Results
The second quarter of 2022 ended on Thursday, June 30th, 2022.
For the second quarter, the consolidated return for Torre Financial accounts was -30.20%.
For the same period, the S&P 500 (SPY) returned –16.11%.
The Nasdaq (QQQ) returned -22.54%.
Returns for individual accounts may vary as each account is managed separately.
Market
The second quarter of 2022 posted the worst first half of a year since 1970.
Inflation has surged to its highest level in four decades.
Russia’s invasion of Ukraine has put additional stress on supply chains already rattled by the COVID pandemic.
Rising interest rates and fears of an ensuing recession have led to a risk-off mindset.
On June 15th, the Fed raised rates by 0.75%, the largest increase since 1994.
Growth companies have been adversely affected as their valuation relies on cash flows out in the future. As rates rise, cash flows in the future are less valuable today.
Relatedly, IPO volume is down 95% from this point last year.
Tiger Global, a technology-focused hedge fund, is down ~$25 billion this year. Their long only portfolio is down ~60% year-to-date.
Other asset classes are also struggling.
U.S. Treasuries, typically considered a safe haven and hedge against equities, are down between 6% to 22%, depending on the duration.
Bitcoin, the world’s largest cryptocurrency, fell 58% in Q2, posting its worst quarter since 2011.
Three Arrows Capital, a large crypto hedge fund with over $3 billion in AUM as of April 2022, officially fell into liquidation after not paying its debt.
The only winners year-to-date have been driven by commodities.
Energy was up nearly 70% for the year as of June.
Oil prices climbed as far as 65% in the quarter, underpinning the growth in energy,
Other commodities such as wheat, cotton, and milk were up significantly, reaching highs of +65%, +40%, and +35% respectively.
Needless to say, it has been a challenging environment, underscored by drastic and somewhat unnatural price movement in commodities.
The current changes in the market seem just as dramatic as when the pandemic emerged two years ago.
Portfolio
Top performers in Q2 2022
Only two portfolio companies are positive for the year. Both are in defensive areas - Agree Realty (ADC) is a Real Estate Investment Trust (REIT) and United Healthcare (UNH) is a healthcare insurance provider.
Veeva Systems (VEEV), Visa (V), and Mastercard (MA) have spectacular fundamentals with a well-balanced approach between growth and profitability. These companies have high growth rates, strong GAAP profitability, high free cash flow, and low capital expenditures, all underpinned by their strong competitive advantages.
Bottom performers in Q2 2022
Needless to say, many companies have been adversely affected by the changing macro climate. Higher interest rates have resulted in a re-rating of multiples that have affected companies with longer-dated free cash flows. For Cloudflare (NET), Workday (WDAY), and Okta (OKTA), the issues seem contained there. These are all enterprise SaaS companies and their fundamentals remain intact.
Upstart (UPST) and Paypal (PYPL) have both seen their business adversely affected. To start, they are both usage-based business models, as opposed to subscription-based models with recurring revenue. Hence, they see greater booms and busts.
Upstart (UPST) originates loans and sells them to institutional investors. With the recent change and uncertainty, institutional investors have been less interested in buying loans. As interest rates increase, the value of the loans drops – they would prefer to wait for things to settle. To accommodate their consumers, Upstart decided to hold a few loans on their balance sheet. This was not well received by the market, as it introduces new liabilities and significantly reduces the company’s free cash flow. The CFO has mentioned their intent to revert this practice. The next call will be particularly insightful. While this is a difficult time, zooming out, Upstart is very well positioned in a very large market.
Paypal (PYPL) has been going through a series of changes over the last year. Originally focused on growth, they had attempted to buy Pinterest. Without sufficient support, those plans were scrapped and they decided to focus on profitable growth. Their partnership with eBay is coming to an end, which has been a headwind for revenue growth. E-commerce sales, a main driver of growth, faces difficult year-over-year comps from the pandemic boom. Paypal is now re-focused on their core offering, improving checkout and expanding into mobile. Paypal has an attractive financial profile with strong profitability and accelerating growth over the next few years. Their largest asset is their network of merchants and consumers for digital payments and their direct relationship with both sides, somewhat akin to American Express.
Insights
Inflation is a key driver behind a lot of the recent change. Any signs of a peak in inflation could potentially alter the Fed’s rate hiking plans.
The two major drivers behind inflation are fuel and food prices. These are supply drivers, unlikely to be controlled by increasing interest rates.
For related reasons, the Fed prefers the Core PCE Price Index as a measure of inflation, because it excludes food & energy. This index peaked 3 months ago with a high of 5.3% and has more recently moved down to 4.7%.
Oil has historically been highly correlated with CPI.
Commodity prices seem to have turned since mid June.
Oil future are down from their peak, with a meaningful decline in June.
Wheat futures are also down from their peak in mid-May, declining by over 33.5%.
Commodity price changes are leading indicators. Their impact will take at least a month to trickle through to consumers, and the price index.
The first half of 2022 is off to the worst start since 1970. The only worst starts in history have been 1940, 1962, and 1932.
In 1970, the market rebounded and recovered the entirety of its losses.
If inflation continues its decline, the Fed could soften their tone, in turn boosting equities.
--
Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
Disclaimer: This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and all employers and their affiliated persons assume no liability for this information and no obligation to update the information or analysis contained herein in the future.