Time to Rebalance Your Portfolio as Overvaluation Concerns Grow
2024.08.02 04:06
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 (NASDAQ:). 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 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 (NASDAQ:), 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 (NASDAQ:), Apple (NASDAQ:), Amazon (NASDAQ:), and Alphabet (NASDAQ:).
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 (NASDAQ:) in 2022, or the stocks will no longer respond to positive earnings cycles, as with Gilead (NASDAQ:) 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 (NASDAQ:) and bought Microsoft.
Visa (NYSE:) and Mastercard (NYSE:) have struggled lately, but I can’t envision the global economy growing over the long term without Visa (NYSE:) and Mastercard (NYSE:) being at the center of that growth; our holding period in these two positions is now just about ten years.
Intuitive Surgical (NASDAQ:) 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 (NYSE:) has stalled out more recently, but I have no concerns about the position.
Boeing (NYSE:) 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.
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