Dear Partner,
In the second quarter of 2024, Woodbridge Capital Partners I, LP (the “Partnership”) returned -4.29% while the S&P 500 returned 4.28% (with dividends reinvested). Since its inception in April 2020, the Partnership has returned 156.02% compared to the S&P 500’s 119.55%.
The companies we are invested in made solid progress in the second quarter. Below is a discussion of developments relating to our largest positions, followed by some brief general commentary.
Our telecom company investment released its second quarter earnings this past week, posting satisfactory results. Management also announced a capital markets day for their Swiss subsidiary (the one that will be spun off in Q4 and which we discussed in our previous letter) and indicated that analysts had raised their price targets for the Swiss subsidiary from $11 to $12. Incidentally, Kyosuke and I were in Switzerland a few weeks ago. It was encouraging to see the Swiss subsidiary’s logo everywhere, even on the tops of mountains (we saw a large billboard after taking a cable car to a summit near the town of Grindelwald).
Our insurance company investment continued to benefit from strong stock market returns and higher interest rates. This is because their primary business is variable annuities – a type of insurance that combines aspects of life insurance with financial engineering to give policyholders a lifetime stream of income that is somewhat dependent on the performance of stock and bond markets.
Meanwhile, our banking company investment emerged as one of stronger performers in the Fed’s annual stress test. In addition, we were glad to see regulators signal a willingness to dial back Basel III, a set of proposals which would increase the amount of capital that banks need to hold in reserve. At present, US banks are very well capitalized – far stronger than they were before the financial crisis of 2008. Additional capital requirements at this point would simply penalize bank shareholders and stifle lending unnecessarily.
Our tech company investment reported blowout earnings for both the first and second quarters, which exceeded expectations across the board. They also continue to make good progress with their cloud business, which has finally begun to turn a profit and which we believe the market is entirely neglecting.
Our semiconductor company investment saw its stock hammered in the second quarter after releasing their projections for a new business segment. This past week, they also released their Q2 earnings, which badly missed guidance and sent the stock tumbling again. In our view, the market overreacted to both of these announcements. Indeed, the company is seeing its margins pressured by the investments it is making to support future growth, but we firmly believe the payoff will be worth the wait.
In the second quarter, US economic activity continued to expand at a solid pace. GDP increased at an annualized rate of 2.8%, after increasing 1.4% in the first quarter. Inflation pressures have also continued to ease, with the latest report for the month of June showing -0.1% inflation. Prices overall rose just 0.26% in the second quarter, or 1.05% annualized, well below both the long-term average of ~3% and the Fed’s target of 2%.
Meanwhile, unemployment has been slowly rising. The June jobs report showed that the unemployment rate had risen to 4.1% – the highest level since November 2021. 4.1% unemployment is still quite low historically, and somewhat higher unemployment was an expected consequence of the Federal Reserve’s efforts to reduce inflation by raising interest rates. Given the progress that has been made in taming inflation, the Federal Reserve is likely to begin lowering interest rates soon to reduce the risk that the economy slows too much and enters a recession. While the Fed did not cut rates at their meeting this past week, traders are currently placing the probability of a rate cut at the Fed’s next meeting in September at nearly 100%.
Recent weeks have also brought dramatic events in the US presidential race, with the Republican candidate Donald Trump narrowly avoiding an assassination attempt at a campaign rally and the incumbent and presumptive Democratic candidate Joe Biden dropping out of the race. As the election draws nearer, it is natural to wonder what effect the outcome might have on Woodbridge. I think the effect, one way or the other, would be small, but not negligible. There is the sentiment on Wall Street that Donald Trump would favor policies that would be more beneficial to stocks, such as lower taxes, less regulation, and a more protectionist trade policy. All of these things could be beneficial to the companies we are invested in. Which candidate is better for our nation as a whole, I will leave for you to decide. In any case, we do not spend much time worrying about politics. We prefer to focus our efforts on finding good businesses at attractive valuations with margins of safety large enough that we should not lose money regardless of who is in the White House.
Even more than interest rates and the election, the dominant thread in markets continues to be artificial intelligence. Since the public release of OpenAI’s ChatGPT in December 2022, AI has been Wall Street’s hottest buzz word. The frenzy around AI powered the stock market to new heights in 2023, and this force continued on into 2024. Leading this rally has been NVIDIA, whose GPUs are well-suited for the task of training AI models like ChatGPT. Investors pushed up the price of NVIDIA by a spectacular 239% in 2023 and another ~149% in the first half of 2024, briefly making it America’s most valuable company.
While artificial intelligence is likely to be the defining technology of the coming decades, it is important not to get too carried away. Investors have a tendency to underestimate the time that it takes for technological advances to work their way into productivity and earnings growth, leading them to pay too much. There are countless examples of this in history. Also, not every AI-related stock will be a winner. We have no direct bets on artificial intelligence, but a few of our stocks do stand to benefit from it. More importantly, we do not believe we have any investments that could be made obsolete by it.
While the market continues to reach new highs, that is largely attributable to increasing investor focus on the largest tech companies. Stocks in many other areas have been all but ignored. As a result, the investment opportunities available for those willing to roll up their sleeves and dig through the piles of discarded names continue to be very attractive. Looking at our current portfolio, we are confident that the Partnership will outperform a low-cost index fund over the long-term. We are grateful for your continued trust and remain committed to your investment success.
Thank you,
Jesse Flowers & Kyosuke Mitsuishi
1https://finance.yahoo.com/quote/%5ESP500TR/history?p=%5ESP500TR
2https://www.cnbc.com/2024/07/25/us-gdp-q2-2024.html
3https://www.bls.gov/news.release/empsit.nr0.htm
4https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html