Inflation continues to cool while the economy and jobs market are showing signs of stress which will prompt the Federal Reserve to cut interest rates. For the broader equity market, euphoria around Artificial Intelligence (“A.I.”) resulted in extraordinary performance in semiconductor stocks (e.g. NVDA) whose bubble-like qualities have caused remarkable market distortions as investors chase A.I. stories and ignore the rest. I am pleased with our balanced portfolio returns considering we have no semiconductor investments and I believe the current market dynamics present very exciting prospects for our partnership with multiple avenues to drive significant investment returns.
First, our investments are selected on their standalone merits (i.e. we target a minimum 2x multiple-of-money regardless of A.I.) and our portfolio has significant exposure to industries that will likely accelerate as interest rates come down. Second, it is my belief that monopoly/oligopoly industry structures with pricing power will be the biggest beneficiaries of A.I. – our portfolio is fully invested in this theme across a diverse set of sectors. Third, the broader equity market now appears overvalued as 87% of the S&P 500 index now trade +25% above their historical valuation while nearly half our portfolio trades at a 25% discount to our assets’ historical trading value. All-in, the S&P 500 trades at a +19% premium to its historical valuation whereas our portfolio trades at a 10% discount to our assets’ historical valuations. The table below shows the magnitude of this dynamic vs our portfolio.
- The Information Technology (IT) sector now represents 33% of the S&P 500 and trades at a massive +41% premium to history. Other volatile sectors such as Financials, Industrials, Health Care (biotech/pharma), and Materials are also inflated compared to history
- We have no semiconductor stocks and significantly more favorable valuations portfolio-wide
Portfolio Update
There were no new positions added nor exits during the quarter. A couple of items worth mentioning:
- Title Insurance: In June, Rohit Chopra (head of the Consumer Financial Protection Bureau) testified to Congress that Title Insurance does not fall into the category of “junk fees” that the Bureau is targeting. He further testified that his agency has limited jurisdiction, if any, over the industry given each state has its own insurance regulator. This is a positive development as it alleviates some concerns (trivial as they may be) about the federal government meddling in the industry
- Waste Collection & Disposal: Waste Management announced a $7 billion acquisition of Stericycle that will enable it to penetrate the faster growing medical waste market. While the deal is only 7% of Waste Management’s enterprise value, I believe it has the potential to boost profits by ~15% in 3-4 years. Industry implications from this deal are also positive for several reasons. First, I believe this was one of the only synergistic large deals WM could do given anti-trust regulators would likely block a traditional Waste Collection & Disposal deal of scale. Second, given Waste Management’s limited ability to do any sizable deals in its traditional market, its competitors Republic Services and Waste Connections (both portfolio investments of ours) stand to benefit as the best suitors for future industry consolidation.
I believe the significant discount embedded in our portfolio, limited exposure to the frothiest pockets of the market, and differentiated strategy to the A.I. theme position us well for very attractive investment returns. I approach each day with humility, curiosity, and determination to deliver a best-in-class wealth management solution for our partnership with unparalleled alignment of interests. My family balance sheet remains fully invested and I am grateful to be in your service. Thank you for your trust and please feel free to reach out anytime.
Your partner and fiduciary,
Faris Jafar, Chief Executive Officer
Phone: (734) 678-8562