Hi all, I recorded the strategy update above last week, with the lightly edited transcript below.
It was a big week in Australian biotech with a major trial failure from Opthea. I also recorded podcasts with Dr Alan Taylor, Chairman of Clarity Pharmaceuticals, and Professor Louise Emmett, which I'll send out shortly.
Michael
Transcript
If you've been following us for long time, you’ll know we're heavily invested in growth, biotech, and the pointier ends of the market. Over the last two years we've implemented a tight risk management framework around what we do, and the past few week shows how important, how valuable that can be.
It also really takes the pressure off decision-making, because we’re very systematic about when we enter and exit positions.
Around the 20th of February, which you can see in these charts, a rapid sell-off began across the NASDAQ and semiconductor indices, and growth proxies like ARKK. Things have swung from full ‘risk on’ to a sudden reversal.
The challenge now is to figure out whether there is weight to this. How serious is this reversal? And what's the best way to take advantage of the opportunities that it throws up?
Markets reached heavily oversold levels. Usually when markets get this oversold, you see a recovery. We saw one on Friday, though it seemed a bit weak.
Nasdaq 100 and RSI
This is a measure of oversold/overbought conditions, and it has been a pretty good indicator in the past. It’s not always perfect, but it does show you how far things have come, and so quickly.
I've always found it interesting to follow CTA positioning, which is a proxy for how large quant funds are positioned, as everyone is using the same data in similar momentum models. This is calculated by Goldman Sachs:
You can see that over the better part of a decade, market moves were driven partly by these huge funds swinging from max long to max short. Most shares don’t trade hands in selloffs, as major shareholders are the same in the beginning and end, so these moves at the margin can have an outsize impact.
When you're at the top of this range and all the momentum/quant/vol targeting funds are fully invested, there's a huge amount of room for them to sell and cause a drawdown. Similarly, after this kind of move happens, they’re primed to buy in the future – once they reach this limit, they can’t sell any more. From these points, you generally need something to deteriorate further for markets to fall further, you need something bad to happen.
We're now at the point where people have gone from very bullish and fully invested to very pessimistic and under-invested. There were rumours of pods blowing up and whole trading teams being fired, which always happens in these big swings, and huge funds derisking substantially. That part of the move is done, so now for this to continue we’ll need actual conditions to deteriorate further and that’s what we’re looking at now.
This chart was put out by the Atlanta Fed. You can see they have an estimate of GDP that's widely watched in the market.
Around the same time as the sell-off started, they dramatically slashed their forecast for US GDP. You don't see this very often. Usually when you see these kinds of moves in the market, and huge swings in CTA positioning, with everybody going from risk on to risk off, it’s usually a market thing and you don't see any change in the underlying economy.
But in this case, you're seeing forecasts dramatically deteriorate. So that is cause for concern and something worth watching. I should add, this is just a forecast from the Atlanta Fed.
But there are other data points that are quite relevant.
This chart is from Truflation, which tracks a basket of goods and services roughly equivalent to CPI. The prices of bread and milk and the like are all publicly available. Truflation tracks them in real time and updates their inflation estimate daily.
Once again, right when the sell-off started in February, you can see a huge collapse in the prices of goods and services that make up CPI.
The most likely reason that would happen is if there was a fall in demand, happening across a range of goods and services.
So, this is not just a move in financial markets – rather markets have sniffed out something going on in the real economy as well.
At the same time, we saw US airlines warning of lower demand, with people cancelling flights and not booking trips at the same rate as they were previously. This is often a leading indicator.
We have some granularity here, apparently, it’s been driven largely by a fall in government spending.
The US is currently going through a massive efficiency drive where they've cut almost every department. Trump just signed an executive order to cut the entire Department of Education, for example, and leave it to the states. The US is like Australia in the sense that the states are responsible for education, but you have a national body (arguably redundant) as well.
Economic moves happen at the margin. You don't need everybody to lose their jobs to have a severe slowdown. We already know that Washington is cutting spending, not just directly but also in these huge grants to non-governmental organizations.
All the highly paid people who are now unemployed are cutting back spending, and it could be that this is already affecting things like airline bookings, inflation, and perhaps enough to move the needle on national GDP.
This is matched by news from major companies as well, with profit warnings and guide- down from casinos and other cyclical industries that are at the pointy end of discretionary demand, and act as leading indicators of what could happen next.
There's no guarantee that this leads to a broader slowdown.
There are powerful benefits to cutting Government spending, and the stated aim is to bring down inflation as fast and hard as possible without causing a recession. The hope is that by releasing all these unproductive employees onto the job market, cutting wasteful spending and having less regulation – and certainly fewer regulators and referees on the field, they'll be able to foster a positive economic environment for business.
There's a good chance this actually works - but we’ll just have to see.
This is a data point from Las Vegas. Casino spending has been declining for months.
We've noticed quite a few stocks, growth stocks in particular, have been rolling off for over six months now. Which is often seen in selloffs. It starts early in the pointy ends of the market (growth, biotech, discretionary spending) and then broadens out.
So, the real question is: will this rolling slowdown expand into something more serious?
If you cut spending and fire hundreds of thousands of employees - possibly even in the millions if you include NGOs and adjacent service industries - that impact of that is felt today. But the benefits will come over the next three, six, twelve, even twenty-four months.
This is also why a risk-managed approach can be so effective, because we started reducing risk long before any of this became clear. And we still don’t know if this is a short-term blip before broader business enthusiasm takes over, and markets are back to the races, or if this is an extended slowdown.
Our approach now is to position for either case. We've already moved to approximately 40% cash and could go higher, and this automated approach is fairly unique in the market.
This is a recent quote from the US Treasury Secretary, Scott Bessent:
He's basically saying corrections are healthy and normal – he's clearly sending a signal to the market that the administration is OK with the current moves.
Market participants are always trying to figure out when policy makers will react.
At what point in a sell-off or slowdown will they come out and say enough is enough?
Those kinds of statements often signal a market bottom, and often a rapid recovery. It's that policy shift.
Instead, he’s saying this is part of the plan, that they want inflation to keep coming down and they want government bond yields to come down, as well as lending rates for everyone. This is an explicit policy decision from them, and the current market correction is not enough to scare them... yet.
And really, this is kind of what they're trying to solve:
Around 2020, after COVID, there was a huge increase in US spending, and this is what they’re trying to unwind. And the challenge is the pain from this comes first, while the benefits will come later.
This is a chart of semiconductors.
Semiconductors were the red-hot trade of the last two and a half years, since the release of ChatGPT, when it became clear there was going to be an immense capex cycle that wouldn't have happened otherwise.
There's always semiconductor capex cycles, but this was a new one, a new reason to invest vast amounts in AI-related infrastructure.
But over the last year, semiconductors markets are actually down.
This index includes things like Nvidia, in which we've done very well, and Taiwan Semiconductor, which has done better than most companies.
Under the surface it's much uglier and most semiconductor companies are down a lot more than this index. And that's been happening for some time. The peak was mid last year, and the index is down significantly from that point. The good news is this is laying the groundwork for a sustained rally in the future, but at the moment, we're still in sell-off mode.
There were some pretty big falls in stocks that were previously high performers.
Deckers makes Uggs and Hoka shoes, amongst other brands. I'm sure you've noticed a trend away from Nike towards those thick cushioned shoes like ON and Hoka, and Deckers was a major beneficiary. They're basically being cut in half since the beginning of that sell off in February.
This has also hit software very hard.
There’s a huge debate going on as nobody's entirely sure what AI means for Software-as-a-Service. If you recall during the last cycle, software went from being on-premises to being cloud subscription, going from a one-off price that you might pay every two to three years to something that you'd pay every month.
That increased everybody's software bills substantially and created an entire SaaS industry. But with AI, it's so much easier to build your own software, or adapt open-source software for your own needs. We’ve done that ourselves, moving from Salesforce to an open-source alternative that is in many ways better (easier to use, and employee time is valuable).
For companies like Trade Desk, it’s changing the way people are spending on advertising.
The end outcome is really still up in the air and we’ve seen a lot of software companies pushed back to the valuation lows.
I don't think they're necessarily all a buy because we just need to see.
Many of these companies have fairly extortionate and aggressive business models and are heavily reliant on highly remunerated salespeople and lock-in contracts, as well as all kinds of barriers to migrating your date. These are basically economic rents that software companies have imposed on every company and now everybody has a new reason to take a hard look at their spending.
It’s not all bad news, there’s a bullish take too. It's extremely likely that a lot more software will be written, and a lot more data will be stored in databases. There will be huge demand from all these agents. We've talked about this before, but the software as a service industry was still linked to population.
If you're selling Salesforce, there's only so many people that could potentially use it, with the upper limit being the world’s population if everyone subscribed - a limit that companies like Google and Meta might actually approach.
But if you have every company spinning up 20 different agents for each existing employee, all of a sudden you break that link between population and potential customers and might massively expand the potential market for these companies.
If you can spin up 20 productive sales employees that can make calls, schedule meetings, do a lot of that kind of entry-level sales work, that will drive demand not just for sales-related licenses, but also databases to store the data, and a huge amount of internet traffic.
There's a lot of potential winners in that scenario.
But at the moment, because there's this uncertainty, it's not quite clear which way those things will land.
It's one of those exciting and interesting times where for many of these companies you can make a case both ways.
With our approach, if you take a quantitative approach to investing, you'll probably dodge the worst falls. And if we pick the right winners and reach our profit targets on a small number of those, we’ll generate fairly and we'll be able to realize pretty significant profits. This happened last year, where we returned over 50%, despite a number of substantial reversals which our risk model managed to dodge.
Here’s some examples of companies that started rolling over six months ago.
Elf has been taking market share in cosmetics and is still growing while many other major companies in the sector are shrinking. They’re performing well and taking market share. But they’ve been cut in half since August last year when we closed our position, purely on risk.
We still have conviction in the company and their results have affirmed this, but at the moment we have no position, and this saved us from a fairly substantial reversal. It's amazing how powerful that risk model can be, even over just the last couple of years.
I don't think anybody would forecast they would both take market share, drop 20-30%, and then drop another 50%. But that's exactly what happened and we got to watch the pain from the sidelines.
A similar situation happened with AMD. It wasn't quite clear a couple of years ago, or even a year ago, how much the massive spend going to Nvidia would also benefit AMD. As it so happened, it didn't benefit much at all, the vast bulk of profits went to Nvidia. AMD didn't even grow on a top line basis. Their AI business performed modestly, but they were shrinking elsewhere.
And out approach to risk got us out of AMD quite early, while keeping a large exposure to Nvidia, which ended up being the right play.
This is Transmedics, which is a company that we owned and ended up selling on the risk model only for it to again, basically collapse afterwards.
This is worth explaining in more detail.
The blue line is the strategy performance applying the risk model to the stock, so you can see that for extended periods it was in cash. There were a few occasions where it bought and then took profits at set levels, and that generated a higher return than owning the stock alone.
Many of you have been reading these letters for years. A few years ago, I would have said we want to own Transmedics long term and will ride through the ups and downs, and we'll just deal with the drawdowns because we're long-term investors.
But this is a far better approach.
Returns are higher and it's a much humbler approach too. We don’t know if something will change in Transmedics business in the future. In this case there was a short report with some pretty serious allegations, much of it hyperbolic as you’d expect but some has weight. It seems a number of hospitals are not happy to be paying the prices Transmedics is charging. Transmedics is trying to force hospitals to use their jets and their infrastructure, and there’s a loophole in the sense that they can charge high prices that are paid by the system elsewhere. And that’s starting to garner political attention, the outcome of which lies in the future.
I don't think it’s something you can really predict, but the market sniffed it out earlier.
If you think about why this works, there's a lot of people that know what's going on in a company.
There are a lot of insiders that buy – or choose to sell or not sell – which is very relevant at the price-setting margin. The insiders are speaking to their families and friends every day, who without having to know specifics, have some idea of how things are going.
Every customer, every buyer, and every supplier of these companies has a better idea of what's going on than financial analysts.
And I think that's why this works. A company we own will typically be going gangbusters, growing, hiring, insiders encouraging their friends and families to buy, while holding on to their own stock. Then if/when the wheel turns, management, their customers, suppliers, competitors, either start selling or stop buying. The heat comes out of the stock, it drops 20-30% and then the risk models say sell.
Then the painful part - financial analysts look at the company and by all reports everything is still going great. It’s down 20-30% which means its good value, and we should be buying here.
But then over the next three to six months the news comes out, and you get these large selloffs long after the insiders knew that things had changed. And all of a sudden, you’re in a 50-80% drawdown and then the fundamentals say sell.
This is so common in growth stocks that our strategy is designed to explicitly take advantage of it, and this is why we’ve exited so much of our US growth exposure.
One thing we didn't sell are our Aussie biotechs, not least because they don’t have the liquidity for this kind of strategy, and also because the results are so lumpy and don’t play to the strengths of that kind of strategy.
Syntara has a near term catalyst coming up in the second quarter of this year. We had a tiny position nearly two years ago and supported the company in several capital raisings subsequently.
Then late last year they had a really good result where they announced the interim results of their trial, which were already good enough to basically say the trial was a success.
Of course, in the final six months things can change. It's still a small trial; there's only 16 people. Perhaps some patients sadly pass away unrelatedly because they're extremely sick patients. That could change the outcome. Similarly, the positive effects that were seen in the first half of the trial could reverse, then that would also be negative. But it's unlikely given that we’ve already seen extended benefit in some patients who weren’t expecting anything.
If the company reports in line with the interim data, this is an extremely undervalued company. It’s trading on a ~$120 million market cap. Equivalent transactions in the United States were all over a billion dollars.
They do need to raise somewhere between 70 and 100 million AUD, which is potentially challenging with the current market cap. But I do think the final trial result will open a lot of opportunities, and if the market doesn’t see it, there will be partnering opportunities like we saw with Neuren Pharmaceuticals.
There's a huge amount of interest in the space and there's no disease modifying treatments available. This is one of our highest conviction positions, and something we’ll know a lot more about soon.
This shows a brief summary of the data:
Symptom score reduction was 62%. Competing trials were at 30 to 40%. And patients really stabilized, which is an extremely positive result.
In this disease, myelofibrosis, there’s just JAK inhibitors which alleviate symptoms until the side effects of the drugs become so high that patients can’t take them anymore. That’s how bad it is, and how poor prospects become.
So, it's very exciting that Syntara has designed these drugs in Sydney and got these early results.
The good thing about Syntara is that the more you learn about it, the more you like it. And this is the company that had a long difficult history, with plenty of dilutive capital raisings, and I don’t think many people in the market have done the work.
Clarity Pharmaceuticals
One stock that hurt us recently was Clarity. There’s been a huge unwind. I've put three lines on the chart below. The lowest one was our average entry price. We bought around a dollar and then bought more in the cap raise around $2.5. And we sold some at ~$8, which was our 4x profit target. And sold more on our risk model when the stock sold off to $4.60. But we retained a ~5% position, but the stock continued to sell-off
One issue is that the timeline is extended. So, absent a takeover, first revenues are likely in 2027-2028, and so with hindsight momentum and market excitement got ahead of where the company actually was and subsequently unwound.
We’ve recorded two podcasts recently, one with Chairman Dr Alan Taylor, and the other with Professor Louis Emmett, who is running one of their key trials out of St Vincents in Sydney.
I’ll share these podcasts and transcripts shortly.
But for now, there’s little to anchor the stock price. This is an extremely ambitious company. They want to bring a new treatment for prostate cancer to market, and they also want to bring a new diagnostic to market. That will take money, and likely a lot more than the $100 million or so that they have on their balance sheet. We – and the rest of the market – expects there will be a raise at some point in the next 12 to 18 months. And we can see that funds are selling it short in anticipation of that.
This is actually a well-established playbook, and highly effective in the Australian market.
Everybody knows which companies need to raise money, so you can sell short in anticipation of it. Usually they’re done at a discount, and you can either get filled int he raise, or if the stock trades down and the company doesn’t let you in, close your short then.
The risk is an acquisition or partnering deal that raises the capital without needing to go to the market. If this happens, the short position will have to reverse quickly.
On some days, over 50% of the volume is short selling, which is why the stock is so soggy. But there’s plenty of risk in that play as well.
As the valuation contracts, the potential upside gets much bigger too. It goes from a 2x- 3x opportunity to a 5x-10x opportunity. And once the company raises, that capital overhang vanishes.
Our second largest position is ROOT in the United States.
This is one of our classic true customer love, explosive growth investments.
Unlike almost every other growth stock we look at, it stayed at all-time highs. And that's really encouraging. Our profit target is around $200. We're not quite there, but we're close. Usually, the companies that perform well in the selloffs do the best after.
We think this is like an exciting opportunity. ROOT has a really good way of winning consumers. They analyse driving behaviour through an app. They can see if you're driving late at night, they know if you're breaking heavily, if you're driving erratically, and which suburbs you're driving through.
All that data allows them to price insurance, which is otherwise pretty blanket, often even just postcode and age based.
If it does a good job and prices risk correctly, they'll be able to make money where others do not. And you can see they've swung from a loss to a profit, the loss ratio has come down significantly, and it’s clearly an effective way of winning customers and taking market share. And you can see that growth forecasts from here are fairly modest and attainable.
We still have a small position in Nubank, but closed most on our risk model. They're killing it in terms of customer acquisition, growing extremely fast, and are now up to 140 million customers. We've basically owned them throughout this last 50 % increase in customers. They've dominated Brazil.
If you meet somebody from South America, they'll happily show you their Nubank app.
One thing that disappointed the market was that gross profits didn't increase in their last result. Revenues and customers expanded, but they moved into lower risk, lower margin loans. A lot of their lending was very high margin credit card and personal loans, they’re now trying to move into higher quality customers and business lines.
Profits have come down and that’s caused a sell-off in the stock.
We need to respect that, as this isn’t the first market darling South American fintech we’ve seen.
There were a couple a few years ago that were red-hot, like StoneCo and PagSeguro. Both got annihilated in the market. And there's no guarantee that doesn't happen with Nubank. We’re sticking closely to our risk model as the stock will start selling off long before it’s apparent in the quarterly updates.
But at the same time, we do want to pay a lot of attention to this company because there's very few companies of this size, with this growth and this runway.
One of the most important questions to answer with growth stocks is how much further can you go? A recent example was Tesla, once it had two of the best-selling cars globally, where could it go from there? It's quite hard and reliant on new business lines.
Nubank is well established in Brazil, but still very early in Mexico, even earlier in Colombia, and haven't even started in other Latin markets. All they have to do is roll out their successful offering in new countries to open up whole new avenues of growth. So, you have a multiplicative effect of new customers from new countries, new customers from existing countries, and increasing revenue and profit per customer. It’s an exciting opportunity.
The other company we really like is REAX in the United States. It’s a small company, and for a US stock has extremely low trading volume as well, but they're rapidly gaining agents by offering a much higher, capped revenue split, while offering stock as incentives to sign them up.
If you're a successful agent, it makes a lot of sense to move to REAX, use their platform, their software, and their backend. And the stock incentive is a sweetener.
I think this is one of those under-the-radar growth stocks, where, at a billion dollar market cap today, you could blink and see it two or three times the size.
REAX KPIs
I thought I'd touch on Nvidia. They’re still the market leader and their Blackwell offering seems to be selling extremely well. They're the only company that can do this full stack offering, and their inference product is getting better and better.
Nvidia investor relations
At the moment they’re trending down and we don't actually have a position, but their next 12 month EV/EBITDA is about 20 times.
This market correction has really moved down the valuations of these companies. It peaked at 40-45x and is now down to 20x, which is roughly where it bottomed a couple of years ago.
As it turned out, this was the layer that captured most of the AI value.
Nobody knows exactly how this industry will evolve, but the picture is becoming clearer. DeepSeek released an open-weight model that was basically as good as the market leaders, spending only a few percent of say, the $7 billion/year that OpenAI is spending.
Nvidia financials and estimates
So it's clear that the models themselves are going to be really, really cheap. And with cheaper models, they're going to be used a lot. The demand for inference has really only just started. AI agents are just starting to be used now, and software AI has only just started to be able to work on entire code bases coherently, rather than snippets and more limited context windows.
So this is still one of our highest conviction positions and I’m sure we’ll own it again soon.
Summary
In summary, there's been a broad, sharp sell off over the last few weeks.
We've gone from overbought to oversold really fast. CTAs have gone from max long to almost max short. W=We de-risked along alongside them with ~40 % cash, though we do still have plenty of risk on in Australian biotech, which is still a part of the market with exceptionally low valuations and is a really exciting place to be.
This is very different positioning than the last times we’ve seen these sell-offs where we’ve been fully exposed and under a lot of pressure.
The cash is all earning decent interest rates, and we can now take the time to look at all these companies and assess which ones are the truly great growth opportunities. The last time we were in this position was November 2023, and the fund rallied over 150 % in the eight months that followed, with 82% of that in the first six months of last year.
So we're pretty excited.
If I had to guess this sell-off does have legs, there is something going on with underlying demand in the United States, and a lot of Government and NGO employees have lost their jobs.
These were high paying jobs too, and those people will be cutting travel plans, cutting personal spending to the bone, and drawing down on savings and investments, rather than putting that cash in the market. That’s going to reduce pricing pressure on the real economy, on inflation, as well as financial markets.
But that short term pain will likely lead to lower inflation, hopefully lower bond yields, and meanwhile those deregulatory moves (and more competition for private sector jobs) will give the sector an enormous boost.
So in the mid-to-long term we might end up with the Goldilocks-style market we had from 2010 to 2018, especially if in the near term valuations reset.
That's a very real possible outcome on the other side of this sell-off, and is the stated policy goal. And if that happens, growth stocks and tech will likely be the best performers. And the interesting thing about the AI revolution is that it's been the usual suspects in tech that have captured most of the value from that increased compute and storage.
Closed AI companies like OpenAI and open weight companies like DeepSeek will continue to battle it out.
But we have increasing conviction that the model layer is going to be very cheap to use. Which means it will be used a lot, and that’s going to require a huge amount of compute and database capacity, and that’s going to benefit those major cloud providers.
In terms of our fund, basically the best time to invest is when we're in cash, and ready to catch the next wave, while the worst time is when everything’s extended and up 50-100%+, as it means our holdings are a long way from their lower risk boundaries.
So we're going to sit tight and wait for the next set of buy signals and plan to capture the next big growth and tech rally, of which there almost certainly will be one at the back end of this, particularly if inflation continues to trend down and that translates to lower bond prices.
So in the market place of funds, I think we’re offering a very unique approach and the best part is we don’t need to predict whether markets recover today or there’s a 3-6+ month digestion period and another sell-off.
In other news, we're in the final stages of launching our retail product. I've been talking about this for years, but we've completed most of the docs for a retail ETF. Given it would still be a few months away, we’re planning to launch an unlisted retail fund first, which would convert later.
It will be a lower risk/return version of our current fund, just holding midcap and large-cap growth, with no biotech for example, as we’ll need every position to be highly liquid.
It'll be more transparent and far easier to access, as investors will be able to buy or sell as many shares as they want on a daily basis.
So let us know if you’d be interested in that and I can send through more information. We’ll also organise trips to Melbourne, Perth, Adelaide and Brisbane, so let me know if you want to be included in that.
Ok that’s been 40 minutes so I might wrap up there, thanks so much for dialling in.
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