Good Capitalism

To Our Investors and Friends,

The S&P 500 Index (S&P 500) fell 1.1% in the first month of 2021. Oil advanced 7.6% this month to end at over $52 a barrel on the view that demand should improve throughout the year. The 10-year treasury bond increased 18 basis points (bps) in the month to 1.11 bps, while the spread between the 2 and 10-year widened 20 bps to 100 bps. Small cap stocks continued to lead the market higher, a trend that began late last year. The Russell 2000 Value Index advanced 5.3% for the month while the Russell 2000 Growth Index increased 4.8%. Large cap stocks began the year in decline. The Russell 1000 Growth Index decreased 0.7% for the month, and the Russell 1000 Value Index declined 0.9%.

According to Yuval Noah Harari, author of Sapiens, A Brief History of Humankind, Adam Smith’s groundbreaking book, The Wealth of Nations, presented a much better alternative to the economy run by the aristocrats of their day. Capitalists were incentivized by profit to build factories that would provide jobs to workers and cheaper goods to society in a way that benefited everyone. Greater profit meant more money to build, create jobs, and lower prices for all. This virtuous cycle was far better than the wasteful spending of aristocrats that went to finance ornate palaces, ostentatious clothing, and elaborate parties that provided little benefit to the rest of society. For over 200 years, the incentive structure created by capitalism has been the driving force behind economic growth that brought significant numbers of the world’s population out of poverty. In the United States, this virtuous cycle remained present up until the early 1970s, as all levels of society grew their standards of living at a relatively similar rate.

Among many things clearly revealed by COVID-19 is the vast growing disparity between the top and bottom earners in our country. In fact, a recent Washington Post article, “The Covid-19 Recession is the Most Unequal in Modern U.S. History” reveals that the top 25% of workers by income experienced a slight increase in compensation since the onset of COVID-19, and the bottom 25% of workers experienced a 30% decrease over the same time frame, exacerbated by unemployment ranks that grew at eight times the rate of the top 25% of earners. Unlike the economy of 50 years ago, many large corporate leaders have spent much of the last 20 years shedding the lower paying jobs of the many to provide greater income to the few. We believe this has dramatically weakened the foundation of some of America’s oldest blue-chip companies, and like the aristocrats of centuries ago, has opened an opportunity for an economic system that is better for all...which we call “Good Capitalism”.   

Like the early capitalist that created virtuous cycles for society, we believe many leading digital economy companies are doing so now. Shopify (SHOP), Square (SQ), and Etsy (ETSY), among many, are using the tools of the fourth industrial revolution to build businesses that benefit consumers, their workers, and shareholders alike. We believe that these virtuous cycles will continue to drive their businesses forward as many older businesses suffer from the inequities of their own making. We acknowledge that this is aspirational and that inequities won’t disappear overnight, but we think as investors, a greater balance is required for sustainable economic growth.

We saw this past month that current imbalances can lead to unpredictable events – thousands of small investors banded together to topple formidable hedge funds through massive, short squeezes. Technology is a tool that can disrupt current norms and we expect more of these black swans in the future. As good capitalism becomes more dominant, we expect a more sustainable balance in our economy, the environment, and our democratic system.

All the best to you,

Arthur K. Weise, CFA

The views expressed are those of Kingsland Growth Advisors and are not intended as investment advice or recommendation.  For informational purposes only.

A Year of Disruption

To Our Investors and Friends,

The S&P 500 Index (S&P 500) increased 11.7% in the last quarter of 2020, enabling a 16.3% annual gain in a highly tumultuous year. Oil advanced 21% in the quarter to end at over $48 a barrel on the view that demand should improve in 2021. This move reduced oil’s drop for the year to approximately $12 a barrel, or 21% lower than at the end of 2019. The 10-year increased 24 basis points (bps) in the quarter to 93 bps, while the spread between the 2- and 10-year widened a similar 24 bps to 80 bps. We can thank the Federal Reserve’s early monetary stimulus at the beginning of the crisis for the significant increase in the stock market last year and for the noteworthy recoveries in interest-sensitive sectors like housing and autos. Small cap stocks roared ahead in the last quarter of the year, helping this part of the market to catch up to larger companies that posted better returns for much of the year. The Russell 2000 Value Index advanced 33.4% for the quarter while the Russell 2000 Growth Index increased 29.6%. This year-end move helped the Russell 2000 Growth Index to post a 34.6% increase for the year and the Russell 2000 Value Index to post a much more modest 4.6% annual gain. Large cap stocks performed less robustly for the last quarter of the year. The Russell 1000 Growth Index gained a more modest 11.4% for the quarter, finishing the year up 38.5% and the Russell 1000 Value Index advanced 16.3% in the quarter, edging into positive territory (up 2.8%) for the full year.

We have highlighted the stark differences between the digital economy and the industrial economy since the founding of Kingsland Growth Advisors a little more than two years ago. COVID-19 acted as a catalyst to accelerate the digital economy in a way that most could not have anticipated, including us. We think that the strength of the digital age companies will build upon itself, and the weakness of the brick-and-mortar economy and will diminish the importance of many companies in the future. This reshuffling of the economy is ultimately being driven by business transformation enabled by the intelligent tools of the fourth industrial revolution, including artificial intelligence, big data, internet of things (the network of physical objects connected to the internet), robotics, genetics, and other innovations that are shaping how we live and work. Although it is way too early to tell, it is possible that this is the beginning of a new “Roaring 20s” that mimics the changes to the economy that occurred 100 years ago with the widescale acceptance of automobiles, radio, telephone, and electricity that all drove the second industrial revolution.

As can be seen in the following chart, the performance of the members of the S&P 500 revealed the difference between old and new. The youngest cohort experienced tremendous growth after the additions of dynamic businesses like Tesla (TSLA) and ETSY (ETSY) to the S&P 500 late in the year. In fact, the average company in this 25-and-under cohort appreciated 55% in 2020. The 26- to 50-year-old cohort S&P 500 stocks grew a robust 18% in 2020. Of note, Amazon (AMZN) turned 26 this year. Older companies were either only slightly higher or flat for the year as the constituents lost relative ground to their younger peers. At the end of the year, 13% of the S&P 500 weight were companies 25 years or younger; 33% companies between 26 and 50 years old; 23% are 50 to 100 years old, and 31% of the Index weight consists of businesses over 100 years old. The 50-and-under crowd grew from 38% to 46% of the Index weight in 2020, an 8% shift in weight from just one year ago.  What does this mean? Even after the Index added a number of next generation companies last year, the S&P 500 still primarily consists of old economy companies, which likely will continue to provide modest returns in the future.

Chart source:  www.slickcharts.com.

Kingsland Growth Advisors believes that the digital economy is just beginning to transform the overall economy. Even after a robust year for growth stocks, we believe ample opportunity remains for capital appreciation of these new and next-generation blue chip stocks in the future. We will try to continue to position our portfolios for growth and explore new opportunities that will lead the economy of the current decade and beyond.

All the best to you,

Arthur K. Weise, CFA

The Ignorance Tax

To Our Investors and Friends,

The S&P 500 increased 10.8% during the month of November, as news of effective COVID vaccines and an orderly US election created significant enthusiasm for a better 2021 and beyond. Oil blasted higher, up 26.7% in the month to over $45 a barrel on a view that increased demand was just months away. The 10-year fell a modest 4 bps in the month to .84%, while the spread between the 2- and 10-year contracted 6 bps to 68 bps. For the second month in a row, small cap value dominated the market. The Russell 2000 Value Index increased 19.3% in the month, helped by an enthusiasm for cyclical stocks. The Russell 2000 Growth Index gained 17.6%. Large cap indexes did a decent job of keeping up. The Russell 1000 Value Index gained 13.5% and the tech heavy Russell 1000 Growth Index moved up 10.2%.

Reflecting on all the changes we have had to live through in 2020, I am surprised by how so many investors are preparing their portfolios for a return to the world we knew. I think there will be many who pay a high ignorance tax in the years ahead. The Ignorance Tax is a concept we are all familiar with if we are honest with ourselves. A few months ago, my failed Do-It-Yourself efforts to repair a broken dishwasher resulted in me inadvertently destroying the appliance. I paid a few hundred dollars in an ignorance tax…the price paid to replace a dishwasher that was functioning well enough before I got my hands on it.

It is not just the not-so-handy that have been paying an ignorance tax this year. Ego, emotion, and bias are leading many to make poorly informed decisions that are costing them small fortunes, their jobs, and even their lives. The age of COVID is transforming the world incredibly quickly, and many of us are paying a high ignorance tax in our refusal to accept these changes as our new reality. Our very reaction to COVID – many refusing to change their day to day lives – is the most obvious sign of a resistance to accept this brave new world.

In Ludwig and Hess’s Humility is the New Smart, the authors suggest that we need to take our time responding to the onslaught of new data in order to make better decisions. The old way of reacting quickly based on pre-conceived bias or ego will prove even more costly in the era of the fourth industrial revolution. This has been especially true in 2020. COVID is forcing a change in how we work, engage with friends and family, and even vote in elections. Ignoring these changes now and in the future will certainly result in a high Ignorance Tax in the years ahead. The simple assumption that the world will return to normal, the way it was in 2019, at any point in the future ignores all the new data supporting the many changes that have already taken place in our economy. We will spend our time understanding this transformation so that we can capitalize on the future that is yet to come.

All the Best to You,

AKW

And the Winner is…the Digital Economy

To Our Investors and Friends,

The S&P 500 declined 2.8% during the month of October, as a global increase in COVID cases threatened to dampen the recovery, and election jitters impacted investor enthusiasm for stocks. Oil plummeted 11% in the month to less than $36 a barrel as lockdowns in Europe reduced demand. The 10-year increased a robust 19 bps in the month to .88%, while the spread between the 2- and 10-year widened 18 bps to 74 bps. For the first time in a long time, small cap value dominated the market. The Russell 2000 Value Index increased 3.6% in the month, helped by an improved outlook for banks. The Russell 2000 Growth Index gained a more modest .8%. Large cap indexes declined this month. The Russell 1000 Value Index declined 1.3% and the tech heavy Russell 1000 Growth Index dropped 3.4%, likely driven by profit taking ahead of the election.

There is considerable anxiety surrounding this election cycle. The health crisis and economic crisis has done nothing but increase concern surrounding the outcome of the election. We believe the economy and the stock market are poised to move higher over the next four years, no matter what the outcome this week. COVID has revealed the power of the digital economy to support and eventually largely replace the old economy of the brick and mortar world.

Last week, Microsoft’s CEO Satya Nadella stated simply, “The next decade of economic performance for every business will be defined by the speed of their digital transformation.” This economic change is a force that even our politicians cannot prevent, no matter how much their constituents want them to. It empowers corporations to do business where they can maximize their results. Corporations are no longer tied to a city, state, or country to move their operations forward. In fact, a growing number of California-based technology companies are allowing their employees to work wherever they want on a permanent basis. This freedom will certainly help them attract and retain the best employees, thereby accelerating business development and growth of their companies. Those companies tied to a brick and mortar footprint will simply be at a growing disadvantage.

Policy changes can impact business at the margin, but if any company needs government policy to survive, it has already lost. We don’t invest in these old relics dependent on political favoritisms for survival. We focus on the future, and will continue to search for the very best businesses the market has to offer and look to own their shares as long as their opportunities are poised to drive the growth of their businesses. We encourage our investors to take advantage of any dislocation in the market over the next week or so to add to these industry leaders. Their future is bright, and if market depression over political outcomes provides an opportunity to buy their shares at lower levels, we will be there to do so.

All the Best to You,

AKW

Staying on the Sidelines of the Speculative SPAC Craze

To Our Investors and Friends,

The S&P 500 increased 8.5% during the third quarter, as the bull market widened to include industrial stocks along with technology stocks on the view that earnings should accelerate as we get through the COVID crisis. Oil increased 2.4% to end the quarter at over $40 a barrel, a less robust gain on expectations for a slower demand recovery. The 10-year increased a modest 3 bps in the quarter, to .69%, while the spread between the 2- and 10-year widened 6 bps to 56 bps. Growth’s dominance continued. The Russell 1000 Growth increased 13.2% for the quarter, helped by strong performance from mega-cap technology companies. The Russell 1000 Value gained 5.6%, as financials lagged, and energy stocks plummeted. In small cap indexes, similar trends were realized as the Russell 2000 Growth expanded 7.2% and the Russell 2000 Value gained 2.6%.

This has been a year of considerable turmoil driven by the worst pandemic the world has seen in 100 years, the worst economic crisis in 90 years, and the worst social crisis since the 1960s. Possibly the greatest surprise has been the quick reversal of one of the most violent market routs in history…causing a 35% decline over a mere 23 days from mid-February to the end of March. The new bull market is being led by new leadership, which is firmly held by the fourth industrial revolution beneficiaries, those using intelligent tools to provide better solutions for their customers. Enthusiasm for these next generation businesses has spilled over into many areas, some of which are highly speculative…. especially the SPACs.

SPACs (Special Purpose Acquisition Companies) are blank check companies. Management raises money in the market with the purpose of acquiring and making public a private company. Management is incented with a large ownership stake in the SPAC, often 20%, and usually must make the investment within a predetermined time frame. Failure to make the investment, or get shareholders to approve of the investment, results in a return of capital as the SPAC is dissolved. Shareholders have the right to approve or disapprove of the investment and can sell their shares at any time, making such an investment more liquid than private equity or venture capital.

As can be seen in the Chart below, the new bull market has ushered in a speculative SPAC frenzy that has resulted in more than $80 billion in capital raised over the last year. There are now over 140 publicly traded SPACs, of which 65 became public after the market’s March bottom.

Source: William O’Neil database.

We think the SPAC craze is indicative of the public’s desire to get in on new companies early in their development. We are avoiding them, however, because they fail to meet our investment criteria. SPACs are likely the most speculative investments out there, because the SPAC investor has only a rough idea of what management intends to invest in and is completely dependent on that decision to make a return. The company that is receiving the investment is getting a very large amount of money early in its lifecycle, which heightens the prospects that bad decision-making squanders it away. This compares to venture capital investments that typically have multiple funding rounds that provide growth capital to companies over time.

We will continue to search for the very best businesses the market has to offer and look to own their shares as long as their opportunities are poised to drive the growth of their businesses. Unlike SPAC investments, these founder led businesses have been fully vetted by existing customers and public investors, dramatically reducing the chance that negative surprises present themselves like we recently witnessed with the most famous of recent SPAC investments, Nikola (NKLA).

All the Best to You,

AKW

Better Businesses Have Higher Near-Term Valuations

To Our Investors and Friends,

The S&P 500 increased 7.0% during the month of August, continuing its technology-driven march higher. Oil increased 5.8% to end the month at over $42 a barrel. The 10-year rallied during the month to 72 bps, a 17 bp increase, while the spread between the 2- and 10-year widened to 58 bps. Growth’s dominance continued. The Russell 1000 Growth increased 10.3% in the month, helped by strong performance from mega-cap technology companies. The Russell 1000 Value gained 4.1%. In small caps, the differential between growth and value was far more modest as the Russell 2000 Growth expanded 5.9% and the Russell 2000 Value gained 5.4%.

In this investment letter, we attempt to answer the simple question: why is the market willing to pay more for leading technology companies than leading industrial companies? We decided to compare the top ten S&P 500 technology companies by market cap to the top ten S&P 500 industrial companies. In short, the market is placing a premium on near-term valuations for faster growing, more profitable businesses that are earlier in their lifecycle. In fact, the valuation premium of technology companies is double that of industrial companies, comparing 2021 estimated consensus earnings multiples (46x for tech and 22x for industrials).

A simple examination of the fundamentals of these two groups helps explain the premium tech is receiving. Over the last 12 years, this technology cohort has grown cumulative revenue by over 1000% vs a mere 21% for the industrial cohort over the same time frame. This growth differential is entirely tied to maturity of business and global opportunity in front of them…the average tech company cohort is 28 years old addressing a global market, while the industrial cohort is 122 years old and focused on a smaller geographic footprint.

As can be seen in the chart below, the tech cohort is also far more profitable, generating 66% gross margins compared to the 32% gross margins offered by the industrial cohort. Spending on R&D and sales narrow tech operating margins to 25%, which are still higher than the mature industrial operating margins averaging 17%. This profitability advantage can be attributed to the greater scalability of tech businesses…excluding people-intensive distribution businesses Amazon (AMZN) in tech and United Parcel Services (UPS) in industrials, the average leading technology company employs less than half the number of people needed to run the industrial companies.

Fewer people required to address a larger opportunity suggests higher profitability will come to technology companies. In fact, technology companies are expected to grow earnings at more than a 40% rate over the next five years compared to a 9% rate for the leading industrial companies. Using simple math, in five years, technology companies are projected to earn approximately 5x as much as they earn today, while industrial companies are poised to earn 1.5x more. That means in five years from now, investors are paying an estimated 8.6 times for the tech earnings stream and an estimated 14.5 times for the industrial earnings stream. The market appears to have it right... tech companies are likely more undervalued than industrials if these estimates are correct. It is the FED’s “lower for longer” interest rate policy that has forced the market to appropriately place more value further out in time...a trend we expect to continue.

We will continue to search for the very best businesses the market has to offer and look to own their shares as long as their opportunities are poised to drive the growth of their businesses. Short term, the shares often appear to be rich on near-term earnings metrics, but over time, we expect them to prove their worth.

All the Best to You,

AKW

Not Your Parents’ Tech Driven Bull Market

To Our Investors and Friends,

The S&P 500 increased 5.5% during the month of July, building on its second quarter gains. After a tremendous run from the bottom, oil increased a more modest 2.6% to end the month at just over $40 a barrel. The 10-year fell during the month to 55 bps, a 14 bp decline, while the spread between the 2- and 10-year narrowed to 34 bps. As has often been the case over many quarters, large outperformed small, and growth outperformed value. The Russell 1000 Growth increased 7.7% in the quarter, helped by strong performance from mega-cap technology companies. The Russell 1000 Value gained 4.0%, helped by both consumer staples and the utility sector. In small caps, the Russell 2000 Growth expanded 3.4% and the Russell 2000 Value grew 2.1%.

We are questioned daily as to whether this rally is Tech Bubble 2.0. We believe that unlike the tech bubble of our parents in the late 90s, the consistent rally in the technology sector is quite different and is driven by sustainable fundamentals. We think the market has entered a golden era of growth as the digital economy is becoming the mainstream economy, and the industrial economy is losing its importance as a driver of economic growth.

The modern industrial economy began with the invention of the modern internal combustible engine in 1876, followed by the invention of the automobile in 1886. Once created, it took decades for these advances to change the global economic landscape. The Federal Highway Act of 1956 established the modern US highway system that enabled the connectivity required for a robust industrial economy across the United States. For much of the last two decades, China built a similar system across their country to build out their industrial economy.

We see a parallel in the digital economy that began with the introduction of the semiconductor industry in the 1960s and the personal computer industry in the 1980s. The internet is the highway system that not only connects both smart phones and computers across the US, but across the world. This connectivity is allowing for growth arguably unlike anything we have ever seen in the history of the planet.

We decided to compare the growth trajectory of e-commerce leaders Amazon (AMZN), founded in 1994, and e-commerce tools enabler Shopify (SHOP), founded just a decade later. As can be seen in the chart below, after its first decade of growth, Amazon was able to grow their revenue at a 31% annual rate from year 10 through year 17 since founding. During this same time frame since founding (SHOP is now 17 years old), Shopify was able to grow their GMV (value of merchandise sold on sites using the Shopify e-commerce engine) at an 82% annual rate. We believe this much faster growth can be attributed to both vastly greater connectivity among devices just ten years later as well as vastly greater receptivity of consumers to participate in e-commerce.  In fact, this greater connectivity helped Amazon grow its revenue by another 10-fold over the last decade.

The technology bubble of the late 1990s was built primarily on speculation about what would come. Today’s technology driven bull market is largely based on robust fundamentals that are growing at a rate that we have never seen before. Although some stocks most likely will need to consolidate before going higher, we believe that this new bull market has a long way to go. We will continue to spend our time discovering and owning these next generation blue chip companies and enjoy the benefits of their growth as they reshape the global economy.

All the Best to You,

AKW

Welcome, Welcome, Welcome!

To Our Investors and Friends,

The S&P 500 increased 20.0% in the second quarter as the market anticipated the end of the economic and healthcare crisis driven by both massive monetary and fiscal stimulus and a decline in COVID-19 cases throughout Asia and Europe. Oil prices (WTI) rebounded a robust 92% to over $39 a barrel as signs of an economic recovery began to appear in China and other parts of the world. The 10-year was little changed from last quarter, ending 4 bps lower at 66 bps, while the spread between the 2- and 10-year ended at 50 bps. Growth stocks continued to lead the market - the Russell 1000 Growth was up 27.8% in the quarter compared to the significantly less robust 14.3% gain in the Russell 1000 Value. Small cap stocks rebounded more significantly than larger companies, but the growth-value disparity was equally wide. The Russell 2000 Growth expanded 30.6%, helped by both technology and healthcare, and the Russell 2000 Value rebounded a less robust 18.9% as the recovery in financials was one of the weakest since the market bottom in late March.

John Oliver opens his weekly show with the words “welcome, welcome, welcome!” This is an appropriate enthusiastic greeting for the Millennial Generation that has entered the stock market en masse during the last several months. Retail investors historically have shown up late to a bull market. This new group of investors uncharacteristically entered the market during a rare 30%+ sell off.

The Millennial Generation has had little exposure to equity markets since the 2009 market bottom, but according to brokerage firms, millions of younger investors have used their COVID-19 stimulus checks to open discount brokerage accounts in recent months. Robinhood, the newest discount brokerage entrant and innovator, has helped lower the barrier to entry for new investors through both the introduction of zero commissions and fractional shares to enable small investors to own companies with share prices in the hundreds or thousands of dollars per share. These first time Millennial investors are a stark contrast to what the older Baby Boomers have done during the same time frame. Some brokerage firms estimate that about a third of investors over 65 sold all their stocks during the market downdraft.

We may be witnessing a generational transition in the stock market. Given that Millennials are just entering their mid-30s and should be experiencing strong wage gains for years to come, it could provide a long tailwind to the market. In addition, a Visual Capitalist report estimates that $30 trillion dollars, the biggest wealth transfer in history, will move to Millennials over the next 30 years.  A potential generational transition may in small part explain the disparate experience of value stocks vs growth stocks. A survey collected by Morning Brew suggests that 49.7% of Millennial investments are in the technology sector, and an additional 12.1% are in the healthcare sector, versus a combined 7.6% in industrials, financials, and materials. This may help explain some of the dramatic disparity across different sectors in the market. It is hard to believe a Millennial will choose to buy such old blue chips as GE, Wells Fargo, and US Steel over new blue chips Tesla, Netflix, and Shopify.

Whether or not this new group of investors sticks around as the economy recovers, we will continue to focus on finding innovative companies that harness the power of technological change that improves people’s lives. We think that this focus on the future should continue to drive positive returns for our investors that likely will continue to exceed the returns of the S&P 500 over time.

All the Best to You,

AKW

Time to Fire Your Passive Manager

To Our Investors and Friends,

The S&P 500 increased 4.5% in May as massive monetary and fiscal stimulus continued to push the markets higher despite horrific news on both the COVID-19 and unemployment front. Oil prices (WTI) rebounded a robust 88% to over $35 a barrel as signs of an economic recovery began to appear in China and other parts of the world. The 10-year was little changed from last month, ending at 65 bps, while the spread between the 2- and 10-year ended at 49 bps. Growth stocks continued to lead the market - the Russell 1000 Growth was up 6.7% in the month compared to the more modest 3.4% gain in the Russell 1000 Value. Small cap stocks experienced an even wider disparity, likely indicating a more permanent impact of change on this part of the economy. The Russell 2000 Growth expanded 9.5%, helped by the promise of biotech to solve some of the virus issues, and the Russell 2000 Value rebounded a mere 2.9% as the poor outlook for banks suppressed returns.

We are witnessing an incredible amount of turmoil driven by both the impact of COVID-19, and protests and riots that broke out across the country since the senseless death of George Floyd on May 25th. “I can’t breathe” defines where the country is right now...the inequity among Americans is coming to the forefront and likely will accelerate change. Those that hold onto the past will be relegated to the history books, while those that embrace the future can help shape it for the better.

Over the last decade, equity market fund flows have been dominated by investors pouring their retirement dollars into passive indexes. Investors are wholeheartedly rejecting higher cost mutual funds that have not generated the higher returns required to justify their fees. This occurs at a time when we are witnessing how quickly people can change their behavior. What is not changing quickly is the components of the S&P 500. As can be seen in the chart below, the greatest danger S&P 500 index investors face is stagnation. On April 6, the S&P 500 removed Macy’s (M) from the index. On May 12th, Dexcom (DXCM) was added to the S&P 500 index.

For more information on this chart service, please visit www.williamoneil.com.

If the S&P 500 index was an active manager, it would be fired. Taking time to make changes may have made sense in the past, but this rigidity will prove quite costly in a rapidly evolving economy.

Many speculate that Tesla will be added to the S&P 500 sometime later this year or early next year. Ford and General Motors have long been part of the index. (GM was added back in after it went bankrupt during the financial crisis). Tesla stock is up over 4000% since it went public in 2010. It is no wonder that the S&P 500 has massively lagged every major Russell index over the last 20 years.

We will continue to focus on finding innovative companies that harness the power of technological change that improves people’s lives. We think that this focus on the future should continue to drive positive returns for our investors that likely will continue to exceed the returns of the S&P 500 over time.

All the Best to You,

AKW

Revisiting Nassim Taleb’s The Black Swan

To Our Investors and Friends,

The S&P 500 increased 12.7% in April as massive monetary and fiscal stimulus helped the markets rebound from the disastrous COVID-19 pandemic. Oil prices (WTI) continued to decline, down 8% to approximately $19 a barrel, as oil demand/supply remains imbalanced. The 10-year was little changed from last month, ending at 64 bps, while the spread between the 2- and 10-year ended at 44 bps. Difficult environments for both energy and financial companies helped growth’s dominance remain intact. The Russell 1000 and Russell 2000 Growth index both rebounded approximately14.8%, while the Russell 1000 Value Index increased a less robust 11.2%, and the hardest hit index, the Russell 2000 Value, recovered 12.3%.

It may be surprising to hear that COVID-19 is not a Black Swan, meaning an unexpected event that changes our perception of the world. In a recent CNBC interview, Mr. Taleb pointed out that we have had many pandemics in the past, including several since the turn of the century. Many Asian countries were well prepared for the crisis and appear to be recovering after a less severe disruption. A decade of cost cutting in the U.S. (including at the CDC itself), and outsourcing production of everything from medical equipment to drugs, left this country in an unusually vulnerable position, for which we are now paying a high price in both lives and dollars.

We believe there are a few points worth mentioning from The Black Swan. In the book, Taleb writes, “In the last 50 years, the 10 most extreme days in the financial markets represent half of the return.” With this in mind, we will resist calling a bottom in the market and missing these rare return days. It is best not to have a firm opinion on how this plays out. There are simply too many unknowns to try to guess the outcome. Along these lines, we are struck by Talab’s lesser accepted 50/1 rule, which is a more extreme version of the 80/20 rule. The 50/1 rule states that 50% of performance, economic growth, wealth, etc. is generated from a mere 1% of participants. This may explain why, as many have noted, the market value of the top 5 companies in the S&P is a rough match to the market cap of the bottom 350 companies. We believe it is a sign that our economy may be at an inflection point and is why we will continue our hunt for rare, outsized opportunities.

We believe the 50/1 rule is the best explanation for the wide disparity in fortunes of companies during this downturn. It may explain why 20%+ of the population is unemployed, and the stock market is off a mere 14% from the high. The Federal Reserve and Washington are pumping a lot of money into the economy right now to both dampen the impact of COVID-19 and strengthen financial markets. Let’s hope the end result isn’t a real Black Swan that reshapes our country to something unrecognizable. Nevertheless, we will be preparing for an uncertain future, and change in the direction of where the economy is heading.

All the Best to You,

AKW