⏩ Skip ahead to three market themes to consider as we turn the page from 2021 to 2022.
⏩ Or skip ahead to the 2021 portfolio performance review.
Number Go Up
I recently got turned onto a crypto podcast called Only Up. While I don’t know for a fact what the name is referring to, my interoperation is a reference to the idea that crypto seems to “only goes up” in value.
This idea may be best memorialized in the “number go up” meme which could actually be the theme for 2021. Assets of all kinds have significantly appreciated in value over the last several years on the back of federal governments around the world printing money. And that is only the most recent part of a decade long bull run since the financial crisis.1
It’s prudent to ask if the good times can last.
In that vein, last November, in the lead-up to the 2020 US presidential election I initiated a short position against the US stock market.2 To be sure, it was a small position and I was very much net long US equities at the time. This was a hedge.
The reason for the hedge was mainly a concern there could be a contested election if the result was close.
I was correct. Well, sort of. I had no idea the full scope of the shitstorm that would ensue but, to put it simply, it turns out the election was close.
For four days after the November 3rd election the winner was not fully clear. Yet, from election day through November 6th, the S&P 500 rallied approximately 6%. That’s a significant move over any one week period, not to mention while the election of the most powerful person in the free world hangs in the balance.
Needless to say, that was not the reaction I expected from the market and the hedge was ultimately unnecessary and unprofitable.
In Q3 of 2021, I initiated a similar hedge but with a slightly longer expiration. The position is still open.3 The concept of hedging still feels relevant today because I find the US economy in an unfamiliar place. For millennials, we’ve not lived in anything approaching a high inflation environment during adulthood.
As we wrap 2021, if I have one concern, it’s the impending rate hikes stemming from a more hawkish Fed which is a scenario that creates a different macroeconomic environment than we have become accustom to.
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Themes
With that hawkish Fed backdrop, there are three public equity themes I’ve been considering as the calendar changes from 2021 to 2022.
Growth Remains Out Of Style
Growth stocks have indeed been hammered to closeout the year. During September, October, and November companies trading at high sales multiples, with no sustained earnings, were hammered down. Historically this is a common outcome as the Fed becomes hawkish.
These are ugly, ugly charts for some relatively widely-held stocks. This list doesn’t include some others — like Robinhood or Peloton — which have been completely decimated by more than the 40% downward limit on the above chart.
During this same time period, the S&P 500 continued to roll on increasing about 3%. This brings us to the next point.
US Market Remains At All-time Highs
Despite some serious pain in corners of the market, the S&P 500 index is at all time highs. The overall valuation of the S&P 500 is certainly not cheap, historically speaking.
There is at least some logic in this valuation. At the start of 2021, the price to earnings ratio of the S&P 500 was 31x. To end the year that ratio has dropped to 24x on the back of 65% earnings growth.4 Put simply — companies are indeed doing well. Certain companies, and thus their stocks, can manage through an inflationary macro environment.
COVID-19 Remains A Market Mover
The Omicon variant may prove to not be a headwind for the market in the mid- to longterm. However, it did show how COVID-19 can still impact the market in the short-term.
On November 26th, the Omicron coming out party spiked the market volatility index by the 4th largest 1-day increase ever.5 On this news the S&P 500 fell 2.3% that same day. A one day decline greater than 2% is very rare6 — showing that COVID-19 still has market moving power in Q4 2021.
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The backdrop for each theme is the hawkish Fed, and it’s the Fed that is the short-term impediment in 2022. However, in the longer run, it is a must for the Fed to shift policies.
What does this mean for retail investors? Interest rate increases are the catalyst for a continued shift away from valuing unprofitable companies on a sales multiple (and general “momentum”) and back to a more traditional valuation model based on cash flows (and actual earnings). In other words, deepening losses on holdings that fit this unprofitable bucket of companies in the short-term.
The thinking is this hedging strategy can have multiple benefits in 2022:
- Keep from selling individual (longterm) stock holdings in a panic — particularly those growth names with stocks that will be hurt due to rate hikes but with businesses that can still thrive
- Potential tax loss harvesting if the hedge proves unwarranted
- Asymmetric upside if the hedge proves to be timely
Most individual investors do not employ this type of hedge.7 Many of those same investors absolutely do end up panic selling in tough times.
Here’s to hoping this hedge is unwarranted and unprofitable.
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2021 Portfolio Performance
There’s a quote in Wolf of Wall Street that can be revised to summarize this portfolio’s performance in 2020…
The year I turned 26, I made $49 million dollars, which really pissed me off because it was three shy of a million a week.
…that’s because in 2020 the portfolio landed at a 99% return for the year — just 1% shy of a double, which really pissed me off.
Not really, actually. It doesn’t piss me off because those types of returns are so far beyond unsustainable, it’s not even funny.8
Before we get to the 2021 performance, there are a few things to tackle.
First, how did the market do overall? The S&P 500 ends 2021 with a 27% return and is sitting at 4,766. At the start of the year, most prognosticators were not within earshot of this price level.
That isn’t terribly surprising as, historically speaking, a 27% year is a very strong return. Number go up, indeed.
Looking back to 2020, I was curious how the S&P 500’s top performers from last year did in 2021…
Of the fifteen top performers from 2020, eleven beat the market in 2021. One might have expected these strong 2020 performers to take a bit of a breather in 2021. That did not materialize and number went up — only PayPal went negative in 2021.
As for the best performers of 2021…
Asset Allocation – Q4 2021
No discernible change from the last time this was calculated.
2021 Portfolio Best Individual Stock Performers9
The biggest theme is clearly semiconductors, with three of the top five falling in this sector.
Since it remains a hot theme — if crypto assets were considered, the top two holdings would be Solana and Ether which, using our actual cost basis, appreciated in 2021 by approximately 600% and 390% respectively.
2021 Portfolio Worst Individual Stock Performers10
There are a couple themes here but the biggest is China — which I was bullish on in 2020 as well as at the start of 2021. Part of my bullishness was because I thought it could be a hedge against the US.11 For better or worse, being long China has not gone well in the short-term.
2021 Portfolio — Overall Equities Return
When the broad stock indices are up huge, as they were in 2021, it becomes much harder for a portfolio to outperform. As an example, only three large hedge funds performed better than the S&P 500 for the year.
For the year, our publicly traded stocks in the portfolio gained 18% compared to the S&P 500’s 27% return.
The last quarter of the year meaningfully dampened returns for the growth portion of the portfolio. That said, the focus is not about 1-year returns. The goal is compounding returns over a multi-year period.
The 3-year annualized return for the portfolio is 35% against an S&P 500 return of 26%.
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2022 Playbook
- Initiate weekly ETF buying schedule12
- Preserve cash position to buy during drawdowns13
- Re-initiate small hedge against US stock market
Short and sweet. Keep it simple, stupid.