My 2021 Carnage: End of Year Summary

Investment Analysis Clubs Saul’s Investing Discussions
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**Re-posted version: Removed reference to a twitter personality after MF removed the post but said I may repost it if I removed that reference.

I did not use margin, but this year I took over my taxable and non taxable accounts from a big brokerage and deployed most of my savings and retirement in self directed fashion. I’ve invested part-time over the years with a typical Motley Fool buy and hold approach. I’ve been a member of MF since the 90s, so I’m not exactly a newbie.

I scaled into a growth portfolio over 2021. Not necessarily as a strict adherent to dollar cost averaging, but mostly that it just didn’t seem prudent to invest the equivalent of 10 years of my salary dollars all at once.

My peak at 2021 just prior to the drawdown in November was up about 30%. Meager, kind of, compared to others here but I had several “poor timing” buys - UPST, LSPD… but overall sitting up 30% was gratifying and reassuring. I didn’t feel pressure to compare myself to others, and I’m acutely aware of historical returns in the stock market, so 30% felt awesome! Since then, I have watched with a “buy and hold” philosophy on most of my holdings (I did sell out of LSPD on day of earnings and trimmed UPST a little). I am now down about 11% since I took over my account, having completely erased any gains I had from 2021 by Christmas.

In real dollars, I have lost $1.3million from my ATH (people rarely post real dollar amounts here).

I don’t need the money for many years, so perhaps it will recover. But I have two thoughts that feel like a cautionary tale to guard against developing a cult-like, group think mentality here on Saul’s:

  1. it is plausible that “things are different this time” as we are seeing the unwinding of generational phenomena: quantitative easing, a release from an era of ultra low rates, trying to exit a pandemic in stuttering fashion, and a political climate in America which has not been seen, well, probably ever.

  2. Our philosophy here of head-in-the-sand with respect to valuation may be a dogma we should reconsider. It is very possible that this is the sole greatest threat, the most acute blind spot, to the members of this community. Some Growth Devotee Investors (GDIs) have posited that a 65-70% decline from all time highs for growth stocks is possible if not likely. If that were to happen, my retirement would likely be out of reach indefinitely. Not an end-of-life event, but it would certainly change where I thought I was going in the next 20 years.

For others, it may signal financial ruin entirely.

My portfolio (percentages not listed, but ranges from 5-8% generally) below. One could certainly point out that a few aren’t really current high growth players - PATH, MGNI, ROKU in particular. Part of that was not being comfortable putting such a high dollar amount in 8 stocks - 14-15 Is more my comfort level given my stage of life and proximity to retirement. In retrospect, this was the wrong decision, but sometimes education can be humbling.

DDOG
CRWD
ZS
SHOP
SNOW
U
AMPL
MNDY
UPST
ROKU
PATH
MGNI
S
ZI
NET

Anyway, I’ve very little choice but to continue the strategy I’ve embraced and hope that this is but small sample size growing pains. I can honestly say if the carnage stops here, if we’ve somehow found a bottom, well, I was prepared for a 30% drawdown all along so this feels about what I was prepared for.

That it happened in about 60 days, however, was shocking.

And boy, I hope the pessimistic GDIs are wrong.

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I’ve received several messages of encouragement and advice offline (TY) and one commented that my post read like I investing long term buy and hold. As a clarification, I meant I transitioned from that style to a full embrace of Saul strategy with an “intent” to hold, but to sell out when necessary in 2021.

The same helpful character pointed out that when we have large pullbacks, that is the time to ruthlessly consider selling out of companies for which the growth story is slowing or has fallen off the pace of others in an attempt to have recoveries to “higher highs” through the ebb and flow of the market.

In that spirit, as we’ve plumbed some new depths today, I’ve shifted the holdings to an ever increasing percentage of the elite growth leaders while reducing some of my laggards in hopes that I eventually see a “higher high”… at some point (gulp).

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" 1) it is plausible that “things are different this time” as we are seeing the unwinding of generational phenomena: quantitative easing, a release from an era of ultra low rates, trying to exit a pandemic in stuttering fashion, and a political climate in America which has not been seen, well, probably ever.

  1. Our philosophy here of head-in-the-sand with respect to valuation may be a dogma we should reconsider. It is very possible that this is the sole greatest threat, the most acute blind spot, to the members of this community. Some Growth Devotee Investors (GDIs) have posited that a 65-70% decline from all time highs for growth stocks is possible if not likely. If that were to happen, my retirement would likely be out of reach indefinitely. Not an end-of-life event, but it would certainly change where I thought I was going in the next 20 years."

I agree with your points. I had wanted to write that earlier but I was concerned about adding to the pain and fear that people on this board (including myself) are feeling currently; but I do think that these are important lessons.

Hypergrowth valuation is VERY vulnerable to interest rates - this is not a myth. It’s a correlation that has stood the test of time in multiple cycles.

And it so happened that in the last few years, interest rates have fallen to historic low; and this was the drug that caused people to think “valuation didn’t matter” - that was right only because interest rates were falling in the last few years (and especially since the pandemic began).

When it’s starting to rise (like now), valuation starts to matter tremendously.

Have a look at the chart (link below) for 10 year treasury yield and 10 year TIPS (real) yield and you can see how even very SLIGHT increases in rates (in March 2021 and currently) cause hypergrowth stocks to suffer a heart attack.

By the way, rates are still way below historical norms even with the recent slight increase. Now what happens to hypergrowth valuation when rates revert to the mean and go back up to what it was pre-pandemic?

https://www.cnbc.com/quotes/US10Y

https://www.cnbc.com/quotes/US10YTIP

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On the valuation point, we can see how Cloudflare has performed in the recent carnage (down 48% from peak) as compared to other high multiple stocks like Snowflake and Datadog.

If you follow their numbers - whether it’s growth, margins, retention rate or customer net adds - there’s nothing there to justify the >50x EV/NTM revenue Cloudflare was trading at in the second half of 2022.

But prior to this carnage, people bought into the story of them being the 4th public cloud. I must say that the CEO is very good at weaving tales and spinning narratives.

When rates were low and falling, story matters and valuation didn’t.

Now there is a complete reversal when rates are rising.

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Hey catsunited, I noticed these comments you made…

“Hypergrowth valuation is VERY vulnerable to interest rates - this is not a myth. It’s a correlation that has stood the test of time in multiple cycles…Have a look at the chart (link below) for 10 year treasury yield and 10 year TIPS (real) yield and you can see how even very SLIGHT increases in rates (in March 2021 and currently) cause hypergrowth stocks to suffer a heart attack.”

…so I thought I would heed your advice and look into this.

I started by taking a quick look at the first US10Y chart you posted, and I noticed a rise in rates from July 30 (1.23%) to October 29th (1.56%). I assumed based on your statement that Saul’s returns would have suffered during this period, so I looked at his latest monthly review, and was surprised to see his returns actually increased during this period of rising rates. Pretty materially in fact, as his YTD returns grew from +21.9% at the end of July, to +82.8% at the end of October.

Perhaps it was different this time?

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But prior to this carnage, people bought into the story of them being the 4th public cloud. I must say that the CEO is very good at weaving tales and spinning narratives.

Hi catsunited,

If I understand your post correctly, you are saying that CLoudflare’s story has been ‘false’ all along. It sounds like you don’t think they ever have a chance of becoming as big as a ‘fourth public cloud’.
If so, could you explain why? What inside tech knowledge do you have that breaks the CEO’s narrative apart?

As a non-tech guy, from what I’ve ‘researched’ (which really just consists of reading the writings from other generous posters and especially Muji + Peter Offringa’s SSI insights), I personally do believe in a big future for Cloudflare.

Of course, valuation matters. Certainly was very pricey when it was above 60B market cap. I refrained from buying NET vs other hypergrowth stocks until NET’s price fell below $140 in December, then I opened a position, and added more at $131 later in the month, and added more at $110 today.

Like anyone else on this board, I can’t predict the future. I could be very wrong and my position underperforms the market forever.
However, I think I can understand the probabilities and chances of a company’s future growth, and it looks very bright for NET.

Referencing Offringa’s post: https://softwarestackinvesting.com/cloudflare-q3-2021-helpin…

As it relates to becoming the “fourth public cloud”, I don’t think Cloudflare has aspirations to displace AWS, Azure or GCP…Cloudflare is taking a different tact, focusing on network connectivity. The networking of compute nodes is arguably is what makes the modern Internet useful. Cloudflare aspires to provide the underlying “fabric” of the Internet, which means delivering fast, reliable, dynamic and secure connectivity between hyperscalers, private data centers, enterprises and end users…Cloudflare provides onramps to the network, enhanced with dynamic traffic routing and security. This is enabled by a globally distributed network of over 250 PoPs located within 50ms of 95% of world’s population. With Cloudflare for Offices, the number of locations will balloon into the thousands…

Cloudflare could become a public cloud for ‘everywhere’ and for ‘everyone’.

If Cloudflare were to sustain 40-50% YoY revenue growth at a massive scale in the future, for years and years to come, like AWS has been doing, then its current market cap of ~40B looks like a better buy to me than some other growth stocks out there today.

If you look at AWS’s YoY growth rate from 2014 to 2021, you find they grew at 43% in 2014…fastforward to 2021 and they are still at 39% YoY growth despite hitting revenue run rates above $60B.
That’s absolutely incredible at their current run rate.
In 2019, one analyst valued AWS at over half a trillion dollars on an expected 36B revenue for that year. If we estimate that for today we can say AWS is worth $900B today, if not more.

Should NET achieve similar scale and growth of 40-50% YoY for many years, like AWS, then it could easily be a 25x investment gain from today’s prices.
NET shows promise with no break in its current narrative as it has delivered nonstop quarters of 50% YoY growth with zero deceleration so far. And one hope (yes, it is hope) is that its nonstop/accelerating product innovation will eventually show up in acceleration of revenue.

Meanwhile you see stocks like ASAN already showing signs of deceleration while at less than half a million rev run rate!
Or CRWD with a persistent concern of continued YoY growth deceleration in the 1 billion revenue run rate range.

I’d choose NET over those kind of decelerating growth stocks at today’s prices.

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Hi jonwayne235,

I am saying that when rates are falling, the market is willing to look far into the future and buy into the possibility that NET becomes the 4th public cloud - even though you can’t see that in their numbers yet.

When rates are rising, people “shorten their duration” and want to see strong near term numbers in assessing a stock’s valuation.

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I am saying that when rates are falling, the market is willing to look far into the future and buy into the possibility that NET becomes the 4th public cloud - even though you can’t see that in their numbers yet.

Catsunited,

I didn’t address your belief on rates/valuations in my reply and focused just on NET’s business, as this stuff is going too far off topic for this board, but since you insist upon blaming rising rates as the explanation for everything, I am going to just say what I think about it here and leave it at that.

https://www.marquetteassociates.com/wp-content/uploads/2021/…

"The first quarter of 2021 saw the 10-year Treasury yield nearly double, which had a profoundly negative impact on growth-oriented and higher-valuation stocks."

Well, that’s interesting. Rates doubled back then. I think you can blame yields rising on the growth sector rotation/crash from February to May, sure - because the market is an emotional and psychological mess that overreacts to everything.
But then, why did growth stocks rebound like crazy to ATH through October? Was watching the yields rise at the time some kind of actionable data for you, back then? Did you sell out of your growth stocks and stay out from February onward? (I hope not!)

"Generally, higher interest rates are expected to lead to lower equity returns and vice versa, all else equal. While the pace of change in the 10-year during the first quarter was enough to rattle investors, data from the last decade does not support an overall negative correlation between the movement in interest rates and equity returns. Since the Global Financial Crisis (“GFC”), monthly returns of the S&P 500 Index and monthly changes in the 10-year Treasury yield have exhibited correlations ranging from modestly negative to strongly positive. This is in stark contrast to the correlations from previous decades, when equity returns and interest rate movements tended to be strongly inversely related, as conventional wisdom would suggest. Roughly 75% of the monthly correlation observations from 1970 to the beginning of the Global Financial Crisis were negative, compared to less than 14% from the GFC to the present day.
While many variables likely contributed to this disconnect, the absolute level of interest rates may be the most important factor.

At higher absolute levels of interest rates, however, the data show a stronger negative correlation between yield changes and equity price movements. The idea that the absolute level of interest rates helps determine the extent to which movements in yields impact equities begs the question: Is there an inflection point at which increases in rates are more likely to lead to diminished equity returns?
While there are many factors at play, a quadratic regression on the correlations observed from 1970 through today implies that negative correlations begin at a 10-year Treasury yield of around 5.8%. For investors, this may help allay concerns about the impact of future rate hikes, with the 10-year still below 2%."

Here’s my takeaway points:
Are you predicting 10 year yield rates to spike up towards 5.8% over the next year? If so, you should probably sell all your stocks and time the market.
Except, guess what, no one has a crystal ball, and in fact I think the chances of that happening remains quite low - evidence I’m seeing points to inflation rates peaking out in the first half of 2022 rather than continuing to rocket up in perpetuity.

So how would you feel if what actually happened was you sold out near the bottom, you watch as the rate of rise of inflation rates continue to fall and thus the 10 year yield stays below 2 or 3%, fed becomes less hawkish, then your growth stocks surge to new ATH as their businesses continues to perform spectacularly, and you sit there dumbfounded with your hands under your glutes in frustration?

Keep in mind, while rates might go up over the next few years, our businesses aren’t going to stop growing. If SNOW keeps expanding at 75-100% over the next several years, NET keeps chugging along at 50%+, guess what? By the time rates “actually matter”, these stocks may have grown into their valuations already and have outperformed the broader market.

So, if your response is in agreement with me that:

1.) rates eventually do matter (at an absolute threshold which we aren’t anywhere close to passing),

2.) no one can predict the future,

3.) you stayed invested within your growth stocks while rates jumped in 2021 anyway,

then 4.) you might also agree with me that talking about this stuff is pretty much useless/non-actionable unless you want to go try your hand at timing the markets rather than focus on what you can control: your personal understanding and conviction in the underlying businesses invested

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