Sunday Finds + 3 Thoughts From Last Week
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3 Thoughts From Last Week:
Is China less investable now? Ever since the Russian invasion of Ukraine we’ve seen China stocks absolutely puke. For example, Alibaba is down 63% in the past 12 months and down 30% in just the last 30 days. I do not follow the Chinese economy closely, so this could be because of some domestic issue (they are going through a bit of a real estate crisis right now) I’m unaware of. Or it could be part of the global liquidation that has the S&P 500 down 6% in the past month. But why are Chinese stocks getting hammered so much worse than other markets? I think — and this is pure speculation — it could be because western investors fear what happened to Russian stocks could happen to Chinese stocks if the CCP decides to expand its borders militarily, like an invasion of Taiwan. If you own Russian stocks, you’ve basically been zeroed over the past few weeks. And even if your shares weren’t zeroed, it’s not like you could sell anyways, with Russia deciding to close its stock market on February 25th. Given what has happened with the Russian economy in the past few weeks, how likely is it for the same thing to happen to China at some point in the next 10 years? Personally, I think it is fairly low given how important the nation is to the world economy. But people certainly think it is higher compared to a few weeks ago. We are likely seeing that perceived risk (whether warranted or not) reflected in Chinese stock prices right now.
Is holding cash making a macro call? We’ve been debating this topic internally, so I thought I’d put pen to digital paper and see if it can clear any of my thinking up. From what I can tell, there are two schools of thought when it comes to a cash balance in a portfolio. One school thinks you should only hold any meaningful cash as a residual of good ideas that meet your hurdle rate. Finding a lot of stocks that you think are investable? Your cash balance should be close to zero. Struggling to find any good ideas? Let the cash start to pile up. The second school thinks it can be helpful to have a portion of your portfolio in cash (5%, 10%, 15%, whatever). Why keep the cash? Because the future is uncertain, and cash can give you tons of flexibility (both literally and psychologically) if the market goes into a tailspin and fantastic buying opportunities present themselves. The drawbacks of each strategy are fairly obvious. Having minimal cash restricts your ability to make portfolio changes without selling down existing positions. On the flip side, holding cash is technically making a macro bet (i.e. saying that stocks you like will fall further) if you are seeing opportunities that meet your hurdle rate, and can become a drag on returns if the big drawdown doesn’t materialize. There are merits to both philosophies, and I don’t think you neccesarily need to pick a side. But it is something to chew on as you decide how you are going to manage your portfolio.
Are digital companies insulated from commodity and energy headwinds? I love investing in companies that live in the digital world. I really love investing in digital utilities (analysis in the Feb. 6th newsletter). Why focus my energy there? Because I believe these companies can weather macroeconomic shocks better than companies that operate in the physical world (i.e. they are generally more resilient). This isn’t some wild or novel theory, but one I think investors should consider with what is happening to commodity prices. Oil, lumber, steel, nickel…you name almost any commodity right now and the price is ripping higher. If these trends hold, companies that need to build anything in the physical world to operate their business are going to see major cost pressures. Digital platforms and other software companies will not. Now, one could argue that if commodity spikes lead to a general economic downturn and a recession, the knock-on effects will eventually come for the financials of internet/software stocks. While true, this comes back to my point about not just investing in companies that operate in the digital world, but digital utilities. These are services that people/businesses are less likely to churn off of in an economic downturn, which in my mind makes them extremely resilient. If commodity/energy prices stay elevated over the next few years, we’ll see if this thesis is correct.
See you next week,
Brett
***Our fund, Arch Capital, may own securities discussed in this newsletter. Check our holdings page and read our full disclosure to learn more.***
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Catch-up on Our Shows From Last Week:
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