The following segment was excerpted from this fund letter.
In the current bifurcated investment environment, winners win, and losers lose. Big time. Trends get taken to extremes. We’ve long thought an AI bubble was possible. I’d say we’re there, though it may still be early.
Fortunately, we recognized Nvidia’s (NASDAQ:NVDA) potential and bought it early in the year. It was capturing the bulk of AI profits with a significant market lead and deep competitive advantages. We believed it was more like Microsoft (MSFT) than Cisco (CSCO), which implied significant potential upside to its intrinsic value. It’s since more than doubled and reached our bull case level. To justify current market expectations, we believe Nvidia needs to accomplish something unprecedented, like sustaining its current 65% operating margins for decades.
That’s possible, but unlikely. Even if it happens, it won’t be linear. What’s more likely is that Nvidia continues to surpass near-term expectations with the launch of its Blackwell chips later this year, which will be undersupplied. Markets would likely extrapolate any strength.
Bill Miller once said markets go on a journey from undervaluation to overvaluation and back again. The same is true for securities. When we make an investment, we want to capture as much of that journey as possible. We recognize it’s impossible to time your entry and exit perfectly. We work actively to mitigate our (and investors broadly) behavioral tendency to sell winners too soon.
In this case, we still believe it’s possible for the AI/quality compounder momentum to get more extreme. Nvidia currently trades at 47x fiscal 2025 earnings, which corresponds to Cisco’s mid-1998 level (the ultimate peak in March 2000 was 152x!). Likewise, the S&P 500 Tech sector trades at 33x 2024 earnings, a similar level to late 1998 and early 1999. During that period, gains continued for another 12-18 months.
We don’t expect history to repeat but are cognizant that times of euphoria tend to last longer and get more extreme than most anticipate. This one may end the way of the Nifty Fifty euphoria of the late- 1960’s or the Tech Bubble of the 90’s, namely a crash. That would be a painful outcome. Though in those prior crashes, low multiple stocks vastly outperformed.
We don’t think we’re there yet, especially as some of the Mag 7 still trade at reasonable valuations (Alphabet trades at 24x next 12-month earnings; Meta at 26x).
For now, we are watching Nvidia closely. It continues to outperform on most days and the fundamental backdrop remains intact. The market will likely give us the first signal that change is afoot. We never like to sell our winners after only a matter of months, especially in taxable accounts. We aim to maximize returns, which requires we remain flexible. Nvidia’s giant move this year closed the discount to intrinsic value. While we can’t make the case that it’s undervalued, we also don’t believe it’s significantly overvalued, which is typically where euphoria ends. We will be monitoring it carefully.
We see the most compelling long-term opportunities in unloved areas of the market, which we’ve been shifting more into gradually. While that’s hurt us short-term, we have conviction it’s the right move long-term.
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Stock Data from Bloomberg as of 6/30/2024. Data Sources: Bloomberg, Patient Capital Management The S&P 500 Index is a market capitalization-weighted index of 500 widely held common stocks. Investors cannot invest directly in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. Magnificent 7 is a group of stocks made up of mega-cap stocks Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Amazon.com (AMZN), Meta Platforms (META), Tesla (TSLA) and Nvidia (NVDA). Sahm Recession Rule: Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months. Leading Economic Indicators (‘LEI’) is composed of 10 economic components whose changes tend to precede changes in the overall economy. Personal consumption expenditures (PCE), also known as consumer spending, is a measure of the spending on goods and services by people of the United States. The Nifty Fifty was a group of 50 large-cap stocks on the New York Stock Exchange that were most favored by institutional investors in the 1960s and 1970s. Capital Expenditures (CAPEX) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. West Texas Intermediate (‘WTI’) Crude Oil is the underlying commodity of the New York Mercantile Exchange’s oil futures contract and serves as one of the main global oil benchmarks. Purchasing Managers Index (‘PMI’) is an indicator of the prevailing direction of economic trends in the manufacturing and service sectors. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. References to specific securities are for illustrative purposes only. Portfolio composition is shown as of a point in time and is subject to change without notice. Portfolio holdings and portfolio discussion are for a representative Opportunity Equity account. Holdings discussed may or may not be included in all portfolios subject to account guidelines. Investors should carefully review and consider the additional disclosures, investor notices, and other information contained elsewhere in this document as well as the Offering Documents prior to making a decision to invest. All historical financial information is unaudited and shall not be construed as a representation or warranty by us. References to indices and their respective performance data are not intended to imply that the Strategy’s objectives, strategies or investments were comparable to those of the indices in technique, composition or element of risk nor are they intended to imply that the fees or expense structures relating to the Strategy or its affiliates, were comparable to those of the indices; since the indices are unmanaged and cannot be invested in directly. The performance information depicted herein is not indicative of future results. There can be no assurance that Opportunity Equity’s investment objectives will be achieved and a return realized. Returns for periods greater than one year are annualized. The views expressed in this commentary reflect those of Patient Capital Management portfolio managers as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Patient Capital Management disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. Any data cited herein is from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Click for the Opportunity Equity Strategy Composite Performance Disclosure. ©2024 Patient Capital Management, LLC |
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