Cavallini Capital 2022 Annual Letter to Investors
Striving to Consistently Outpace The S&P 500 Index
0% Management Fee, Performance Fee Only
1/1/2022 – 12/31/2022
2022 Annual Letter to Limited Partners
Cavallini Capital LLP.
Greg Cavallini
5445 DTC Parkway, PH 4.
Greenwood Village, Colorado 80111
Results January 1, 2022 to December 31, 2022
Cavallini Capital, including dividends reinvested (hereinafter call CC) had a negative return, Please contact Greg at greg@cavallinicapital.com for results. The S&P 500 Index including dividends reinvested (hereinafter called the S&P) had a negative return of 18.10%
Cavallini Capital Investor Gains vs. The Competition
Below you will see 5 separate results:
1. An average of all U.S. stock mutual funds. These Funds are actively managed by individual(s) who are the smartest and brightest in selecting stocks.
2. Results from a typical mutual fund that is invested in a similar manner to CC. T. Rowe Price (PRDGX) has Assets Under Management (AUM) of about $14 billion. PRDGX represents a prototypical fund for an ordinary investor seeking to put money in an investment vehicle focused on stocks. Results are represented net of fees.
3. The S&P which is passively managed.
4. Investor gains in CC net of fees.
5. Results of CC.
To view track records, please contact Greg Cavallini at greg@cavallinicapital.com.
Inflation
Without doubt, this has been the most challenging year in the fund’s 5 ½ year history. It is no coincidence that it has also been the most challenging year in financial markets since the Fund’s inception in July of 2017. We are stepping away from a world of 2% interest rates to most likely a world of 5% interest rates (at least in the short term).
This gets us to our first topic and one of the most discussed topics of 2022; inflation. Typically inflation occurs when governments pump too much money into financial markets and / or very cheap money is widely and readily available. Most people seem to think that the last payment protection program by the Trump administration and the Biden administration payment protection program, were too much for the economy. To further exacerbate the problem, it seems the Fed was late to increase interest rates in order to cool inflation. No matter who or what is at fault, 2022 produced the highest inflation we have seen in the last 40 years.
As a money manager, I should have seen in foresight what I so clearly see in hindsight. Inflation hit a 40 year all-time high of 9.1% in June. The market started to anticipate that the Fed would begin interest rate hikes. This caused stocks to start tumbling as early as January. In fact, the Fed began increasing rates in their March meeting. The Fed went on to increase rates 6 more times at the fastest pace since the early 80’s. In recent weeks, the Fed has now signaled that rate hikes will slow down. Indeed the latest interest rate hike was lower. Looking forward, we could see a situation where the Fed stops hikes all together in the short term. The general consensus is that they will raise rates possibly two more times for a total of 50 basis points. The latest inflation reading looks to indicate that interest rate hikes have started to lower inflation. December’s inflation reading sat at 7.1%. The continuous and aggressive rate hikes kept stocks on a downward trajectory. It has also been a particularly violent year for stocks. When it comes to volatility, this year has been more tamed than the 08 financial crisis. In fact, it has been the most volatile year since 2000. In 2022, there have been at least 84 days in which the Nasdaq moved 2% or more in either direction in a single day. For context, in 2008, the same situation happened in 83 days. Furthermore, this has been the worst result for stocks in a single year since 2008. 2022 was also the 3rd worst result for the S&P since 1975. The lone bright spot were energy stocks. I also think it is important to gauge how the Fund is performing against similar peers. The Wall Street Journal tracks over 1,400 actively managed mutual funds. Of those, only 40 had a positive return in 2022 and the average return for all was -18.2%. The 40 funds that had a positive return had large positions in energy. Though overall they performed better than Cav Cap. this year (year to year anything can happen), Cav. Cap. is significantly ahead of the average since inception. It is important to highlight these numbers so as investors, and potential investors, comparisons can be made under a proper perspective. If one simply looks at a one year results, it would be discouraging, As investors, we want to look at the entire picture.
Interest rates act like gravity against stocks. Stocks that are particularly vulnerable during these times, are stocks which have no profit and little to no free cash flow. This would make sense because those companies need to borrow money until they are profitable. As such, when interest rates rise, the borrowing cost gets more expensive sinking the company into a bigger debt hole.
Now is time to look forward and best position ourselves for 2023. What’s to come is anyone’s guess as 1 year projections are not how I invest money. However, we have some good data that point to a positive outlook for the next year. As with the positive outlook, there is also the negative sentiment as to what could transpire.
Lets start with the positive sentiment backed up by some hard data. There have been a total of 13 rate hike cycles since 1954. On average, the S&P has risen 14% in the following 12 months once the Fed stopped increasing rates. The S&P had positive gains in 11 out of the 13 rake hike cycles. The best performance was in 80/81 when the S&P rose more than 40%. The worst performance was in the 69/70 recession when the S&P sagged 11%. Another encouraging note is that US equities outperformed other popular assets during those 12 months after the Fed stopped hikes. US Equities outpaced Global Equities, Bonds, and commodities on average. The results were as follows in the same order as listed in the prior sentence, 14%, 13%, 10%, -2%. Furthermore, only 4 times since 1928 has the S&P produced negative returns 2 years in a row.
Now for the negative sentiment going into 2023. The market fears that because the Fed raised rates too quickly, it will induce a mild or strong recession. Many people talk about a soft landing, meaning the Fed can raise rates without causing a recession. History does not favor that thought process, but by no means does it mean that anything is for certain. Because we do not know if a recession will or will not occur, we have to protect the portfolio from this possible outcome. As in the past, I have selected stocks that have low debt, high free cash flows, and healthy net income. These stocks tend to weather rough recessions storms better than most.
Whether the good or the bad forecasts come true in 2023, the Fund will keep investing as it knows best; for the long term. Recessions come and go. This is normal for markets and as investors, we should be prepared to be in that up and down environment knowing that in the long run stocks perform better than any other asset. Inflation can cause a bit more pain on investors as it seems to linger longer than recessions. I would argue that the best asset to combat inflation is stocks. Inflation has a way of being sticky which causes longer down periods for stocks. In time, like recessions, inflation also goes away. We seem to be on the right track at the moment. Advisors suggest Gold as an alternative to combat inflation, so let’s have a look at how Gold can perform.
Gold
Gold has been seen as the safe heaven when economic, political, and / or general financial disasters strike. From the surface, this seems like a reasonable conclusion. When interest rates are low, the opportunity cost is low and you are able to buy more gold. It is of particular advantage when the dollar falls against a basket of foreign currencies. In this particular case, one could buy foreign currencies because the USD goes a longer way, thus giving one more cash to buy gold which is denominated in the dollar. Finally, during geopolitical tensions, like the war in Ukraine, Gold is seen as a stable asset.
However, not all is well with the Gold theory once deeply examined. Let us look at some hard data. From 1971 to 2021, the price of Gold has gone up about 50x, but stocks have performed much better during that same time period. That should be eye opening given that the 1970’s was not a kind decade for stocks. During that period, the annualized return of the S&P 500 was 11.2% versus Gold’s 8.2%. Furthermore, if you take away the decade that Nixon went off Gold, the annualized return for Gold was 3.6% versus the S&P 500’s 12.2% and 8.2% for Treasuries in the last 40 years. Gold is actually down 32% since 1980 (excluding 2022) when taking inflation into account.
Gold can be a good speculation play on a very short term basis, but this takes considerable knowledge. It is hard to find evidence of an investor who has consistently performed well over the course of many years by trading Gold in the short term. Furthermore, Gold can be expensive to maintain while it produces nothing. If you own gold, you have to pay to store it and insure it which generates a negative return. Gold does not grow in volume over time and it produces no dividends or earnings of any kind. If an investors owns 1 ounce of gold, 100 years later, he will own exactly 1 ounce of Gold. Gold has no real world application either. The world’s inventory far exceeds its use. One example is the Iphone. It is true that a little tiny bit of gold is used to make this product, but it is insignificant in comparison to the world’s reserves. To give some perspective, Copper and Steel have real world application and are needed for building cities, buildings, and other human necessities.
When it comes down to it, what motivates the purchase of Gold is the belief that the fearful will grow as it is seen to be a uncorrelated assets to the stock / bond markets. Gold is an investment with negative yield and no discernable investment value or structural use, whose price is determined mostly by fear – fear of inflation, war, and paper money. Research conducted by Duke University Prof. Campbell Harevy and Claude Erb found that it’s only when measured over long periods – a century or more – that gold has done a relatively good job of maintaining purchasing power. Over the short term and medium term, its real or inflation adjusted, price fluctuates no less than that of any other asset.
Ana and I have the majority of our investable wealth in CC and so long as CC is in operation, this will always be the case.
I can’t promise results, but I can guarantee that our wealth will be in lockstep with yours.
Sincerely Yours,
Greg Cavallini
Notes:
The record above displays Cavallini Capital’s track record since inception on July 1, 2017.
Disclaimer: Greg Cavallini, as General Partner of Cavallini Capital, LLP, makes no representations or warranties to investors regarding the probable success or profitability of Cavallini Capital, LLP, and the Track Record, Results and Comparisons set forth herein shall not be used as an expectation on benchmark for any new investments or ventures.