Cavallini Capital 2023 Semi-Annual Letter to Investors
Striving to Consistently Outpace The S&P 500 Index
0% Management Fee, Performance Fee Only
1/1/2023 – 6/30/2023
Cavallini Capital LLP.
Greg Cavallini
5445 DTC Parkway, PH 4.
Greenwood Village, Colorado 80111
Results January 1, 2023 to June 20, 2023
Cavallini Capital, including dividends reinvested (hereinafter call CC) had a positive 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 positive return of 16.89%
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.
Current Market Environment
The markets are off to a roaring start in the first half of 2023. The S&P 500 is up 16.89% and the NASDAQ is up more than 31.73%, good enough for the best start to a year since 1983. Many managers and investors have been asking themselves, what has led to this great start? Curiously enough, at the end of 2022, many were expecting a recession to unfold in 2023. Thus far, that has not been the case.
As the market has rallied, more and more people seem to finally be diverting their cash and/or other assets to stocks. There are several ways to verify this trend. For example, one can look at net inflows to market tracking ETFs. Another example is something that we track at Cavallini Capital, the options market. Bets on bullish call options recently hit a level not seen since the frenzy in November of 2021. This denotes market participants believe the market will go higher. Call options give the right to buy shares at a specific price by a specific date.
We also saw the S&P finally climbing out of the longest bear market since 1948. This means the market has risen more than 20% since its lowest point, which happened in October of 2022. The current bear market lasted more than 248 trading days.
Historically speaking, the fast start to 2023 bodes well for the next 12 months. Going back to the 1950’s, the S&P rose 92% of the time over the next 12 months, and during those 12 months, the average return was 19%.
Recent Runup in Stocks: What to Do?
I often hear investors and money managers explain that they took profits off the table because of a recent run up in their stocks or portfolio. Simply selling stocks because they increase in value in a short period of time is not wise, in my opinion. One should only sell a stock if the intrinsic value of the stock is less than the current price (meaning it is overvalued), the fundamentals of the company have changed for the worse, and / or a better investment opportunity has come along.
Let us address each one of those scenarios. 1) Suppose you own stock A and you buy the stock at a price of $125. In the first two months since owning stock A, the company reported much better than expected earnings and thus the stock shot up to $200. This would represent a gain of 60%, a dream start. At this point, many investors would cash in and take some (or all) profits. However, as a long term investors, this could be a mistake. Before buying stock A, the investors should have an idea of how much the company is worth (and the stock price). If the investors did his/her research before buying stock A and concluded that the stock selling for $125 was worth at least $275, it would make no sense to sell. In other words, the investor is selling an asset for less than it is worth, something we would obviously want to avoid. 2) The more reasonable take as to why an investor sells a stock is because the fundamentals of the company have changed permanently or margins have slowly been eroded. In this case, it may even make sense to sell the stock at a loss. 3) It is perfectly acceptable to divert capital from current positions if a new better investment with more probability for the upside and less likelihood of loss comes along. In fact, we at Cavallini Capital are always searching for new investments that we think will provide more upside while minimizing the downside.
Long term investing works, but only when a logical and disciplined process is followed. Since the market bottomed in March of 2009 following the financial crisis, the S&P is up more than 700%; a statistic that should resonate with that view point.
The Fed’s Fight Against Inflation
Inflation continues to dominate the headlines in markets and the financial news cycle. Inflation has come down significantly since its 9.1% peak back in June of 2022. As of today, the inflation rate stands at 4%. The inflation rate is measured by the CPI index, ergo todays CPI index is 4%. There are two major inputs in the CPI: energy prices (gas) and housing prices. About a year ago, the average retail price for a gallon of gasoline was $5.11. That was the highest price in at least 30 years. The price has now dropped more than 27%, which has had an enormous result on the CPI and its steady decline. Home prices make up about 42% of the CPI. Unlike energy prices, reported real home prices tend to lag current day home prices. The Case-Shiller Index measures repeat sales data but reports on a two month delay and a 3 month moving average. Because homes usually go under contract a month or so before they close, it means that April data is reflective of decisions made late last year / early this year; in other words, it’s lagging. Going forward, the CPI should continue on its downward trajectory as home prices begin to reflect more of the on the ground reality. Of course, there can always be a shock to the financial system that turns the momentum around.
In March of 2022, the Federal Reserve started increasing interest rates, and doing so aggressively. They raised rates every time they met from March 2022 to May 2023. In June of this year, they decided to “pause”. The hikes at each meeting ranged from as low as 25 basis points to as high as 75 basis points. All told, the Fed rose interest rates from 0% to a range between 5% and 5.25%. This was the fastest rate hike cycle since the early 1980’s. The Fed does this in order to bring down inflation. Given that we were at 9.1% and now we are looking at 4%, it seems to be working. The tricky part is when to stop and even lower rates. It takes time for these policies to show up in the economy and thus the inflation rate. The current concern now is that the Fed has raised rates too much, which could cause a recession. They were late to raise rates in order to avoid the problem in the first place, but now markets are worried that the Fed may continue to raise rates 1 or 2 more times this year. This makes it harder to borrow money to buy a house or start a business. The impacts could hurt growth and make the economy contract, a very real possibilities, given previous rate hike cycles and the results to the economy thereafter.
When interest rates are hiked to such a level, it creates an asset competition. For over a decade, we have heard that “cash is trash.” There was good reason for this popular phrase, bank’s savings rates and other “risk free assets” like 1 month T-bills were yielding close to 0%. This caused investors to put money to work in the stock market or perhaps into risker bonds. The phrase TINA was often used, “There Is No Alternative.” However, because of the relentless rate hikes starting in March of 2022, as of today an investor can buy a 1 month T-bill yielding 5.17%. You can do so directly from the government and pay virtually no fees. A US government Treasury Bill or Note is as safe as an investment will ever be. The US government has never defaulted on their loans and most likely never will. High Net Worth Individuals and Ultra High Net Individuals see 5.17% as a much better alternative than the risky bond market and/or the volatile stock market. At above 5%, you are outpacing inflation, which sits at 4%. If you have $10 million dollars in the bank account, making over $500K essentially risk free, looks very attractive. Undoubtedly some of these folks and large institutional investors, such as endowment funds etc., have put some of their cash into these risk free return assets. Who knows, maybe they have even sold a good portion of their stock portfolios.
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
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.