8x forward sales, and Vista Capital closed on the purchase of Avalara at 8.5x forward sales. Private equity firms have plenty of money, an incentive to spend it, and have a multi-year holding period. Likewise, large cap pharmaceuticals have oceans of cash and are looking for ways to replace revenues from drugs that will go off patent. Amgen Inc. (“AMGN”) just offered to buy Horizon Therapeutics (“HZNP”) at $116.50 per share, about 50% higher than the shares were trading in November.

5) Year-end tax loss selling has created some interesting opportunities. For example, when cannabis reform was excluded from the year-end omnibus bill, the industry’s ETF (“MSOS”) dropped from $14 to about $7 and ended 2022 down 73%. Meanwhile laws around cannabis continue to soften in many states. There are still any number of challenges and issues for the industry; however, for those with a longer-term investment horizon and the stomach to ride out the inevitable ups and downs, this might be a buying opportunity.

6) China is moving towards re-opening, and if that continues, I expect that to be good news for global growth.

Conclusion: Have we reached maximum fear?

Gold has rebounded sharply the past few months, and a Bank of America survey of portfolio managers revealed that they hold collectively as much cash as they’ve held since the 9/11 crisis in 2001. In addition, in December, the CBOE equity put/call ratio spiked above 2.0, which was higher than it went in either the tech bubble or the financial crisis, when it hit 1.8.

None of these data points by itself is enough to conclude that the worst is behind us, but in the past extreme fear indicators like these have been a better time to buy/own stocks rather than to sell them. While I do not think it’s time to jump in with both feet, I believe that it is important to stay invested in anticipation of better times ahead.

Please feel free to contact me with any questions or comments and best wishes to all for a healthy and happy new year.

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