2020 Mid-Year Review

July 1st, 2020

The first half of 2020 ended on June 30th, 2020. Throughout this period, the S&P 500 (SPY) returned -4.0% and the Dow Jones Industrial Average (INDU) returned -8.4%. For the same period, the average return for Torre Financial accounts was -6.5%, with a range of -10.8% and +9.9%.

The major constituents of the S&P500 — Microsoft, Apple, and Amazon — have taken off. Meanwhile, the financial sector has taken steep losses and been slow to bounce back. We focus less on macro factors and more on the performance of our portfolio companies. We’ll dive into further details below.

As a reminder, portfolios are tailored towards each investor’s risk profiles and investment goals. While the S&P 500 and DJIA serve as general benchmarks, they do not provide an apples-to-apples comparison. Each portfolio has unique objectives and strategy.

Review

The year started off strong, marching to new highs through mid-February. As fears over the coronavirus materialized, the U.S. stock market crashed within just a few weeks, ending the longest-ever bull market, only to come roaring back.

The S&P 500 bottomed on March 23rd at 2,191.86 as the economy was shut down to contain the virus. A historic drop in oil prices drove prices to negative territory and turmoil in the bond markets led the Federal Bank to unprecedented action.

Through the purchase of mortgage paper, ETFs, and even direct corporate debt, the Fed’s balance sheet has bubbled up from 3.8 trillion to over 7 trillion. Coupled with stimulus from programs like the Payment Protection Program, money supply has increased significantly.

Personal savings rates skyrocketed, reaching a historic 33%. Retail investors poured money into the market, notably through the free application Robinhood.

In June, the S&P 500 rallied back and briefly erased the entirety of the losses.

Many investors, however, remain much more cautious. Assets in money-market funds reach unprecedented levels, with over $4.6 trillion on the sidelines.

At the mid-year mark, the economy has re-opened and is now grappling with a potential second wave.

Portfolio

We have maintained our disciplined investment approach throughout the volatility. We take comfort in the measured valuations of our companies, especially in comparison to some of the high-fliers in the market. Results will show over time.

We took certain action to re-position our portfolios for the new reality.

In April 2020, a promising Chinese-based Starbucks competitor, Luckin Coffee, was exposed as a fraud. The lack of transparency makes it difficult to trust Chinese companies for the long term. We are not comfortable holding Chinese companies. We sold out of all Chinese stocks, including JD.com and Alibaba.

Disney and Booking.com are two portfolio companies that are significantly affected by Covid. Although they are great companies and likely to survive, they are going through a rough patch. They are taking on many years-worth of debt to cover today’s expenses. While earnings will likely bounce back in a few years, it will take many years to cover this debt.

Plenty of companies are taking advantage of the historically low interest rates. There is a nuanced distinction between those that are able to leverage that cheap capital for strategic use versus those that have to cover empty expenses (akin to a bucket with a hole in it).

We have placed a renewed focus on companies that will not only survive, but thrive, in the new world order. The tech mega caps including Amazon, Facebook, and Alphabet will be sure to gain from the work-from-home movement.

We maintain confidence in our consumer staple companies — Procter & Gamble, Kimberly Clark, General Mills, and Pepsi. The panic purchasing at increased time at home will likely sustain higher demand for their products.

Highlighting some of our other portfolio companies:

• Cisco — We expect them to benefit from the work from home situation, especially given their dominance in the enterprise video conferencing space with WebEx.
• LabCorp and Quest Diagnostics — These labs are pivotal in the push for coronavirus testing.
• United Healthcare and CVS — Healthcare insurers are still receiving premiums, although many operations have been delayed.
• Cerner — Hospital software is not going anywhere.
• Intercontinental Exchange — The rise of retail traders and increased volatility is likely to benefit the owner of the NYSE exchange.
• Raytheon Technologies and General Dynamics — We’re confident the government will continue to invest in defense. General Dynamics, make of Gulfstream jets, also has the potential upside of increased private travel.

The most radical change to our portfolio companies is the addition of younger, high-growth technology companies. Given my full-time job in software development, I feel I have a unique window into opportunities in this space. I’ve highlighted the top choices below:

• CrowdStrike — Cloud-based cybersecurity company, leveraging AI for endpoint security.
• Workday — Cloud-based human capital management software (think of ERP software, but for managing people).
• Okta — Cloud-based identity access management solutions.
• Slack — Enterprise messaging app (think WhatsApp for companies)
• Cloudflare — Focused on making the internet more performance, reliable, and stable

Insights

It is hard to believe the stock market has almost recouped the entirety of the losses from earlier in the year. It seems the world is worse off than the stock market leads to believe. Two key insights here:

• The economy is backwards-looking, while the stock-market is forward-looking.
• The injection of roughly $4 trillion is bound to have a significant impact.

Each dollar injected into the stock market has a magnified impact. Think of company XYZ with a market cap of $100 billion trading at $100. If the next trade executes at $101, XYZ’s market cap would jump to $101 billion. The marginal increase in stock price created significantly more value in market capitalization.

We invest in companies. We look for opportunities that are truly compelling, so we have conviction to hold through the rough patches for the next 5–10 years. On the flip side, to sell is to admit a mistake. This quarter I began tracking my mistakes.

• Throughout 2017 and 2018 I was purchasing Union Pacific as it dropped from $105 down to low $70s. I sold on the way up, primarily in the $90s. Today, it trades for $165.
• Throughout 2018 and 2019 I was purchasing Vipshop. It shot up from ~$9 to $20, only to come crashing down to under $5. Instead of holding my conviction, I sold on the next short-term bump up to $7. Today it trades for $20.
• Throughout 2019 I was purchasing JD, as it dropped from $55 to under $20. I sold when it bounced back slightly in the high $30s. Today it trades for $60.

The idea of tracking these mistakes is to reinforce my conviction. Through the troughs it seems like there is no way out — all hope is lost. This is an emotional reaction. In order to reduce or eliminate these mistakes we must 1) acknowledge them and 2) plan to prevent them. As I mentioned above, we cut ties with all Chinese companies. The lack of trust is too significant a doubt to hold through, or even add, through these troughs. There are many opportunities in the USA that I am much closer too and much more familiar with.

My full-time job is in technology. My biggest personal bet is that Juniper Square will be successful. Companies like Juniper Square fetch high valuations — multiples of 25–30x revenue are not uncommon. I not only accepted that when I signed on, but I see the opportunity that it will become much more.

While I was previously incapable of seeing this opportunity in other companies, I now better understand how to think of these opportunities. These have to be viewed as long-term investments. There are a lot of unknowns. Using behind-the-napkin math you can get to a ballpark future valuation. But this is more art than science. You must gauge the opportunity qualitatively, understanding the value they are producing and the long-term implications of it. You put a lot of faith in the team. Identifying a mission-driven company can make a significant difference.

We are in the midst of unprecedented times. I have no idea of the short-term direction of the economy or the market. It’s impossible to predict the trajectory of the virus itself, unemployment, the impact of fiscal stimulus, Fed monetary stimulus, and many other variables. There are new variables each day that influence the trajectory and the outcome of the situation.

I choose to simply focus on what I believe the long-term earning power will be for the businesses I follow, and then invest in the best opportunities.

General Update

In April 2020, the California Department of Business Oversight (DBO) conducted a regulatory examination of Torre Financial. This is expected and a typical part of the process, given that investment advisory is a regulated business.

This was a long, enduring process wherein the DBO requested accounting documents, client statements, client invoice notices, and much more for various periods of time.

Torre Financial is now a structured business. We’ve formalized our accounting, using QuickBooks to manage the business. We’ve set up dedicated email addresses — info@torrefinancial.com and federico@torrefinancial.com. We’ve updated our regulatory forms including Form ADV and ADV Part 2.

I share this because it was a great experience. If you’re interested, reach out to me. I’m happy to share more about it.

Torre Financial wouldn’t be possible without you. I want to thank you for trusting me with your money.