Q4'22 & 2022 CGC Quarterly Letter
A tough year, but a great comeback in 2H
*Note: A previous version reported a 12% gross return for the quarter and a -31% return for the year. This has been corrected to a 12.3% gross return for the quarter and a -30.8% return for the year.
Fund Performance
In Q4 2022, Cedar Grove Capital Management, LLC (“Cedar Grove Capital” or the Fund” or “CGC”) returned 12.3% gross return compared to 7.1% for the S&P 500, -9.5% for the S&P Consumer Discretionary ETF XLY, -21.5% for the Cannabis ETF, and 5.8% for the Russell 2000.
Portfolio Commentary
We are happy to report that we bounced back meaningfully in the final quarter of 2022, beating all our benchmarks handsomely.
The key takeaway? We did not lose money in Q4’22.
While we did end the year -30.8%, this was dramatically less than our lowest performance at the end of Q2’22 which was -44.1%.
In Q1, we were on the “inflation is transitory” train and did not appropriately reduce our net long exposure to cyclical names and the cannabis sector. While earnings had yet to flatten or decrease, unanticipated multiple contraction in tech and retail names led to heavy losses in Q1.
In order to recoup some of the losses, we deviated from our core investment principles and strategy by trying to capitalize on the market’s historic volatility. This proved difficult and expanded our losses in Q2.
By the end of Q2, our position of transitory inflation was long gone. Additionally, in Q3 not only did we return to our core investing strategy, but our research into the underlying consumer fundamentals greatly concerned us. Our initial thoughts are published in the post below from September.
The data we digested led us to sell into the rally in late August and liquidate all of our positions but two. Considering the market was hell-bent on inflation data and the words of J Powell, we did not feel confident in our ability to invest in that market environment and decided to sit it out. Lessons learned from Q2.
With virtually all of our core positions closed during Q3, we were left with our Twitter arbitrage trade and some call contracts we already wrote off at a $0 NAV.
To end the quarter, we finally recognized our gains in the Twitter takeover (thank you Elon), a brief snapback in cannabis names from the Biden announcement, and the possible passing of policy towards SAFE and 280E.
We were skeptical that policy would be changed and tweeted about selling into the rally.
We exited our call options and decided not to partake in the FOMO. A wise decision.
While the market was rejoicing peak inflation and a possible FED pivot, we further doubted the probability of this occurring and became even more concerned about the consumers’ state going into 2023.
We outlined our opinion on holiday sales to those that subscribed in the posts below to try and sound the alarm once again to anyone that wanted to listen.
With the market too optimistic about earnings and a FED pivot, we decided to re-enter the market at the end of November and establish our biggest net short position since the founding of CGC. We deployed slightly less than 50% of our assets across various names and ETFs with over 94% of deployed capital in a “short” capacity.
We announced these interim positions for paid subscribers here before the market pulled back again which was us shorting lululemon (LULU), RH (RH), and others into their prints.
Of our deployed capital, we were able to return 27.8% in just 4 weeks. You can see our current and old positions in the next section and our closing remarks/setup for 2023.
Top Positive Contributors to 2022 PnL
Warby Parker (WRBY) / SHORT / +4.11%
Peloton (PTON) / SHORT / +3.4%
RCI Hospitality (RICK) / +2.87%
Xponential Fitness (XPOF) / +1.64%
Twitter (TWTR) / +1.62%
Portfolio at End of Year
2023 Market Commentary
The winning trades of the year clearly ended up being LONG energy and staples while also being SHORT technology, bonds, and cyclicals.
While this might have been the winning trade for 2022, I don’t think the same setup is in store for 2023.
We believe a recession will come next year if we aren’t already in one, and that will have serious effects on equities. Many believe demand for oil will spike since China is reopening but while we believe that a modest uptick is warranted, we do not believe that oil prices will rocket back up to summer highs unless another escalation occurs on the eastern front.
Consumer staples on the other hand have been a safe haven trade for many investors in 2022 which has pushed multiples up to what we believe to be exorbitant levels. With many companies in the space having taken price all throughout this past year, volume impacts will catch up to them. This includes many restaurants like Chipotle (CMG) for instance that will notice changes in consumer income demographic as trade downs become more widespread.
With the bond market returning some of the worst performance results over the last three decades, we do believe that come Q2/Q3 2023 it might be the time to look at bonds as a potential LONG trade opportunity once the dust settles with FED hiking and inflation coming down.
Despite a near reversal from 2022’s trades, we still believe that many hope for a technology snapback and are continuously piling into names in an effort to regain portfolio returns lost during the last year.
In our opinion, this setup looks to be a mediocre trade given the market environment is still not friendly to unprofitable technology that happened to skirt by this year with layoffs and cost-cutting efforts.
The increased cost of capital, continued need to extend cash runway, and maintain margins will inevitably to increased layoffs and job opening reductions.
This all plays into our thesis of how the consumer will continue to get pinched in the new year.
We cautiously believe the following:
SHORT the broader market into Q1 earnings → Q1/Q2 of calendar year
S - Cyclicals, tech, select energy, crypto, multinationals with heavy USD-denominated debt and European exposure
L - Precious metals
Once earnings expectations come down enough and a reset occurs, risk-on assets will become attractive with some contrarian plays
S - Staples purely on valuation, energy, and deSPACs
L - Banks, bonds, financial services, select discretionary, sticky/high recurring revenue generating companies → ex, Pool Corporation (POOL)
Lastly, as many have been waiting over the last 5 years, we do not believe meaningful policy action will occur for cannabis in 2023 but valuations will become very attractive for many to go dumpster diving and wait until changes become reality too attractive to ignore.
Closing Portfolio Remarks
We are still deeply concerned about the rapidly deteriorating state of the consumer and shared our final thoughts for the year on Christmas Eve.
As you can see in the prior section, we’re still heavily short retail and tech and believe that at current conditions, the market could find a bottom in Q2, frontrunning further negative lagging economic data. Only when we believe earnings have come down enough and FED rate expectations are appropriately priced will we revisit reversing to a risk-on position.
Until then, we believe that our short positions will continue to reward us going into Q1 as earnings season once again kicks off and earnings revisions are adjusted greatly to the downside.
Time will tell just how bad FED policy will ripple through the economy but we believe we are attuned to what’s actually happening and have learned from 1H’22.
Lastly, we were happy to announce our first private acquisition in the pet services space and have decided to launch a FREE Substack on the SMB space. This newsletter will have no set cadence and will post insightful trends and interesting deals in the SMB space. Sign up with the link if you're interested 👉🏼
.If you want to continue getting free access to our opinions/research, subscribe below. I’ve also included a breakdown of what you get.
If you’d like to become a paying subscriber and get exclusive access to our interim positions on a monthly basis + trade research, we’ve included a discount option below as well.
Predictions
Predictions are meant to be far-reaching but also realistic. Revisiting my predictions from last year and what I’m thinking about for the new year.
2022’s Predictions Revisited
S&P 500 returns single digits, at best (Correct)
Self-explanatory.
FED to raise rates 2x, conditionally (Wrong)
Considering how we were team transitory going into 2022, this seemed appropriate. In hindsight, we were widely off as inflation remained rampant.
High-growth tech will feel pain (Correct)
We were right on this call and I still think about how I should have shorted tech into the new year instead of just sitting on the sidelines. Oh well.
Bitcoin gets close to $100k (Wrong)
This one is self-explanatory but while I didn’t think it would get to $100k, I did think it was going to rebound close to it. FWIW, I never have pumped or bought crypto. I’ve said quite the opposite.
Rivian’s valuation gets cut in half (Correct)
By the end of the year, Rivian’s RIVN 0.00%↑ stock was down >82%.
2023 Predictions
S&P earnings next year will be (can’t wait to be wrong btw)
Bull case: $209, YE - 3,850
Base case: $203, YE - 3,650
Bear case: $196, YE - 3,400
Existing home prices will continue to decline by at least another 10% to break below $350,000
Bitcoin breaks $12,000
I believe with the upcoming recession and rush to preserve capital, Bitcoin will be one of the first places that investors will liquidate their holdings in order to bolster their cash position
The FED does not cut rates at all in 2023 but will hint at cuts in early 2024
Bed Bath & Beyond (BBBY) files for bankruptcy
Have a comment on my predictions? Let me know what you think below.
Until next time,
Paul Cerro | Cedar Grove Capital
Personal Twitter: @paulcerro
Fund Twitter: @cedargrovecm