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Russia-Ukraine Letter

By February 25, 2022March 18th, 2022Fund Updates

Dear Investor ,

We wanted to reach out and give an update on our portfolio as elevated levels of volatility have sustained for the first two months of the year. Moreover, we want to inform you of the impact volatility has had on our fund, how we are currently positioning our portfolio, and what our outlook is on the market. In the short two months of 2022, equity markets have had to digest more inflation, earnings season, Fed hawkishness, and now a war in Europe.

Throughout 2020 and 2021 the market experienced powerful returns in large part due to Fed liquidity. A golden rule of investing is to never fight the Fed. This golden rule holds true whether the Fed is being accommodative or hawkish. Long duration assets faired the best in the dovish environment fostered by the Fed for much of the past two years. SPACS, IPOs, pre-earnings tech darlings, and speculative assets roared due to a free money environment. When growth is free, even the earliest cycle business can flourish.

As you know, our investment committee has a fundamental belief that these types of assets do not belong in our portfolio. This belief shows its downside in an environment where money is free, but we also know that on average throughout economic history, money is rarely free. Even in an environment such as today where there is merely an expectation rates will rise in the coming years, these stocks have fallen to extreme lows. In fact, 40% of the stocks in the Nasdaq are down over 40%.

Our investment committee believes the most prudent way to allocate our investors’ hard-earned capital is to find companies that have long-lasting business models that earn money today. In large part, the S&P 500 reflects such companies as the largest market weights are generating the greatest earnings seen in human history. Companies that have strong balance sheets and earnings power are those that can best withstand market events in a rising rate environment. These are the types of companies that will fare best in an elevated inflationary environment.

The selloff seen in January stemmed from higher than expected inflation prompting the Fed to taper and raise rates faster than previously expected. As of last week, futures were pricing in as many as eight rate hikes in 2022 because inflation continued climbing at unsustainable rates. This challenging environment was further threatened by geopolitical uncertainty when it became clear one of the largest exporters of energy was beginning an invasion of Ukraine. This perfect storm has led markets into their worst performance since 2021Q1.

Markets hate uncertainty, and wars bring about significant uncertainty. The presence of an international conflict during a time when we are facing headwinds from inflation and a hawkish fed accentuates the presence of ambivalence. It is more important now than ever before to invest in companies that generate strong earnings from their ironclad balance sheets. Every stock in our portfolio can be considered value or growth at a reasonable price. If a stock in our portfolio has a higher price to earnings multiple than the market, it has a clear track record of earnings growth and steady forward guidance to support that multiple.

Uncertain times are scary for investors and prove that one can never consistently time the market. Conscious of this fact, our investment committee has positioned our portfolio to be in the strongest companies in the world that can withstand any environment.

Throughout this crisis, our team has raised a 10% cash position to take advantage of lower stock prices when we become comfortable being fully invested yet again. The stocks in our portfolio have tracked the S&P 500 thus far in 2022. The large cash position will allow our team to make swift moves once the dust has settled in the geopolitical theatre. Our team does believe that there will be volatility in the coming weeks despite the market’s powerful comeback in the last two trading days. There is much unknown, and when there is a plethora of unknowns, money managers must default to the fundamentals of stocks.

In the face of all this ambiguity, over 80% of companies reported earnings that beat expectations and most companies guided in a positive direction. The resilience of US corporations to generate strong quarters amid a fluid rate cycle, supply chain issues, and geopolitical concerns, is why investors find comfort in owning proven businesses with short durations across US equity markets.

It is our belief that as geopolitical uncertainties play out, it will be proven time and time again that US equity markets are the best markets for global investors to find earnings power, innovation, and the strongest business models.

Every decision our team makes is made knowing our investors chose to invest their hard-earned capital in our fund. We do not take this confidence placed in our team for granted. That is why we believe capital preservation during volatile times is of greatest importance.

Below you can find our portfolio names and weightings. You will see that every company in the portfolio grows earnings at reasonable prices. During these trying times, it is important to remember that stock prices all come down to earnings.

Thank you for your continued confidence in our ability to manage your capital. If you would like to schedule a meeting to go over our positions and outlook in greater detail, please do not hesitate to reach out.

Stay well,

The CEA Investment Team