Striving to Consistently Outpace The S&P 500 Index
0% Management Fee, Performance Fee Only.
7/1/2019 – 12/31/2019
Letter To Limited Partners
Cavallini Capital LLP.
Greg Cavallini
1080 Brickell Ave. Miami, FL 33131
Results July 1, 2019 to December 31, 2019
The S&P 500 Index including dividends reinvested (hereinafter called the S&P) had an overall gain of 10.94% in the first 6 months of the fiscal year. Cavallini Capital including dividends reinvested (hereinafter called CC) had an overall gain of 16.52% in the first 6 months of the fiscal year.
The Influence of Negative Headlines / Sentiment on Investor Return’s
The last three months of 2018 (Oct, Nov, Dec) the S&P took a sharp decline of 19.80%. This was a significant loss for the index but one has to understand the context and the history of markets to truly grasp why it was important, and most importantly, how as investors we can take advantage of the opportunity.
To be categorized as a Bear market, an index (which is a representation of the overall market) such as the S&P has to decline 20% or more from peak to trough. In other words, we missed a Bear market by a measly 20 basis points or 0.20%. The current headlines will tell you that we are on a historic run of more than 10 years (longest in history) without a bear market, but have we really avoided a bear market? By definition, yes we did. However, one can see how close we were to the definition. The question then becomes, if the market had lost another 0.20% would people feel comfort that the bull run finally had a stop and now it’s smooth sailing
ahead because we hit the bear market definition and recovered? I really don’t think it matters one way or another. However, the 19.80% drop of the S&P was significant in a historical context. Since 1928, the market has averaged a 20% drop approximately every 4 years. Understanding this context should have signaled investors to buy, buy, buy!!! Most likely investors were scared off and moved cash to asset classes such as gold and fix income that have produced poor returns in the long-term compared to stocks. Looking back, we know the market recovered in January. It should also be noted that the market could have kept going down, which would have screamed to investors BUY. This gets to the heart of investing, timing the market. Timing the market is simply not possible (if someone does it successfully on a consistent basis or has heard of someone that knows someone, please have them call me immediately) but what we can do is take advantage of the situation. The businesses owned by CC in January were on sale. As such, we fully deployed capital in January and were able to buy more of the companies we own at a lower price. The results have been satisfactory to say the least. I envision it like walking into a mall and seeing my favorite brands selling their goods on sale, of course I’m going to buy the goods. It’s a strange situation that we always seek discounts when we purchase homes, cars, clothes, kitchen appliances, etc. and we jump at the bargain prices, but when it comes to shopping for great companies by buying stock, we get scared of the discount sale. I, for one, love shopping on discount and especially in the markets when our businesses are selling for far lower than their intrinsic value.
It is understandable why investors are scared during tough patches in the market. During that 3 month period we had 3 main topics dominating the headlines: 1) US – China trade talks seemed to have stalled; 2) Global slowdown that most likely would lead to a recession; 3) Fed Chair Jerome Powell announced the high likelihood of 3 interest rate hikes.
1) US – China trade deal: This, of course, has massive implications for not only the companies we own but for any and all global economies / businesses. In some ways the uncertainty has created wonderful opportunities. At no point has my investment decision
process been influenced by whether or not the deal is completed or not. As of now there is an agreement on Phase 1 to be signed on Jan. 15th but, if it is implemented remains to be seen. I would caution on optimism over the trade deal. In any case, good or bad news, we will take advantage of the situation.
2) Global slowdown / recession: When the pundits pontificate on the likely scenario of a recession, which was prominent in late 2018, the market will most likely take a hit. It is times like these that make investing a truly simple process. As Warren Buffet once said “Be fearful when others are greedy and be greedy when others are fearful.” The talking heads on tv are there for one reason only, eyeballs. CC will never make investment decisions based on macroeconomic outlooks by economists, academics, experts, or commentators on TV. Once again, we will simply focus on the businesses we own and keep a close eye. I have added two Youtube links from CNN and CNBC in the midst of the market selloff so you can get a feeling for what was being said at the time as well as to get a visual (Look at all that red on the screen). I have also added a link to a typical article one would have read during the 3 month period. The article is chock full of experts and their opinions.
a) https://www.youtube.com/watch?v=acLlXAew6mg
b) https://www.youtube.com/watch?v=sVurkZ4az8o
c)https://www.vox.com/policy-and-politics/2018/12/18/18146722/why-is-the-stock-market-down
It’s no wonder why investors run away from stocks when they are bombarded day after day after day with such headlines / news / sentiment. The point is not to emphasis if they are right or wrong but instead to understand how difficult it is to limit the influence of such environments on investor’s mind. It truly is a tough situation to handle.
3) Fed Chair Jerome Powell: Mr. Powell signaled that he would hike rates as many as three times in 2019. Rates will always have an effect on the stocks for better or worse. Rates act like gravity in relation to stocks. Theoretically, the higher rates go the lower
stock prices go. There is some logic behind this concept. If rates increase, that means that investors can get high returns on fixed income (seen as a safe investment; there is nothing safe about keeping pace or lagging inflation) with less risk than stocks. In the short-term that can be true, but we are interested in the long term and fixed income has been an abysmal performer compared to stocks backed up by mountains of academic evidence (see Professor Jeremy Siegel from UPenn Wharton Business School). If the Fed Chair were to whisper into my ear what his plans are for interest rate increases / decreases, it would have absolutely no effect on my investment strategy. Interest rates are only relevant to stock valuations (cheap or expensive) compared to the risk- free rate of the 10 Year T-Note.
The message I am trying to communicate is that macroeconomic factors will always persist. At no point will those outlooks influence how I invest or deploy capital. As a capital allocator, I simply want to understand our businesses as best as possible, make sure competitive advantage persists (e.g. margins, story, etc.), evaluate whether they are undervalued, fairly- valued, or overvalued, and continue seeking great businesses to invest in.
3 Year Track Record Outlook:
CC is inching its way to a three year track record. If we do not see a bear market or a recession in the following six months, I am confident that CC will have outpaced the S&P for the cumulative 3 year stretch. This is critical because judgment on a fund should not be made on a 1 year return basis but instead on a minimum 3 year cumulative return basis compared to its benchmark. The ultimate benchmark to beat in the market is the S&P. If my forecast proves to be correct, it denotes about an 89% probability that the record was not produced by luck. When investing, the question should not be “will this investment make money or not” or “will I win or lose on this investment” but rather “what are my odds at having a successful outcome on this investment”. Even the best odds can produce a bad result. What is important is that the investment was placed with the
odds heavily on your side. I propose that a 9 out of 10 probability of successfully outpacing the market on a long term basis is a bet worth taking or at the very least considering with some serious thought given that the stock market has outpaced all other asset vehicles in the long term. On an additional point, CC has applied with Florida State regulators to be a Registered Investment Advisor. I hope this process will be complete before the end of July. I will keep everyone posted.
Note:
At the risk of boring readers with repeated information from previous letters, I am restating what I believe to be the right measuring criteria of a successful Fund. I would rather bore previous readers than have confusion with new ones.
The Yardstick
In the world of professional money management, it seems it is a bit unclear as to what constitutes a good or a bad performance. To me, it is important to make this distinction and what I hope to achieve for myself and my partners. The first priority is the preservation of capital and the second priority is a reasonable return to investors in the long term. The question becomes what is a reasonable return on a long term basis? Below are my conclusions:
a) 5 to 8 percentage points over the S&P. Since we know the S&P historically has given investors about a 9.5% return, I am aiming for a range of 15% to 18% return.
b) Long term basis denotes a minimum of 3 years (preferably 5 years). This assumes no prolonged bear market.
I, in no way, can guarantee these results, but I thought it fair that my partners know what my goals and targets are. I will not abandon my conservative investment style (or so what my analysis tells me are
undervalued or fairly valued stocks) simply to reach the range of return I believe to be adequate. If it cannot be accomplished, I will say so immediately. In a year when CC has a negative return (which will happen from time to time), it would not necessarily make it a bad year from my perspective. For example, if the S&P has a negative 15% return for the year but the partnership has a negative 7% return, I would consider that a successful year. The idea is to gain an edge over the market / averages. I would much prefer to have a year where the market declines by 10% but the partnership only by 5% then to have a year when the market gains 20% and the partnership 21%.
Ana and I have the majority of our investable wealth in CC and so long as CC is in operation, this will always be the case.
I can’t promise results, but I can guarantee that Ana and I’s wealth will be in lockstep with yours.
Sincerely Yours, Greg Cavallini
Track Record
To view track record, please contact Greg Cavallini at greg@cavallinicapital.com.
0% Management Fee, Performance Fee Only
Notes:
The record above displays Cavallini Capital’s track record since inception on July 1, 2017.