Birkoa Newsletter 44 (end-May 2024)
Dear investors, prospective investors:
I wanted to write today with a rather narrow focus, geared towards highlighting certain opportunities that we see within our portfolio. The idea here is to shed further light on the relative cheapness we’re seeing in some components of our asset holdings, which might find expedient capital deployment opportunities for new investors.
We had a decent month of May, with the fund up over 5% in net. However, that number is meaningfully below its monthly peak and it is this dislocation I’d be focusing on here.
Here’s a summary of the newsletter – (summary provided by Chat GPT-4o)
Given the current market conditions, there are significant opportunities to buy into stocks and sectors experiencing temporary downturns within our portfolio. Our fund is focused on strategically investing in these areas to capitalize on short-term arbitrage opportunities and set up for future profits. Here’s why you should invest now:
1. VIX and VIXY: The current mispricing of volatility presents a chance to invest in VIXY at a lower cost, anticipating higher market volatility in the near term while ensuring portfolio insurance.
2. Enterprise Software: Stocks like Salesforce, MongoDB, Atlassian, Datadog and Snowflake are undervalued due to short-term guidance concerns. These companies have strong long-term growth prospects driven by robust financial performance and strategic initiatives in AI and cloud technologies.
3. Crypto/Blockchain Equities: Near-term drops from recent all-time peaks present an opportunity to buy dips, especially considering the macro and political environments (Fed interest rate cutting cycle, approval of spot Ethereum ETF) likely to be favorable in the upcoming months despite introducing risks lately.
4. Hang Seng Index: The recent geopolitical tensions and economic concerns in China have led to a significant drop in the Hang Seng Index. This presents a buying opportunity if you believe in the long-term recovery potential driven by diplomatic efforts and economic reforms.
5. UiPath (new position): The leadership change has caused a temporary dip in UiPath’s stock - a leader within the robotics AI/software automation field. With a focus on innovation and a strong long-term vision, investing now could yield significant returns as the company stabilizes and grows.
6. Dell (new position): Despite a recent revenue decline, Dell’s strategic positioning in AI-optimized servers and the tech industry offers potential for recovery and growth, making it a valuable investment at its current lower price.
7. Boeing and Defense Stocks: Boeing’s stock decline due to safety concerns and regulatory challenges is a temporary issue. Given the increased defense spending amid geopolitical turmoil, Boeing and other defense stocks are poised for growth.
8. European Defense Companies (potential future positions): Companies like BAE Systems, Airbus Defense and Space, and Thales Group stand to benefit from increased defense budgets and geopolitical instability in Europe.
Why Invest Now?
- Arbitrage Opportunities: Take advantage of current market mispricings to buy low and benefit from quick rebounds.
- Diversified Exposure: Gain diversified exposure to various sectors and geographies, reducing risk and increasing potential returns.
By investing in our fund now, you can capitalize on these strategic opportunities and set yourself up for both short-term gains and long-term profitability.
Newsletter:
Invest Now: Capitalize on Market Dips for Short-Term Gains and Long-Term Profits
VIX and VIXY: Understanding Volatility and Its Limitations
What is the VIX?
The VIX, or Volatility Index, is a real-time market index that represents the market's expectations for volatility over the coming 30 days. Often called the "fear gauge," it is derived from the prices of S&P 500 index options. A high VIX reading typically indicates that investors expect significant changes in the market, while a low VIX suggests that the market is stable.
What is VIXY?
VIXY is an ETF (exchange-traded fund) designed to provide exposure to the VIX by holding a portfolio of VIX short-term futures contracts. This allows investors to indirectly trade volatility itself, rather than the individual components of the S&P 500.
Limitations of VIX and VIXY
While VIX and VIXY are popular tools for measuring and trading market volatility, they have notable limitations. One critical issue is the influence of a few large-cap tech stocks like NVIDIA and Microsoft on the S&P 500. These stocks can drive the index in one direction due to their heavy weighting, even if the broader market is experiencing volatility. This can result in a VIX that does not fully reflect the underlying market conditions.
Another limitation is the increasing use of zero-day-to-expiration (0DTE) options, which can distort the VIX. These options are highly sensitive to immediate market movements and can cause fluctuations in the VIX that do not necessarily correlate with longer-term market volatility.
Investment Opportunity
Given these limitations, the recent decline in VIXY could present a strategic buying opportunity to continue to insure our portfolio against future risk scenarios. We anticipate that underlying market volatility will increase—especially driven by broader market factors not fully captured by the VIX due to the influence of large-cap tech stocks— therefore continuing to invest in VIXY at a lower price could be advantageous. This is particularly relevant in an environment where the S&P 500's performance might be misleadingly stable due to a few outperforming stocks, masking the volatility in the broader market.
Enterprise Software Companies
Recent Performance
Recently, software companies like Salesforce and MongoDB have seen significant declines in their stock prices due to several factors, with both their stock prices having dropped over 20% post-earnings this past week.
Salesforce reported strong quarterly results with an 11% year-over-year revenue increase. However, concerns over sustaining its growth and margins in a tightening economic environment have led to mixed reactions from investors. The company's forward guidance has been cautious, reflecting broader economic uncertainties and potential slowdowns in enterprise spending.
MongoDB also showed robust financial performance with a 27% year-over-year revenue increase. Despite this, its guidance for the upcoming fiscal year slightly missed market expectations, raising concerns about future growth prospects in a challenging economic landscape.
Datadog, although reporting strong earnings, has seen its stock react cautiously due to the broader market sentiment influenced by peers like Salesforce and MongoDB. The overall tech sector's performance, particularly high-growth companies, has been under pressure due to rising interest rates and economic uncertainties.
Atlassian and Snowflake have similarly been impacted. Atlassian reported a 21% year-over-year revenue increase, but cautious investor sentiment following Salesforce and MongoDB's guidance has tempered market enthusiasm. Snowflake, despite its innovative developments in AI and data cloud technologies, has also felt the ripple effects of broader sector concerns.
Investment Opportunity
The recent declines in these stocks may present buying opportunities. We believe the market has overreacted to short-term guidance concerns and not fully appreciated the long-term growth prospects, therefore building our present positions in these companies could be strategic. Their strong underlying performance and strategic initiatives in AI, cloud, and automation technologies suggest they are well-positioned to recover and grow once broader market conditions stabilize.
Crypto and Blockchain Re: Volatility and Near-Term Dips
The recent decline in the equities of companies involved in the cryptocurrency and blockchain sectors, such as Coinbase and various mining stocks, has significantly impacted the Fidelity Crypto Industry and Digital Payments ETF (FDIG). This ETF, which includes a broad range of companies involved in digital payments and blockchain technologies, has seen its value decrease double digits from recent peaks.
Coinbase (down over 15% from recent peaks), in particular, has been affected by increased regulatory scrutiny and the volatile nature of the cryptocurrency market. Despite recent strong performance in some quarters, the broader uncertainties in the crypto market have led to a decline in Coinbase's stock from its recent peaks. These regulatory challenges and market volatility have impacted the overall sentiment in related sectors.
Similarly, mining stocks have faced pressure due to fluctuations in cryptocurrency prices, operational challenges, and increasing energy costs. As cryptocurrencies like Bitcoin and Ethereum have experienced significant price swings, the profitability and stock prices of mining companies have been negatively impacted. This has further contributed to the decline in the FDIG ETF, which has a substantial allocation to these types of companies.
We think however, that the political as well as macroeconomic backdrop for this sector continues to be robust, and therefore believe this is yet another dip-buying opportunity within the sector. Recent inflation numbers in the U.S. have suggested that the uptick noticed in the beginning of the year has stalled, and inflation is once again coming down. This has put the Fed rate cutting cycle back in view and crypto/blockchain assets will benefit strongly from it.
Hang Seng Index: Impact of Geopolitical Tensions
Recent Decline
The Hang Seng Index has recently experienced a significant 10% drop, driven by several factors:
1. Economic Concerns in China: The Chinese economy faces multiple challenges, including a sharp downturn in the property sector, deflationary pressures in domestic consumption, and a slumping export market. These issues have contributed to a systemic and confidence crisis.
2. Regulatory Pressures: Increased regulatory scrutiny on major technology firms and other sectors has created uncertainty and volatility in the market, leading to investor caution.
3. Geopolitical Tensions: China's recent aggressive military actions in the South China Sea around Taiwan, have heightened geopolitical tensions, further impacting investor sentiment and contributing to market sell-offs.
Temporary vs. Permanent Factors
Temporary Factors:
- Geopolitical Tensions: These may de-escalate over time with diplomatic efforts and changes in international relations, potentially leading to a recovery in market confidence.
- Market Sentiment: Investor sentiment can stabilize as the geopolitical situation becomes clearer or if there are positive developments in diplomatic resolutions.
Permanent Factors:
- Structural Economic Issues in China: The challenges in the property sector and the broader economic slowdown may have lasting impacts, requiring substantial policy interventions and structural reforms. However, even within these structural areas of concern, we have already begun seeing governmental stimulus being provided in China, most notably in the property sector with the recent announcement by the CCP that it’d buy up excess glut of housing supply in order to alleviate the financial strain within its property market. We think therefore, that this is a moment that’s microcosmic of further governmental support to come and an increasingly optimistic outlook for the markets there. Just some time ago, on June 3rd Hong Kong time, Chinese PMI data for May got released, showing the largest reading in 2 years, therefore giving continued credence to the story of a Chinese economic as well as market resurgence.
As a fund, we’re very well-positioned to benefit further from it.
Investment Opportunity
Given the current dip in the Hang Seng Index, this might represent a buying opportunity since we believe that diplomatic efforts will de-escalate tensions and that the Chinese government will implement effective measures to stabilize the economy. Investors with a long-term outlook like us might find value in the Hang Seng Index's current valuation.
UiPath: Leadership Change and Market Reaction
UiPath is a leader within robotics AI and software automation, and has been on our radar for close to 1 year, monitoring the stock price to find an attractive price of entry. This is the kind of stock that may seem speculative for some, but might return manifold unless it completely falls off a cliff in terms of its business execution.
Recent Developments
UiPath's stock dropped significantly by over 30% following the announcement that CEO Rob Enslin would resign on June 1, 2024, and co-founder Daniel Dines would return as CEO. This leadership change has raised concerns about the company's future direction and stability. Despite strong earnings, the market reacted negatively to the uncertainty surrounding the leadership transition.
Investment Opportunity
The significant drop in UiPath's stock price could present a buying opportunity for investors who believe in the company's long-term vision and the potential of its AI-powered automation platform. The current dip might be a strategic entry point to invest in UiPath's future growth, and so as a fund, we’ve begun building a position in it.
Dell: Challenges and Prospects
Dell is a recent position that we’ve built as of this past week, immediately following the massive dip following reporting earnings.
Recent Performance
- Dell has reported a 14% decline in fiscal year revenues. The cautious outlook on consumer and commercial client spending has contributed to market concerns.
- Despite these challenges, Dell's strong performance in segments like AI-optimized servers and strategic positioning in the tech industry offer potential for recovery and growth.
Investment Opportunity
- The recent drop in Dell’s stock price of over 20% post-earnings presents a dip-buying opportunity for investors who believe in the company's ability to navigate current challenges and capitalize on long-term growth opportunities in the AI sector.
Recent Downward Pressure on Boeing Stock and Other Defense Companies
Boeing's Recent Decline
Boeing has experienced significant downward pressure on its stock, with a 25% decline year-to-date. This drop can be attributed to multiple factors, including:
1. Safety Concerns and Incidents: A series of high-profile incidents, such as emergency landings and technical issues with its aircraft, have intensified scrutiny over Boeing's safety record. The grounding of over 170 Boeing 737 Max 9s due to safety concerns has further damaged the company’s reputation and stock performance.
2. Regulatory and Legal Challenges: Boeing faces ongoing regulatory scrutiny and penalties. Recent issues include a $51 million penalty for arms export violations and quality control problems identified by the FAA, which have added to investor concerns.
3. Market Sentiment: Negative sentiment driven by these issues has led to a bearish outlook, with Boeing trading below its key moving averages and experiencing a technical "Death Cross," indicating potential further declines in the short term.
Investment Opportunity in Boeing
Despite these challenges, Boeing presents a potential buying opportunity for long-term driven investors like our fund due to several reasons:
1. Analyst Ratings and Price Targets: Analysts maintain a positive long-term outlook for Boeing, with recent ratings suggesting an average price target of $245.67, indicating a potential upside of over 28% from current levels.
2. Geopolitical Context: The ongoing geopolitical turmoil, including tensions in the South China Sea and other regions, is likely to increase demand for defense and aerospace products. Boeing, being a major player in both commercial and defense aviation, stands to benefit from increased defense spending and military contracts.
European Defense Companies to Consider
Given the current geopolitical instability, several European defense companies also present attractive investment opportunities:
1. BAE Systems: As one of the largest defense contractors in Europe, BAE Systems is well-positioned to benefit from increased defense budgets and military collaborations within NATO and the EU.
2. Airbus Defense and Space: A major competitor to Boeing, Airbus's defense division is involved in various military and space projects. With the rising demand for defense capabilities, Airbus is likely to see substantial growth.
3. Thales Group: Specializing in aerospace, defense, and security, Thales is another key player in the European defense sector. Its diverse portfolio and strong presence in cybersecurity and digital identity solutions make it a robust investment.
The recent decline in Boeing’s stock and other defense companies offers a potential entry point for investors like us who think that geopolitical instability worldwide would continue to benefit defense contractors. Given the current geopolitical environment and the essential role of defense and aerospace companies, investing in Boeing and European defense stocks like BAE Systems, Airbus Defense and Space, and Thales Group could be strategic moves. These investments could benefit from increased defense spending and heightened global security concerns, presenting a valuable opportunity to build or expand positions in these sectors. Any dip emanating from reasons outside of a fundamental weakness in this outlook, for e.g. the commercial problems in the case of Boeing, are dip-buying opportunities we feel.
In Conclusion:
Each of these assets presents unique opportunities based on recent market overreactions to short-term developments. By carefully considering the underlying fundamentals and long-term prospects, Birkoa as a fund can potentially capitalize on these local dips. Whether it's VIXY’s mispriced volatility, undervalued tech companies, the ever-volatile crypto/blockchain space, the geopolitically affected Hang Seng Index, UiPath’s temporary leadership-induced drop, Dell’s current challenges, or Boeing’s decline amid increased defense spending, there are strategic entry points for informed investors. New capital into our fund would continue to be served well under these conditions.
Sincerely,
Pranjit K. Kalita
Chief Investment Officer