Birkoa Newsletter 39 (early November '23)
Dear Birkoa LPs, prospective LPs and well-wishers:
Hope you are well. I wanted to write to you today with positive news. Before delving into the newsletter, I wanted to provide a quick summary of the main points that I wanted to discuss today, broken down into the following 3 sections :-
Fund Status,
Macro Environment,
Market Environment
The following summary is provided by ChatGPT4 on my original text that'll follow in subsequent sections of this newsletter.
Fund Status:
Recent Challenges and Recovery:
Acknowledgement of a difficult period for the fund.
Confidence in the fund's recovery and upward trajectory.
Macro indicators aligned first, followed by market reactions.
Investing Strategy During Downturns:
Use of market pullbacks to acquire more assets.
Re-evaluation of investment theses during downturns.
Recent recovery has compensated for past losses, nearing all-time highs.
Investment Philosophy:
Belief in taking advantage of downswings in the market.
Macro Environment:
United States:
Declining inflation and a dovish Federal Reserve.
Prediction of the U.S. dollar weakening.
China:
Chinese central bank stimulating the economy.
Government signaling continuous support.
Japan:
Continuation of ultra-loose monetary policy.
Brazil:
Central bank rate cuts boosting commodity exporters.
Geopolitical Factors:
Middle East tensions influencing oil prices.
Positive developments for risk-on assets.
Expectations of a continued rally in commodities due to supply disruptions
Blockchain and Crypto Environment:
Positive outcome of Bitcoin ETF court case.
Anticipation of institutional adoption and bullish market.
Market Environment:
Oil and Energy:
Short-term decrease in oil prices with a bullish long-term view.
Metals and Miners:
Temporary downside with a positive medium-to-long-term outlook due to EV and green economy initiatives.
Artificial Intelligence (AI) and Tech:
AI equities expected to rise with a stable macro environment.
High beta exposure in the portfolio.
Investments in smaller market cap AI companies for high potential returns.
Cryptocurrency:
Recovery from the crypto winter.
Coinbase and similar entities poised for growth with ETF custodianship.
China's Market:
Stabilization and recovery in tech and EV sectors.
Japan's Equities:
Rebound in Japanese equities after central bank's dovish policies.
Specific interest in SoftBank for AI startup exposure.
Regional Banks:
Benefit from reduced treasury yields.
Adding to holdings in anticipation of Fed's rate cuts.
Overall Market Outlook:
Bullish stance based on macro tailwinds.
Expectation of gradual benefit from the Long-Term Debt Cycle framework.
Opportunities in spot currency markets and present holdings.
Now, let's look at each of the 3 sections in detail.
Fund Status :-
I'm happy to write today after close to 2 months following what surely has been a relatively painful period of pullback within our fund. However, I wouldn't write to you today unless I was confident in the strength of the recovery and its continuation into reaching new highs for our fund.
Being a macro fund, and with a relatively longer-term time horizon across each of our positions, seeing our anticipated moves within the macro realm is typically the first stage, followed by the markets. The second part typically lags the first one, and given the intraday volatility and news flow sometimes seems to sway astray for extended periods of time. I believe the August-October period was one such period where even though macro was proving to be correct, the markets themselves were moving for a myriad of short-term reasons. And now suddenly as of this past Wednesday on, the macro and markets finally seem to be in alignment.
Towards the end that such pullbacks are normal and expected, pursuant to following our strategy, we utilize these "down periods" to buy more of the assets we currently own while continuously going back to the drawing board to ensure our thesis itself hasn't been disproven. So ultimately, when the short-term fluctuations give way to the world we anticipate, we recover our paper losses violently and very quickly, which is what has happened in the days since the month of October ended, and we've not only recovered our losses for the month of October but also for September. As of this writing, we are <7% from our all-time highs at the end of July, and my guess is we will continue to build on this to rescale newer highs for our portfolio.
In other words, whenever our fund undergoes a period of downswing, that's truly the time to pounce with vigor. That is a very important aspect of our investing strategy. Every investing legend from George Soros to John Paulson to Warren Buffett have time and again done that - buy more when things go lower and add on to their positions to ultimately make a bigger killing than they would otherwise have. It is adherence to this philosophy while being extremely aware to reevaluate and second guess our positionings that will ultimately enable us to return large compounded annualized gains over our multi-year time horizon.
Macro Environment :-
The macro environment has become considerably more conducive to Birkoa's strategy over the past week or so. In the U.S. with inflation going down in successive months, there's of late been a cooling of the job market that's allowed the Fed to be considerably more dovish than they had been for the prior 1.5 years. This means that the Dollar artificial strength could ultimately break which will be extremely conducive for our assets.
As far as China is concerned, as expected, the central bank there is able to stimulate the economy - something that is impossible to think of here in the U.S., and the primary reason for our bullishness on China per the framework we employ. This stimulus has followed a more piecemeal approach rather than an all out bazooka, which might be the reason for relatively milder performance of Chinese assets as of yet. But, the reading between the lines is the government has signaled continued monetary and fiscal support to the economy going forward, including to the central bank, so it's a relatively high probability bet that the bottoming out process of China is in.
Japan in its recent central bank policy meeting reiterated their ultra-loose monetary policy and the expectation of it to continue and let inflation run hot for the foreseeable future. We expect that to be constructive for our Japanese positions.
Brazil's central bank, which had been among the most capable and prescient in fighting inflation last year, recently announced its first rate cuts, which will be stimulative for a lot of commodities exporters that we own in that country.
Geopolitics have been driving the bulk of market action leading up to the events of this past week. The war in Gaza, at one point, threatened to escalate, which was reflected via a spike high in oil prices. However, now that tensions have eased on that front from the immediate threat of escalation, we expect the pressure emanating from expectations of high oil prices to recede while being bullish for risk-on assets (risk-on assets like equities worldwide had also accelerated their selloff on fears of escalation, which has receded now, thereby accelerating their recovery further the past few days!). Furthermore, slowdown worries have led to a cooling off of the metals rally especially in Lithium. However, the forces of supply side disruption continue to have meaningful impacts on aspects of the supply chain like semiconductors, which means it's just a matter of time before commodities resume their supply scarcity-driven rally than over demand-driven concerns. The geopolitical environment is shaping up nicely for a longer-term bifurcation in supply chains, which was the main reason for our bullish bets within the larger commodities space to begin with. Those forces are still in play, and per our strategy, would only continue to be empowered more in the months and years ahead.
Blockchain and crypto have recently received quite a boost from the spot Bitcoin ETF court case going in their favor, and they're expected to keep marching higher as a result of institutional adoption following the availability of several of these spot crypto funds. The climate seems largely bullish for this segment of our portfolio and the worst of the sell-off/crypto winter from 2022 is largely behind us now. We're in the early stages of a bull market there.
Market Environment :-
The market environment we think is highly conducive to large chunks of Birkoa's asset allocation as a result of the tilt in the macro environment to our favor. While geopolitics in the Middle East might not be conducive for oil prices (and thereby our larger energy holdings) to the extent that they go down as escalation fears ease, we think that's a good thing since that's usually correspondingly followed by a rise up on our AI names both in China and the U.S.. Eventually we believe that oil prices will move up based on physical fundamentals of the demand & supply market, which signals highly bullish oil prices north of >$110 in the near future.
Metals prices might continue to see downside in the near-term, which means our metals miners could perform poorly in the short-term, but given the seismic governmental shift in promoting EVs and green economy both via the political bully pulpit as well as government subsidies both in the U.S. and China, we believe ultimately metals like Lithium and miners would do extremely well in the medium-to-long term. As a result, true to our form, along with the rest of our holdings, we added to our positions within metals and miners over the past couple of months.
Given that the market now sees the Fed is done with its tightening cycle along with the data showing it is okay to do so, our AI equities within the U.S. up and down the chain ranging from semiconductors to simulation software to materials science to Big Tech, will probably continue their impressive march up in the weeks ahead, barring any unexpected inflation surprise to the upside (unlikely!). We had utilized the down periods well in terms of buying into them and creating new positions so we expect to see large gains ahead if the current environment holds up. This aspect of our portfolio unfortunately does lend a large exposure to the direction of the market itself (high beta), but I sincerely think of this GenAI boom as being a macro-geopolitical factor which is why it's important to get into as much of them as possible at the ground level. Going forward, I expect a paradigm shift within the public markets investing space which will come with a premium if you could understand and appreciate the computer science aspect of these technologies well, which would in turn enable you to look beyond the obvious names into more underrated "picks and shovels" companies that might have Venture Capital-like 5x-10x returns over next several years. We have several of these investments within relatively smaller market cap companies in the AI space (for illustrative purposes, a company like Palantir for example). Volatility is unfortunately the short-term price to be paid enroute to these massive prospective gains.
Blockchain and crypto, as noted above, is finally coming out of the winter of the past year, and now that all the frauds have been discovered/weeded out, is prime for a bull market (in a lot of ways, it's already in one). We fully expect our holdings within the public markets space to benefit in a correlated manner to higher price of Bitcoin and Ether. Furthermore, Coinbase being the sole beneficiary as the custodian of these upcoming spot ETFs for institutional investors like BlackRock and Fidelity, would benefit immensely from said institutional adoption. We're about 6% away from reclaiming the highs within this segment of our portfolio, which we think is simply a matter of time before that ceiling is surpassed. This was another avenue we had been building our positions in during this mini-pullback, fully anticipating their success in these litigations.
China seems to be cautiously moving forward and a large part of it is a function of the government's stimulus package; it's been performing steadily for us, and of late several of the worst performing names from China (for e.g.: JD.com) seem to have bottomed out. We think the worst in China is over and think a sustained rally could be taking hold there. While there are still certain doubts over the level of infectiousness of its property sector, the governmental stimulus programs and direct stepping into the financial markets to boost liquidity might prove beneficial for at least our tech/EV holdings there.
Japan equities as a whole wasn't performing well because the markets were frontrunning an end to the Bank of Japan's ultra loose monetary policies as well as that of Yield Curve Control. However, last week after another dovish statement by its central bank, Japanese equities markets have been rallying and we believe the environment is ripe for a sustained rally there. This was our position all throughout the summer when we didn't buy into the market narrative that monetary easing was nearing its end, which is why we were building onto our Japanese positions further. SoftBank, while trading in Japan, is also a global AI play for obvious reasons, so that stock we think has dual tailwinds from both the U.S. and Japan that could help it to sustain a rally. We want exposure to this stock as a means to have a piece of every major AI startup of the future, and loose monetary conditions help in that regard from a valuation perspective of its constituent companies, thereby giving the stock of the parent VC firm SoftBank a lift.
Ever since the Fed has signaled its dovish tilt, yields on the treasury markets - both at the short and long ends - have come down dramatically in these past 3 trading days. The former is extremely beneficial to our regional bank holdings, which while being profitable to us in the net, had fallen considerably off their highs. Now they seem to be recovering quickly, another reason helping our portfolio to recover fast. We believe that the end of Fed tightening would be ultimately beneficial to these regional banks to get back to a stable state in terms of holding customer savings accounts instead of competing for yields against 2-year treasuries. As the Federal Funds Rate decreases next year after the Fed begins cutting rates, that could further help stabilize their businesses, thereby being further beneficial to their stocks. This was yet another portion of our portfolio that we had been adding to.
All in all, our market outlook as it relates to our portfolio, since it's a function of the macro outlook, is bullish. But that doesn't mean there wouldn't be slight pullbacks here and there; I only mean to suggest that the macro tailwinds taking shape were what was envisioned by our fund's framework of the Long-Term Debt Cycle and we might stand to benefit in a gradual manner going forward. There are also a couple of very interesting trades lining up especially within the spot currency markets now that we know the U.S. Dollar will break its stranglehold of the past 1.5+ years, exacerbated by the prior weakening economic environment in China and ultra-loose monetary policy in Japan. Thus, this remains a ripe environment to deploy new capital to our strategy both in terms of adding to current positions as well as venturing into new ones.
Sincerely,
Pranjit K. Kalita
CIO, Birkoa