7/30/24

Second Quarter 2024 Review

The second quarter saw stocks move higher again, reaching levels that seem overly stretched from a fundamental and technical standpoint. The market has seen a significant rotation into mega-cap stocks, primarily led by Nvidia. This led to a substantial divergence across the market, with some market segments showing divergences reaching levels not seen since the late 1990s dot-com bubble and, in some cases, even surpassing those relationships.

History has taught us that markets like these are not favorable to those with a long-term viewpoint because they typically lead to overpaying for stocks, resulting in years of underperformance. We learned this lesson the hard way with some of our biotech investments in the early days of our strategy in 2014 and again with some semiconductor stocks during the 2015 and 2016 timeframe, which set our performance back and caused us to play catch up. Even beating the S&P 500 total return index in 4 of the last 5 years hasn’t been enough to close the gap.

It wasn’t that the ideas were terrible or that the businesses didn’t grow; it was just that all that future growth was priced in, and by the time the growth showed up in the numbers, the market had already moved on. The compounding of that underperformance is very hard to make up. I fear this is the same case today.

This caution means that holding periods matter more than ever in this market. If you have a short-term trader mindset, then the price doesn’t matter. However, for us, it matters and is also essential to our long-term goals and aspirations.

The Mott Capital Thematic Growth Composite, inclusive of dividends and net fees, rose 5.32% YTD through June 30, 2024, versus an S&P 500 Total Return Index, inclusive of dividends, which gained 15.29%. Over the past five years, on a rolling basis, including the first half of 2024, the composite has had annualized returns of 13.08% versus gains of 15.05% for the S&P 500 Total Return.

 

Adding Illumina

During the quarter, we bought shares of Illumina, a blood diagnostics company. With that purchase, we later received shares of Grail, which was divested from Illumina at the EU’s request. Grail is developing technology to analyze blood samples for the early stages of cancer detection.

Rapid advancements in AI applications will likely support healthcare companies making meaningful advances in formulary and product development, so Illumina made a lot of sense. Additionally, the stock has been battered over the past two years, and the valuation reached incredibly cheap levels historically. Earnings and revenue could be at an inflection point, potentially increasing this year. The divestment of Grail was a significant positive for the stock, and upon the announcement of the divestment in June, I purchased the shares.

Grail could also be a valuable company down the road, but at this point, I need more information about revenue trends or earnings growth rates. I am waiting for more information on the company and leaving the small stub position received from Illumina in the portfolio for now.

Portfolio Update

The rest of the portfolio has remained stagnant, with no significant changes, while our cash position has come down to around 30%. I still need more confidence in the S&P 500, the benchmark we strive to beat, with most gains coming from just a handful of names. We hold many of those names, such as Microsoft, Apple, Amazon, and Alphabet. At the same time, I realize the risk in having them, but I can’t sell them because they remain essential to the overall portfolio and the market, creating a conflict. That conflict is what to do with them. I hope that when the time comes, the market will present the answer. Either the growth rates will slow to a point where the longer-term growth story is over, as was the case with Tesla in 2022, or the stocks will no longer respond to positive earnings cycles, as with Gilead back in 2015. The other alternative is that other stocks’ valuations will become so compelling by a market event that a swap will be made, such as the case in early 2019 when we sold Cisco and bought Microsoft.

Visa and Mastercard have struggled lately, but I can’t envision the global economy growing over the long term without Visa and Mastercard being at the center of that growth; our holding period in these two positions is now just about ten years. Intuitive Surgical has had a fantastic run for us since the purchase in June 2022, with the company continuing to place more DaVinci Robotic Surgical Systems, and procedure growth remains strong. Shopify has stalled out more recently, but I have no concerns about the position.

Boeing is the portfolio’s problem child as the company struggles to get its act together. They are now searching for a new CEO and have had plenty of negative headlines in the media lately. Still, the stock is above our purchase price in April 2022, and I do not see anyone coming along and replacing them, so at this point, holding on makes plenty of sense.

We may be entering a period of transition for the market, where the current trends that have been working are reaching a point where they may no longer work. That is simply because we are now further along in the economic cycle; the economy and the labor market appear to be cooling. Once the Fed starts to cut rates, which seems to not be far off into the future, the trades that everyone has piled into will need to be unwound in anticipation of the next cycle.

We will see what the third quarter brings. Still, with the US presidential election and plenty of uncertainty, it seems likely that the market’s period of tranquility is ending and that a period of higher volatility is being ushered in.

Until next time,

Mike

Michael Kramer

Founder

Mott Capital Management, LLC

The Thematic Growth Strategy is also made available by Interactive Advisors through a licensing arrangement with Mott Capital Management; performance may differ from the Mott Capital Thematic Growth Composite.

N.A. – Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.

†  Performance reflects the non-annualized performance from 8/1/2014 to 12/31/2014.

** For periods with less than 36 months of composite performance, no 3-year ex-post standard deviation measurement is available.

Disclosure: Mott Capital Management, LLC is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

An investment may be risky and may not be suitable for an investor’s goals, objectives and risk tolerance. Investors should be aware that an investment’s value may be volatile and any investment involves the risk that you may lose money. Investment performance of a model depends on the performance of the underlying investment options and on the proportion of the assets invested in each underlying investment option over time. The performance of the underlying investment options depends, in turn, on their investments. The performance of these investments will vary day to day in response to many factors. Asset allocation strategies are subject to the volatility of the financial markets, including that of the underlying investment options’ asset class. Diversification does not ensure a profit or guarantee against a loss. Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.

Mott Capital Management, LLC, is an independent registered investment adviser. Mott Capital Management, LLC (“Mott”) claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards.  Mott has not been independently verified.  GIPS is a registered trademark of CFA Institute.  CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

The Thematic Growth Composite is a blend strategy of different market capitalizations, which is approximately divided equally among three sectors.  The Core Growth sector includes large multi-national companies, the Growth Sector includes mid- to large-cap companies, and the Aggressive Growth sector includes small- to mid-cap companies.  The strategy is concentrated, and typically includes approximately 20 positions, and 5% cash.  The portfolio may hold fewer positions in times of market uncertainty, when raising cash as a hedge.  The strategy only invests in stocks, ADRs, and ETFs denominated in USD.  The Thematic Growth Composite was created June 2015.   The inception date of the strategy is August 1, 2014.

The S&P 500 is a free-float capitalization-weighted index of 500 large-cap common stocks actively traded in the United States.  The index is shown as a general market indicator, and may not reflect the same exposures as the composite.

The investment management fee schedule for the composite is 2% on the first $250,000, 1.5% on the next $750,000, and 1.0% on the remainder.  Actual investment advisory fees incurred by clients may vary.  Further information regarding investment advisory fees is described in Part II of the firm’s Form ADV.

Past performance is not indicative of future results.  The U.S. Dollar is the currency used to express performance.  Performance shown represents total returns that include income, realized and unrealized gains and losses.  Net of fee performance was calculated using actual fees.  Composite performance is presented net of foreign withholding taxes on dividends, interest income, and capital gains.  Withholding taxes may vary according to the investor’s domicile.

Policies for valuing portfolios, calculating performance, and preparing GIPS reports are available upon request.

The annual composite dispersion presented is an asset-weighted standard deviation calculated using net returns of accounts in the composite the entire year.  The 3-Year Standard Deviation represents the annualized standard deviation of actual net composite and benchmark returns, using the rolling 36-months ended each year-end.

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