Birkoa Newsletter 31 (End of February Updates)
Dear Birkoa LPs:
At the end of February, I wanted to provide a list of updates on the heels of my prior newsletter mid-Feb. As I had told you then, a much expected cooling off period was underway in the "hot" assets from November-January, namely, China. Some of it had spilled over into our other holdings like semiconductors, cloud computing/SaaS - the same sectors that I had said last time I was dipping into. Furthermore, the macroeconomics of inflation and interest rates hikes led the markets into a bit of a tailspin that re-ignited (temporarily) the environment like last Fall - artificial Dollar strength leading to most other assets getting correlated with one another and falling simultaneously. Let's look into the effects of it all in this newsletter -
Macroeconomically, we're continuing to see an environment that is antithetical to U.S. big tech names and stock market in general within the West. Initially, the market was pricing in a terminal federal funds rate of 5%, following a series of monthly CPI (Consumer Price Index) declines. However, during the month of February, the CPI and PCE (Personal Consumption Expenditure) numbers both came down lesser than expected, which led the market to reprice the terminal rate to 5.5-5.75% and the Dollar to artificially rise. This further exacerbated the cooling off in Chinese equities, which from November-January were finally losing their correlation with the U.S. markets, as they should. This had hurt our Chinese positions and I was busy buying more of them - specifically Kuaishou Technology and a tech bank called China Renaissance. Similarly some of our other sectors - semis, cloud computing/SaaS, energy & oil, and blockchain/crypto - had also cooled off.
The net result was that we came off our peaks eventually settling on a new level, which was when you received your statements for the month. Since then, the artificial Dollar strength has subsided, allowing assets to move more freely. As luck would have it, just the day following on March 1st, China reported manufacturing numbers that showed factory output grew at the highest level since 2012 - crushing expectations and putting it on the path to a much larger economic recovery this year. So much so that its GDP is expected to grow at 5% instead of 4% as earlier expected, with renewed optimism within the markets that the rally in Chinese assets weren't on faulty grounds. Now with fundamental factors on the ground supporting what the market had been looking for, markets in China are poised to go from strength to strength, and this will become the hottest trade for the next 2-3 years, especially as the West slips into a recession. This is precisely why I invested in China - counter cyclicality, and now we'll see the effects of that play out for real. The amount of foreign capital outflows for China from 2021-22 was massive, and given the sluggish economy in the U.S. and Europe, along with Chinese government's support of the economy, all that capital is going to move back into China, further inflating our holdings massively.
After all, there was a reason why I kept holding our Chinese holdings when we had briefly touched +18.5% net overall end of January and didn't sell anything - because we truly are not even at the 40th percentile of where these assets would end up being! Anyway, for some context, just in the day following your statement receipt date, the portfolio moved up 8.5% and it has made another 4% since, thereby currently having recovered 12-13% in net.
As the manager executing this strategy, my only objective is to produce distinguished returns over 3-5 year horizons by having a superior understanding over the rest of the market. One of the ways I do that is by consistently thinking of ways to reorder the portfolio if needed by freeing capital from assets that have lower upside potential in support of those that do. For instance: when during the month of February, I noticed any of our holdings within China, cloud computing/SaaS or semis drop too much on stupid/silly news (like a banker getting kidnapped in China, an executive resigning from a company leading to a price decline, etc.), I kept dipping into them by getting rid of metals or uranium or other positions.
As Warren Buffett says - "I like hamburgers, and when hamburgers go on sale, I eat more hamburgers." The way I look at it, I'm getting something I like for cheap and so long as the fundamentals don't change relative to why my strategy called for these positions in the first place, they will pick up much quicker than the undue dip. So it's heartening to see that Salesforce shot up 15% on Wednesday following an earnings beat for Q4 2022, which seemed to have transferred over to some of our other holdings within the sector as well (Atlassian, Baidu, etc.). Similarly, NVIDIA crushed during its earnings guidance, driven by the recent splurge in generative AI and ChatGPT, which uplifted the entire semis sector.
All this dip buying buoys up our portfolio massively when the causes of overreactions subside - and continually doing so will compound wealth over time. That's one of the things my 3 year horizon affords me - I don't care about looking like a moron in the short-run (like it was during September-October 2022), if I know doing so could return you 150% in 3 years rather than 60% if I didn't take that risk. Over the past year, the opportunities to profit off of such extreme market irregularities have been high, notably within our holdings - primarily because we are getting into counter-cyclical things being the first investors into them, but over time the rest of the market catches on and these things gain more stability. We saw that with China in November, we saw that with semis (having gotten in during the midst of the deep selloff in October '22), we saw that in a small scale with China and SaaS companies this past month of February '23. Every time we come out of these psychology-driven pullbacks, we settle at a new peak and in the process substantially outperform the market.
There's a very famous Buffett quote about this - "First comes the innovator, next comes the imitator, and then the idiot." Birkoa strategy is the innovator - and the market takes some time to catch up to it but once it does, its gangbusters numbers since we'll have bought it for 30-40 cents on the dollar. That's precisely what my framework allows me to anticipate! Given the geopolitical turmoil and macroeconomic regime changes during the past year alone, the opportunities have been plenty. Of course, Birkoa specializes in anticipating these paradigm shifts.
Some of the selloff last month also affected our blockchain position - I increased our exposure there as well. From its peak, our blockchain ETF is down about 22%, but it was down another 7% when I began buying into it. We're doing alright there now and of late some of the earnings within the sector have held up substantially - namely, Square, which beat earnings estimate thereby justifying an upswing. Coinbase is expected to continually go from strength to strength this year, and there's a good chance we'll end up massively higher in this position as well. Bitcoin and Ether or crypto tokens on the other hand, we still aren't in them since we'd much rather take their volatility in a dampened manner via our blockchain ETF and the public companies that it exposes us to. Too much interest rate and liquidity risk within the token themselves, but blockchain companies are more prone to dislocation from the tokens and economic risks since some of these businesses are fairly diversified and represent vast swaths of utilities within the underlying tech.
Oil is right where we were when I last communicated. It's been moving within the present handle for the past 2 months, ready for a breakout. Per a technical indicator widely followed in the chart below (credit: Crescat Capital and Bloomberg), oil is due for a breakout. Following the release of Chinese economic numbers, with such a massive reopening, demand will continue to rise and oil will probably keep moving higher towards $100/barrel. I'm staying put in oil.
Fig: Oil prices are primed for a breakout based on a much-followed technical indicator.
I am extremely happy with the Salesforce news and it shows that software sector in the U.S., which is NOT big tech, could prove to be a recession outperformer. I truly didn't expect such a quick turnaround for the sector, and I think we're in for an exciting year for those names that were beaten down so unfairly. As explained before, these SaaS companies are not directly dependent on the consumer economy, and so they shouldn't have fallen on interest rates or recession fears all last year in the first place, unlike say, Google or Apple or Amazon. Now they're already showing good economics, which means it might well be a quick victory with them. Understanding how a sector plays in the context of the debt cycle framework will be key to managing money as we head into a prolonged period of low growth + supply-side risks in the future. Normal things just won’t work as we’ve seen in the past year. As you well know, I've been warning about stagflation for this decade since I first started talking to each of you, and now it's entering the lexicon more in financial media. Today, there was a symposium at Princeton University's Griswold Center, attended by San Francisco Fed President Mary Daly, among others, where this seemed to have been a major source of discussion.
Birkoa not only has a means to identify these paradigm shifts that baffles these economists of the Fed (they're too bogged down with numbers and models - without understanding the context and human behavior, they don't get the mechanical nature of why things repeat), we are able to show distinguished returns off of that understanding by being early in off-beat assets. This upcoming year as the rest of the market (the "imitators") catch up to us, we'll see possible large upswings. Thus far, as a whole, our sectoral picks have (except for crypto) found a way to be proven correct (China, semiconductors, SaaS/Cloud computing, commodities). This is why I haven't yet realized profits on any position yet, because I'm waiting for our positions to get to the stage where the "idiots" pile on per the Buffett quote. Hence still the 40 percentile reference from earlier.
From what I have found, Birkoa strategy has proven to be generally correct in anticipating macro and geopolitical changes. It was correct in anticipating the following -
Chinese Covid-Zero shift would lead to a rocket ship-like recovery in China assets
Chinese central banks and government boosting their banking, property and tech sectors as part of a national plan post-Covid
The large monetary space in China allowing the Chinese government to implement easy policies as opposed to the U.S. and Europe, thereby leading to a great magnet for foreign capital during a recession in the U.S. (latter part not there yet, but on its way)
The passage of the CHIPS Act in U.S. to boost American semiconductor industry
The military buildup in Taiwan leading to allies like the Dutch and Japanese to side with the U.S. (helping our positions like ASML)
Commodities supercycle after 2 decades
Finally of late, the cloud computing and SaaS recovery as almost like a “Quality” factor heading into the recession to act as somewhat of a recession hedge
Typically the market takes a bit to follow these macro developments. Most of them haven’t yet been realized fully at the market-level, but we continue to march towards that as we speak.
I will keep in touch. If you have any questions, please do not hesitate.
Sincerely,
Pranjit Kalita
Chief Investment Officer