Paul Vs The Market

Ouch.

It’s hard to think of any other way of describing the start to the Freedom Portfolio. It’s also hard to think of a better way of describing the performance of the stock market over the past month. As of the time of this writing, the all-time high for the S&P 500 was September 20th, 2018. That was about a week and a half before the official start of me tracking the performance of the Freedom Portfolio. I couldn’t have picked a worse starting time if I tried.

The S&P 500 opened at 2926.29 on October 1st and closed at 2506.85 on December 31st. That’s a return of -14.3% over the quarter, which is a pretty extreme downturn. During that same time, the Freedom Portfolio is down 22%, which is obviously even worse. Here is a breakdown of the performance by position:

Ticker	October 2018	January 2019	Percent Change
TSLA	305.77	332.8	8.84%
TWTR	28.51	28.74	0.81%
TCEHY	41.04	39.47	-3.83%
OAK	41.54	39.75	-4.31%
DIS	117.28	109.65	-6.51%
KSHB	5.965	5.37	-9.97%
MKL	1195.79	1038.05	-13.19%
GOOG	1199.89	1035.61	-13.69%
MELI	343.84	292.85	-14.83%
AABA	68.54	57.94	-15.47%
ISRG	575.15	478.92	-16.73%
SHOP	166.44	138.45	-16.82%
BLX	21.02	17.3	-17.70%
ILMN	369.15	299.93	-18.75%
JD	26.03	20.93	-19.59%
RDFN	18.56	14.4	-22.41%
AMZN	2021.99	1501.97	-25.72%
AX	34.89	25.18	-27.83%
NFLX	375.85	267.66	-28.79%
BIDU	230.81	158.6	-31.29%
NVTA	16.75	11.06	-33.97%
NVCR	52.94	33.48	-36.76%
BZUN	49.3	29.21	-40.75%
TDOC	86.78	49.57	-42.88%
SQ	100.8	56.09	-44.36%
ATVI	84.18	46.57	-44.68%
IQ	27	14.87	-44.93%
NVDA	284.16	133.5	-53.02%

I would be lying if I said that I wasn’t disappointed to be starting off this way. Obviously I would have preferred to have been up versus the market, but at the same time I am absolutely not worried at all. I have a 20+ year investing time horizon in front of me before retirement. Measuring the Freedom Portfolio’s performance after one quarter would be like judging an NBA game after 30 seconds of play or a baseball team two games into the season.

In fact, not only am I not worried, but a part of me is glad to use this opportunity as a teaching opportunity. While it has been hard to tell for the past 10 years, the stock market is risky. It doesn’t always go up. Sometimes it goes down, and sometimes it goes down a lot and goes down fast. Taking on that risk doesn’t just mean getting higher returns, it also means accepting the fact that sometimes you will get negative returns, and that can be painful. Nobody likes to see their money disappear into thin air, no matter how much they accept that it’s the trade-off for higher returns.

Measuring the Freedom Portfolio’s performance after one quarter would be like judging an NBA game after 30 seconds of play or a baseball team two games into the season.

Okay, so losing money might be expected, but how does that excuse the Freedom Portfolio not only losing money but also losing to the market? Doesn’t this prove I would’ve been better off with index funds? Not at all. I believe that the same reason why stocks outperform other investments over the long term (risk vs reward) is the same reason the Freedom Portfolio will ultimately outperform the market. Yes, stocks under-perform during down periods, but they over-perform during up periods, and thankfully those up periods outnumber the down ones. I believe the case will be the same with the Freedom Portfolio. When the market is down, the Freedom Portfolio will do even worse, but my hope and expectation is that when the market is up, the Freedom Portfolio will do better, and over the long run those up periods will more than make up for the down ones.

In fact, I even predicted this a few months ago:

Furthermore, I entirely suspect that in a down year, I would see my individual companies drop more than the market by virtue of the type of companies I tend to favor. I fully expect that there will be years where I lose to the market, sometimes badly. The hope is that over the long term, those years are more than made up for by the up years.

– What is Paul vs the Market? by Paul Essen, September 6, 2018

So while this start is certainly disappointing, I can’t say it’s entirely surprising. We were in the midst of the longest bull market in US history, and while I still don’t believe in trying to time the market, it does seem safe to say that we were overdue for a downturn. My confidence is completely unshaken and it won’t be shaken even if there is another quarter or two where the Freedom Portfolio under-performs. Risk goes both ways, and times like these are the price we pay for out-performance in the good times.

Notable performers

Worst performers

nVidia (NVDA): Remember the cryptocurrency craze around 12 months ago when everybody was trying to work “blockchain” into their business model and people were losing their mind over things like bitcoin and ethereum and ripple? Well, prices eventually fell back down to Earth and not too many people are talking about cryptocurrencies anymore. So it probably wouldn’t have been great to have invested in a company that was in any way related to cryptocurrency, huh? Well, unfortunately, nVidia got caught up in the cryptocurrency craze. How? Because it turns out that the GPUs that they are so good at making are great to use for “mining” cryptocurrencies. So while the craze was building, their product was flying off the shelves faster than they could restock them. Once prices crashed and it no longer was profitable to mine for cryptocurrencies (and yes, I realize I’ve used that word a lot and I am looking forward to not having to type it again for a while), demand dried up in a hurry, which caused a giant inventory headache for nVidia as they now had a bunch of GPUs that they couldn’t sell. That’s why their market cap has been cut in half (and then some) over just this past quarter.

I actually got pretty lucky with nVidia in that I had sold roughly half of my position earlier in 2018 (before the formation of the Freedom Portfolio) because I was concerned about what the collapse in cryptocurrency prices would do for demand for their chips. Even I didn’t see a 50%+ drop happening, though (otherwise I would’ve sold my entire position). I still think nVidia is a compelling company, though, and they very clearly still have a lot of growth opportunities ahead of them in that have nothing to do with cryptocurrencies. I’m not necessarily interested in buying here, as I want to see evidence that they’re working through their inventory problem first, but it’ll be on my watch-list for potentially adding to later in 2019.

Square (SQ): One thing that I think the world needs more of is for people to be willing to say, “I don’t know” instead of wildly speculating on things. I’ll go ahead and start: I don’t know why Square is down so much in the past few months other than to point out this interesting fact: Despite being down 44% in the part quarter alone, Square is still up roughly 50% for the year. The best explanation that I can come up with is that the stock had gone up too much and gotten too detached from the business fundamentals, and so when a downturn came it also got hit the hardest. As near as I can tell there are no meaningful changes to the underlying business, so I’m excited to see what Square does when the market turns around again.

iQiyi (IQ): Another one where it is a little hard to separate changes to the business from general market craziness going on around it. iQiyi has had quite a year. It started off with a disappointing IPO where it ended up down around 13% when most IPOs end up with a strong first day. Within the next three months, though, it would go on to nearly triple from its lows. Since then, it’s been a long, slow decline basically back to where it was shortly after the IPO. I suspect the craziness with the US/China trade war and general unease over the health of the Chinese economy might be having a stronger effect on iQiyi’s stock price than any fundamental changes in the business. This is another one where I am excited to see where it goes when things calm down some.

Amazon (AMZN): This might be a surprising pick for being mentioned among the worst performers. Why pick on Amazon (down 25%) when there are bigger losers like Activision Blizzard (ATVI) or Teladoc (TDOC)? Simple: Because as the only Babylon 5 level position in the Freedom Portfolio, Amazon has an outsized impact on my performance. Amazon alone accounted for 20% of the losses of the Freedom Portfolio this past quarter, or more than twice the amount that nVidia accounted for. I hate to sound like a broken (ignorant) record, but I’m a bit at a loss as to why Amazon lost a quarter of its value over the past few months (other than some strange sense of literal symmetry of losing a quarter over a quarter). If it wasn’t already such a large position in the Freedom Portfolio, I would absolutely be looking at adding more. As it is, I’m looking forward to Amazon leading the charge when market conditions do improve.

Best performers

Tesla (TSLA): What a wild ride for Tesla the past few months have been. While they did have an awesome third quarter where they were surprisingly profitable, Tesla’s relatively good performance over the past quarter is honestly more due to lucky short term timing. At the start of the quarter Tesla was suffering from a lot of negativity around Elon Musk’s notorious “Funding Secured” tweet and potential SEC actions as a result. While the stock has been all over the place, at the end of the year it ultimately ended up virtually unchanged from where it was at the beginning.

Also, while I am still a big believer in Tesla over the long term, I worry that 2019 could be a tough year for them. Federal tax incentives to buy electronic vehicles get reduced in 2019 and Tesla made a big push to pull forward as much demand as possible before the end of 2018. They no longer have a massive backlog of demand to fulfill and international expansion could be complicated by the trade war. I wouldn’t be surprised to see a short term struggle for Tesla in 2019 similar to what nVidia went through in terms of dealing with the cryptocurrency bubble.

Twitter (TWTR): Just barely squeaking in with a positive return, 2018 was a weird year for Twitter. Halfway through the year everything seemed to be going great and sentiment finally seemed to be turning around. Then, Twitter seemed to get unfairly lumped in with Facebook and seemed to get punished in unison. I’m still pretty bullish on Twitter’s future, although I am starting to worry about the daunting task in front of them in terms of balancing free speech while also curbing harassment and making twitter a less toxic environment. I know it’s an incredibly difficult task, but management seems to have made some missteps so far which makes certain groups of people feel like they are being censored and that Twitter is taking sides. It’s a potential stumbling block to keep an eye out for.

Disney (DIS): Disney’s 6% loss might not look all that great, even in comparison to the S&P 500, but I think Disney is set up for a big 2019. Much of the past year has been spent preparing for a big transition to video streaming and also dealing with the acquisition of Fox. While there is still work to be done, I’m hopeful we’ll start seeing the fruits of some of those labors in the coming quarters. I’m expecting some big things from Disney in 2019.

Changes in the portfolio

I consider myself a long term, buy-and-hold investor, but that doesn’t mean I’ll never make any changes to the Freedom Portfolio. This quarter had more turnover than I expected due to a lot higher volatility than I expected. In the future, I hope to have fewer buys and sells to report on.

Sells

Alphabet (GOOG) – Sold entire position: There have been a lot of negative headlines around Google the past year or so. It started with James Damore’s memo and the resulting controversy over if Google has a problem with diversity, both ideological and otherwise. Then there has been a lot of scrutiny (both internal and external) about the secretive Dragonfly project and how Google might be considering trying to re-enter the Chinese market with a censored search engine. Google elusiveness over addressing whether or not it was planning to re-enter China along with their strange decision to de-emphasize their “Don’t be Evil” motto certainly did little to allay fears. Next came accusations that Google hasn’t always handled accusations of sexual misconduct in the best way. All of this happened with the backdrop of co-founder Larry Page’s strange absence.

None of these issues alone would’ve been hugely concerning, but taken together it’s certainly worrisome. Perhaps even worse, though, has been the response to them. I like to invest in companies which I believe have strong management, and I’ve been underwhelmed by Sundar Pichai’s handling of most of these incidents.

Lastly, and perhaps most importantly, is that I just don’t know if Google is quite the revolutionary disruptor that it once was. They’re playing catch-up in the fields of cloud computing and home voice assistants. Google Glass was a giant flop and nothing earth shattering has seem to come of any of their moonshots yet. Considering its head start, YouTube feels like it should be a bigger player along with Netflix and Hulu and Amazon Prime. Waymo might still be a game-changer, but it seems like rivals like Tesla and Uber are quickly catching up.

Oaktree Capital (OAK) – Sold entire position: This one should have a bit of an asterisk next to it. Why? Because while I did sell all of my shares of Oaktree Capital in the Freedom Portfolio, I ended up buying some outside of the Freedom Portfolio as part of my emergency fund. You might recall me writing about emergency funds a few weeks ago. The resulting discussion got me to thinking about the idea of mixing some stocks into my emergency fund and Oaktree’s dividend yield of around 7% made it look like an enticing stock to experiment with. So while Oaktree is out of the Freedom Portfolio, I do still hold some shares.

Twitter (TWTR) – Sold small part of position: The sell was motivated by the fact that there were other things I wanted to buy and I had no cash available. Twitter was chosen for two reasons: (1) It had held up better than most during the recent volatility and (2) the concerns listed above about the balancing act between free speech and reducing harassment. My confidence in Twitter took a tiny hit the past few months and this seemed like a good way of representing that.

Tencent Holdings (TCEHY) – Sold some: Like Oaktree, this one should also come with an asterisk. Why? Because while I sold half of my Tencent holdings in the past quarter, I did it basically to keep my exposure to Tencent even while I bought…

Buys

Naspers (NPSNY) – Started a position: this. The following description of my trades gets a little into the weeds, so if you want the TLDR explanation, just know that this isn’t an indictment of Tencent at all and my exposure to Tencent should ultimately stay roughly the same.

The longer story is that Naspers is a South African company that has made a number of investments in various internet and media companies. Back in 2001 it made what is considered to be one of the most successful venture capital deals of all time by investing $32 million in Tencent, which was then a startup. That investment has now ballooned to be worth over $100 billion. Currently, Naspers owns about 31% of Tencent stock. Interestingly, even though Naspers owns more than simply their stake in Tencent, their own market cap is around $85 billion which is significantly less than just their Tencent stake alone.

This isn’t a completely crazy situation (another Freedom Portfolio holding: Altaba, trades at a similar discount to its stake in Alibaba) and there are some good reasons why that discount exists that involve factoring in taxes that might need to be paid if and when the companies liquidate their positions. There is certainly no guarantee at all that the gap between Naspers’ market cap and the value of their Tencent holdings will ever narrow. However, I liked the idea of taking a small chance on Naspers both to see if the gap does narrow, and to see if any of their other investments takes off in a similar fashion. They caught lightning in a bottle once with Tencent. Maybe they can do it again?

2u (TWOU) – Started a position: I’ve long believed that we’re in some sort of bubble in terms of higher education costs and I’ve been wondering if there is a way to profit from the inevitable bursting of the bubble. I’m still looking, but in the meantime, I’ve had my eye on companies trying to disrupt the education market. 2u is a company that had been on my radar for a bit now, but it popped back up when I heard it mentioned on a recent episode of the Rule Breaker Investing podcast. I was amazed to see how far it had fallen (even before the recent market drop) without any clear reason why, so I decided to dip my toe in and start a small position.

Uxin (UXIN) – Started a small position: I believe I first heard about this recent Chinese IPO on the Motley Fool’s Market Foolery podcast. I don’t want to go too deep into Uxin right now, so let me leave you with 2 important things to know about it: (1) It is the leading online used car platform in China and (2) it has been as low as under $3 a share and as high as over $8 a share in the past month alone. I bought my position two weeks ago and it is already down over 40%. This is an incredibly volatile stock right now and not for the faint of heart.

Square (SQ) – Added to my position: As I mentioned earlier, I can’t figure out any good reason why Square has plummeted so much during this downturn. I’m still a big believer in the long term prospects of the business and saw an opportunity to add some shares on sale so I took the opportunity.

iQiyi (IQ) – Added to my position: Pretty much cut and paste from above. I like the cut of iQiyi’s jib, and it’s inexplicable to me how this could’ve been run up to $45 and is now a third of that.

Teladoc (TDOC) – Added to my position: Teladoc was down over 40% this quarter, and unlike some positions down that big, there was a compelling reason why: their CFO resigned after some misconduct allegations. While it’s obviously not ideal and not a good look, I do think the business fundamentals remain unchanged and so I added some to my position.

THE FREEDOM PORTFOLIO – JANUARY 2019

So how does the Freedom Portfolio look now? Not too dissimilar, although there is a new Enterprise level position (hello Disney!). Need a reminder of what these terms mean? Check out: Defining my Terms.

Ticker	Company Name	Allocation	Performance*	vs S&P*
AMZN	Amazon	Babylon 5	300.84%	246.14%
NFLX	Netflix	Enterprise	443.28%	396.47%
SHOP	Shopify	Enterprise	209.96%	195.14%
DIS	Walt Disney	Enterprise	77.15%	-1.50%
TSLA	Tesla Motors	Serenity	53.76%	30.03%
MELI	MercadoLibre	Serenity	119.80%	92.46%
SQ	Square	Serenity	-11.62%	-3.23%
AX	Axos Financial	Serenity	148.98%	80.17%
ILMN	Illumina	Serenity	121.39%	96.05%
ATVI	Activision Blizzard	Serenity	21.39%	-5.95%
RDFN	Redfin	Serenity	-25.05%	-15.71%
TWTR	Twitter	Serenity	26.99%	-3.12%
JD	JD.com	Serenity	-21.44%	-8.01%
ISRG	Intuitive Surgical	Serenity	-11.55%	1.18%
AABA	Altaba	Serenity	-14.09%	-0.29%
IQ	iQiyi	Serenity	-29.97%	-22.34%
MKL	Markel	Serenity	-11.32%	2.49%
TWOU	2U	Serenity	-0.54%	7.62%
BIDU	Baidu	M. Falcon	-27.16%	-13.36%
TDOC	Teladoc	M. Falcon	-7.06%	-0.91%
NVDA	Nvidia	M. Falcon	35.87%	25.77%
BZUN	Baozun	M. Falcon	-39.24%	-25.82%
NPSNY	Naspers	M. Falcon	-1.26%	-2.91%
BLX	Bladex	M. Falcon	-33.72%	-27.60%
NVTA	Invitae	M. Falcon	-33.87%	-20.27%
KSHB	KushCo	M. Falcon	27.86%	39.41%
NVCR	NovoCure	M. Falcon	-25.64%	-12.61%
UXIN	Uxin	M. Falcon	-43.29%	-41.81%
TCEHY	Tencent	M. Falcon	-2.21%	12.11%

*: Approximations. As of 1/1/2019

That’s all for now. Looking forward to checking back in a few months down the line. Thanks for following me on this journey.