Gnostic Capital Global Large Cap Portfolio Return for Q4, 2021 and for Fiscal 2021.

The large cap global portfolio increased by 9.6% for the 4th quarter ended December 31st, 2021.

For 2021, the equity bar, due to rampant money supply inflation, was set quite high. M2 money supply in the United States rose by 12.2%.

The S&P 500 grew in value by 26.8% for 2021. The two leading subsectors of the S&P 500 were oils, up over 47% in 2021 and real estate, up over 43% in 2021. For the first year since 2001, not a single equity subcategory within the S&P 500 posted a negative return.

The DJIA increased in value by 18.7% for 2021.

The NASDAQ improved in value by 21.4% for fiscal 2021.

For the full calendar year, the portfolio ended with a value of $661.14 US per share.

Having started the year with a value of $471.98 US per share, this represented a total increase for 2021 of exactly 40%.

This 40% return for 2021 was sweated out the hard way, the old-fashioned way; no cyclicals, no real estate and no commodity based investments were owned going into 2021, none were bought and sold throughout 2021 and none of the above will be owned for 2022.

2021 was a far more trying year, on the investment psyche, than bottom line numbers would indicate.

Long held positions such as Mastercard and Visa were hard pressed throughout 2021 to remain even and did not assist the overall return one bit. Another formerly hot stock, PayPal Holdings, ended 2021 as a profound disappointment, having declined in value by more than 22% when compared to the prior year. Had the portfolio been too heavily weighted in Fintech, 2021 would have been an utter disaster.

Thankfully, other core positions picked up the slack. Investments such as UnitedHealth Group advanced by a whopping 43.2%. Kansas City Southern was acquired by Canadian Pacific in a stock and cash exchange; the total return for the year was 45.7% on that basis. Costco Wholesale shares appreciated in price by 50.5% during 2021. Microsoft Corp. turned in a 51.2% increase in its share value through 2021. Novo Nordisk produced a share price increase of 60.3% for 2021.

An initial position, purchased using dividends from other equities, BJ’s Wholesale Club, grew in value by 79.6% during 2021.

The highly positive contributions from these companies, even on holdings that may have been more modest in weighting, proved largely sufficient to offset the disappointments in terms of overall account return. As importantly, the relative outperformance of certain investments served to rebalance the overall portfolio weightings, without being forced to execute sales. Fintech remains important to the overall account, but is no longer dominant.

There was also the story of the Covid-19 vaccine producers.

The portfolio had opted to surf the covid-19 pandemic via participation in shares of Moderna and BioNtech, the two leading developers of mRNA vaccines. Initially, the thesis was both investment based as well as offering an intangible “feel-good” theme; successful vaccines would help the world and make money at the same time; what could go wrong with that premise?

Well, as any battle scarred investor will tell you, a whole lot CAN go wrong with a “feel-good” story. One of the great issues with a thematic play is that individual investors, too often, become enamored with a business, so much so that they gloss over certain issues within the underlying business or fail to take heed of competitive developments within a nascent sector. Retail owners always run the risk of becoming too emotionally invested in a security and when that occasionally occurs, investment perspective is lost and replaced with bias.

By mid 2021, it became clear that covid-19 vaccine producers were, in fact, a source of deep division within the investment community. Moderna and BioNtech performed their very best, share price wise, when broad equity indexes were at their very worst; these diametrically oppositional moves to stocks at large made both companies less a thematic play, more a disaster hedge.

As I became more aware of the market’s pricing decisions in treating both vaccine producers as nothing more than a form of calamity insurance, the question then became; “what will investors decide as the disaster ends?” Conceptually, one product companies cannot be appraised like other businesses. Institutional investors hold a clear edge over retail investors in that regard; institutions do not fall in love with stocks; they are colder, more dispassionate, less emotionally tied to a single security.

Retail investors scoff at the failure of active institutional accounts to surpass returns of raw indexes. They do so at their own peril. Tell me, where are the studies indicating that retail investors outperform institutions? Such studies do not exist; they do not exist because retail stock buyers as a whole consistently underperform institutions. What investment firm, in their right marketing mind, will pay to commission reports detailing how individual investors consistently underperform institutions, who themselves fail to best indexes? Nobody will pay the freight to produce such research as it casts a negative light on retail stock buyers, upends the status quo and could damage a major profit center of the investment industry; thus, the delusion persists.

The mere idea to “consider” a sell decision of a much beloved story equity generally puts individual investors into an unhappy place, and so they seek out confirmation that holding remains the true, best course of action. Retail investors often assuage feelings of uncertainty by promoting institutional holdings of their favored stocks (“I own what they own, so it must be a great pick“). This seems odd on its face, considering that individual investors hold themselves out to be superior at stock-picking than institutional accounts, otherwise what would be the point of assembling their own portfolios at all?

Why would anyone consider the investment opinions, from those deemed to have less stock picking acumen, as being necessary to support a thesis, unless they themselves were less than certain of their own choices, and if not certain, what is the point of seeking out external validation, from those they hold in contempt?

One cannot even rely upon historic holding data supplied to the SEC or other regulatory bodies to justify a rational for investment, specifically institutional holding reports; it would be ridiculous for institutions to telegraph purchase or sale objectives and to do so would create downward and/or upward pressures on equities via intent signaling.

Myself, I prefer the nuance of human intelligence gathering to AI brute force word searches. With the understanding that retail and institutional accounts think and behave quite differently; quietly, carefully, I queried certain holders of Moderna and BioNtech to get a sense as to what they would likely do with their holdings at the conclusion of the pandemic. These lines of questioning indicated the potential of an issue; for the mRNA vaccine producers, being wholly dependent upon sustainable vaccine sales, there is no immediate revenue “plan B”. As to vaccine investors, many, surprisingly overly weighted, they expressed a disinterest in a pandemic end; it poses the risk for a negative impact upon their net worth. Within one fiscal quarter, it became clear, to me at least, that ownership of Covid-19 vaccine producers was no longer a “feel-good” story; it was instead a “feel-bad” story (I make more profit provided global suffering continues as before). The entire business case for vaccine producers is a sustained pandemic continuation, or, at the very worst, a gradual stepdown in sales offset somewhat by price hikes. There was NO investor thinking on a more abrupt end to the pandemic. That is the great wrinkle to the long thesis for mRNA investors; they have locked into a mindset that only provides for two possible outcomes, either great or at the worst, just really, really, good.

The discovery of the Omicron variant, in my view, might well spell the beginning of the end of the manic phase of the pandemic. This accelerated my thinking regarding the question; “what to do when the disaster ends”, certainly earlier than I had planned. Coincidentally, Pfizer announced a highly successful phase trial conclusion and an FDA application for a Covid-19 viral first line treatment to be marketed under the name “Paxlovid”. This afforded me with a new option for participation, a less divisive choice.

The model portfolio, in the latter part of Q4, 2021, sold off, in the entirety, the highly profitable positions of Moderna and BioNtech. If the market assigns these investments a valuation based upon some form of disaster insurance, my inclination that the pandemic will sooner, rather than later, be ending, leads me to conclude that my need for such insurance is also coming to an end. Secular waves are relatively easy to surf as compared to tidal waves. My exit, albeit potentially early, is lateral. I replaced the messenger RNA duopoly, dollar for dollar, with shares of Pfizer. In this change, I am still surfing the pandemic, but have changed boards, in anticipation of differing surf conditions. Paxlovid should win sales on treatments as well as potentially cannibalize some vaccine revenues. Pfizer benefits more to its own account, I estimate, than they will lose on the vaccine revenue front, provided that the revenue changeover from vaccination in favor of treatment is pari passu.

For now, Paxlovid offers the potential to sustain Pfizer as a feel-good story in 2022. This may provide me with more time to plan a pandemic endgame. Vaccine company shareholders talked down potential Paxlovid sales, holding out snippets of information indicating that the ability of Pfizer to supply pills would be constrained.

An equally plausible alternative theory is that Pfizer floated a possibility of pill shortages for no other reason than to solidify orders and get governments off the fence, rather than actually having production issues. By way of example, the US has ordered more than 10 million treatment courses for all of 2022 and has been notified by Pfizer that 4 million total treatment courses of Paxlovid will be available for domestic use just in the month of January alone. Almost 19 million total treatment courses have already been contracted for 2022, exceeding $10 billion of potential gross sales, by Pfizer, and the product has only just been approved. I have few doubts that Pfizer will sell every pill that they can contract, as quickly as possible.

The volatility of 2021 and lack of performance in certain investments resulted in a deeper and more thoughtful review of certain business models.

There is a business risk that individuals often undertake when coasting upon the success of certain equities or in raging bull markets. The risk is that when profits/returns are in excess of expectations, abnormal returns represent capital that are considered to be free money, that may be “risked” in the anticipation of generating an even greater return. This same abnormal profit capital allocation risk applies to companies. Corporations are run by people, and specific to monopolies, those at the top of the corporation can often be lulled into a sort of complacency after lengthy periods of high EBITDA returns. Corporate boards assume that the underlying business will never be impacted by competition and therefore, nobody at the top legitimately plans for that possibility, let alone the probability. Those at the top can occasionally become rent-seekers in their own right, dispensing abnormal returns to friends and colleagues via purchases of vanity businesses or inflating corporate expenses on largesse.

In 2021, such monopolistic complacency was revealed within several of the old-guard Fintech. Mastercard, Visa and to a lesser extent, Paypal, were all caught flatfooted by the emergence of nimbler and far lower cost competition. This is now the 4th consecutive year of below M2 processing growth rates for Visa (they are already going into the second quarter of the 2022 fiscal year) and if that does not create a sense of urgency to restore organic processing growth rates, then no amount of time will. Visa and Mastercard have sustained positive earnings momentum, not through organic growth, but rather through steady price increases on the merchants, to a lesser extent upon consumers directly and through the occasional share buyback. They blame lower than expected rates of growth upon lower travel, but as an investor in many of the publicly traded airport operators globally, I can attest that travel by air has been restored in most regions, to levels above 2019, so that excuse now falls flat. Furthermore, what was not spent in travel was expended elsewhere in the economy; it is time for Fintech to stop laying the blame, a lack of corporate planning, upon Covid-19.

I will continue to monitor several of my Fintech holdings quite keenly in 2022. If I do not see the legitimate action required to restore growth, as did Microsoft almost a decade back to revive stalled software sales, then this might force some larger structural portfolio changes. Meaningful portfolio changes have not taken place in the account for almost two decades and I do not entertain this thought lightly. But, nobody wants to be saddled with the next IBM or General Electric; those were storied companies who fell behind the times, were utterly disdainful of competition and belatedly attempted to play catch up via serial restructurings and acquisitions, far too late. External consultants hired to assess issues at major Fintech keep me awake at night; if I ever learn of a McKinsey & Co. mosh pit under construction in front of the Visa head office, then I’ll officially be out.

Specific to the legacy Fintechs, almost all of the monopoly windfall profits earned in the past four years have been continually frittered away upon entirely dilutive acquisitions, too small to care about in isolation, but too many to name, too few generating revenue, not a one adding profit to the bottom line. If an acquisition does not lead to revenue production, at what point is it no longer an investment, but instead, just a vanity expenditure?

Just what the heck was PayPal thinking when it nearly made an offer for Pinterest? How did Pinterest even get onto the radar of PayPal?

The fear by Wall Street of a Fintech blowup of capital, through highly dilutive acquisitions, should represent a legitimate pushback against overinvestment in the coming year, despite the flatness in share prices or declines that look appealing to bargain hunters. I CAN plan and adapt to a change in interest rates. I cannot plan and adapt to a core holding suddenly offering 100% above market value, in a friendly takeover of a barely profitable firm featuring little more than a nice logo and a massive customer churn ratio, which then blows up 1/3 of the acquirers market cap in subsequent years. We all need to be aware of that risk, when it comes to portfolio weightings. Great companies organically grow their way out of slumps, they generally don’t buy their way out of slumps.

There is plenty to model into 2022; rising interest rates, too much capital chasing too few assets, taxation changes, geopolitical concerns, the list is vast. Overpriced acquisitions by quietly terrified CEOS, acting on the behest of M&A firms, who propose to resolve shareholder unrest only to exacerbate the problem, is one more uncertainty that I do not want to build into assumptions.

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