Q1 Letter - 2021
The beginning of 2021 has been a pivotal time for Mirador Capital Partners. We knew the challenges of 2020 would make us stronger, but did not expect that they would be such a dramatic catalyst for growth. We are honored that you not only continue to put your trust in us, but that you are also referring the important people in your lives. Our business is growing as fast as it ever has, we are receiving more referrals than ever (much appreciated), and we’re expanding our office footprint. To support us in our next chapter, we’ve also grown the Mirador family—Annie Herrington is the newest addition to our client services team, and Bryce Sonsteng will be joining us in June as a junior research analyst. We recognize the gravity of entrusting Mirador with your family’s wealth, especially through a year of so much adversity, and want to thank each and every one of you, our clients, for being with us. We look forward to taking down 2021 together.
It’s a Bird… It’s a Plane, It’s the Federal Reserve
The base case for 2021 is that as the economy reopens, earnings growth will return, cash stimulus and quantitative easing will subside, and rising interest rates will cause a slow train wreck for stratospheric equity valuations. The market has realized the early stages of this in Q1. Equity indices have chopped sideways and the high valuation growth names that got us through the pandemic are now taking water as their valuations contract. It’s led to the ‘reopening trade’ and a strong market rotation into energy, financial, and industrial stocks which has managed to temporarily buoy indices like the S&P 500, DOW, and Russell 2000, but even that is running into resistance as the US 10 year treasury yield continues its vertical climb higher.
The most consequential aspect of an interest rate is its ability to compound. Even Albert Einstein had claimed, “compound interest is the eighth wonder of the world, he who understands it earns it, he who doesn’t pays it.” There are two ways to frame compound interest. The commonly understood way is to frame it in terms of the exponential growth of capital over time. Many of us were introduced to this basic concept in grade school when we were presented with the theoretical choice of $1,000 today versus one penny that doubles for 30 days. The 30-day penny actually generates $5.3 million, a surprisingly large number, but plausible if we step back to consider it. Framed in this context compound interest is powerful, but in reverse, the same principle seems unfathomable. When we present the same grade school proposition backward – what is $5.3 million that halves for 30 days' worth? It’s one penny.
In investing, the concept of backward compound interest is called a discount rate. It is the basis under which all asset prices are determined, where a future expected value is discounted back to the present day (e.g. if I think TSLA stock can reach $1,000 in two years, what price is that worth today). The higher the discount rate, the lower the present price; and the lower the discount rate, the higher the present price. And because the discount rate compounds, this relationship turns exponential in both directions.
After a decade of maintaining a zero-interest-rate policy, enhanced by $5 trillion in federal stimulus last year, the Federal Reserve has found itself plugging the dike with both hands. These artificially low interest rates have allowed asset prices to rise to astronomical levels, leaving renowned investors like Jeremy Grantham screaming bubble to anyone that will listen. That’s because investors like Grantham recognize the power of the compounding discount rate – with interest rates so close to zero, a slight increase could inflict exponential downward pressure on asset valuations. In the first three months of 2021, the US 10 year treasury yield rose from 1.0 to 1.7%. As a result, growth stocks took the blow straight to the chin. According to the recent Merrill Lynch Global Fund Manager Survey, 2.0% is the line in the sand where the majority of money managers would sell equities and buy bonds (which also means if you wait until 2.0% you’re late). Any move higher in rates, and the selloff will be difficult to contain.
Luckily for investors, the Fed has shown that it is capable and more than willing to use its entire body to plug the dike if necessary. The March crash was evidence that, aside from the COVID-induced shutdowns, a 20-30% correction in asset prices leads to a deleveraging chain reaction which saps market liquidity and brings the financial markets and economy to a grinding halt. The Fed recognizes this dilemma and has made it clear that it will do whatever necessary to prevent interest rates from causing such a catastrophe. Hence it is no longer a conspiracy theory to say state that the US has entered a new economic paradigm where the markets are no longer free. The world’s most powerful investor country has tag-teamed with the world’s largest printing press central bank, forcing the financial markets to abide. That’s a difficult lesson many active managers, including ourselves, had to learn the hard way in 2020, and we must keep that in mind in 2021.
Opportunities in Enterprise SaaS
In the current environment, we continue to favor enterprise SaaS stocks that trade at reasonable valuations. There are a number of companies in this subsector that have not fit into any of the changing market narratives of 2020, particularly SaaS companies that were not work from home enablers. These companies underperformed their Zoom-ing peers during the pandemic, and are getting sold off with them in recent sector rotation. Despite poor price movement their fundamentals remain intact—digital transformation is a seismic shift that will only grow in the next decade, and these companies continue to execute against their still expanding addressable markets. Because of the value proposition that these companies provide their customers—productivity—their products get purchased regardless of the business cycle. During an economic expansion, companies adopt these tools to grow their businesses faster, and in recessionary periods, they adopt the same tools to cut costs. The subscription nature of their business also helps to dampen any short-term business volatility. As an example, during the pandemic, US GDP dropped 33%. Companies like Lululemon (LULU) saw their revenues drop 60%. In fact one-third of large businesses in the US might have gone bankrupt if it weren’t for the Fed. In comparison, Workday (WDAY), who is not a work from home stock, was unaffected. What’s interesting to point out, is that both stocks dropped 45%, and both have since recovered to the same level. It may just be me, but something seems off with that bankruptcy risk to reward ratio.
Growth has gone out of favor. Fake growth valuations are getting a reality check, and true growth companies just happen to be tied at the hip. This presents a great opportunity for investors to build positions before the market realizes that these companies don’t necessarily underperform during an economic recovery.
2021 is going to be a record-breaking year for earnings growth, and rising interest rates will spark major volatility in the equity markets. Most importantly any volatility that has the potential to crash the party will be muted by the central bank. Doctor’s prescription for the year – don’t bother with the risk label, just take the shot, party like its 1999, stay SaaSy and buy the dip.
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Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.