Q4 Zorik Capital Letter: 2023

Partners,

This recent quarter marked a notable uptick in fear. With renewed apprehensions around inflation and possible recession, the VIX Volatility Index jumped 54%.

In this period, the S&P 500 receded by more than 8% from its high points earlier in the year. Both growth and value sectors experienced this decline. The growth-centric NASDAQ saw a drop of 8.15% while the value-focused Vanguard Value Index dipped by 8.17%.

This decline further illustrates the challenges value-oriented stocks have faced this past year. While the NASDAQ’s QQQ index surged by 38% this year, the Vanguard Value Index rose a mere 10%, and the Russell 2000 trailed at a 7% rise. The strength of the tech sector, yet primarily seven mega-cap tech stocks, is responsible for the vast majority of the S&P 500’s growth this year. 

The equal-weighted S&P 500 index, which moderates the influence of the ‘Magnificent Seven’ (a group of highly weighted, highly performing tech stocks), stayed flat over the year, compared to the 15.9% uptick in the S&P 500.

Zorik, with its focus on value stocks, has lagged over the past several quarters. However, we hold a firm belief that the portfolio is well-prepared for strong outperformance over the next several years.

We believe that growth’s immense outperformance of value (driven by only several stocks) is unsustainable and, therefore, predict a mean revision and catch-up effect from value stocks. Zorik has been excited by this recent market contraction and has, therefore, begun cutting its cash position, working to become fully invested in stocks that will outperform massively over the next several years.

Thoughts on the Economy

We still refuse to eliminate the potential for a recession. Nearly every time rates have been hiked this aggressively and quickly, something has broken. 

Looking from the surface level, economic data showcases moderately higher consumer spending over the past several quarters. However, this is oversimplifying the situation.

For instance, a double digit percent drop in smartphone sales, paired with increasing credit card debts, hints at consumers' pivot towards essentials, increasingly relying on credit.

Therefore it is evident that the consumer is weakening. As a result, it is not unlikely that we see further pain from the consumer, resulting in a couple of recessionary quarters.

In the near term, consumers may accrue more debt to uphold their spending habits. However, with interest payments being around 9.8% of consumers’ disposable income—akin to post-GFC averages—there's a buffer for consumers to moderately increase their debt load.

Therefore, as the job market remains tight, causing wages to keep pace with inflation while consumers have decently healthy balance sheets, we do not predict the potential hit to consumer spending to be lasting or intense. 

As time progresses, we foresee that inflation should continue to fall and the Fed will eventually end the hiking cycle. Nonetheless, the short-term economic events are not overly relevant to what we do. Our primary aim of examining the economy is to understand whether the economy is healthy enough for us to make long-term investments. 

Today we feel that this is the case. While there’s uncertainty over the short term, we do not see notable issues over a three to five-year timeline.

Regarding the situation in the Middle East, we do not see a potential for Iran to become directly involved. Therefore, we do not believe that the events will have major effects on the global economy or oil markets. Nonetheless, we are horrified by Hamas’ actions in which thousands of innocent children, grandparents, women, and men were brutally murdered, beheaded, raped, and burned to death. We fully support Israel’s response as it is paramount for the safety of both Israelis and Palestinians that Hamas’ savage reign over Gaza is ended and that the terrorist organization cannot inflict further massacres on the innocent. 

Market Forecast

Though optimism surrounds the long-term economic trajectory, there are evident short-term hurdles.

At present, market valuation stands at around 20 times earnings, equating to an earnings yield of about 5%. This figure only narrowly surpasses the five-year risk-free rate. Considering the potential for short-term economic headwinds, the broader market appears favored to the downside.

What We Are Doing

Though the broader market is not super attractive, there are strong opportunities in the value space.  

As described prior, the past year has seen a significant deviation between growth and value performances. Capital has drifted from traditional value assets towards avant-garde, AI-centric ventures. This dynamic led to pronounced declines in some indices, like the Vanguard Utilities Index, and others, like the Vanguard Healthcare Index, which underperformed the broader market (S&P 500) by a significant 1500 basis points.

We believe that this discrepancy is not sustainable over the long term. This severe underperformance has led to value stocks being significantly cheaper than the broader markets. As a result, we are highly bullish on value stocks, believing that value will significantly outperform growth stocks as well as the broader market over the next several years.

While money markets look attractive, yielding the same as the market’s earnings yield, we believe that the value segment of the market holds a more attractive yield. Therefore, as we believe the economy should be fine over the long term, we are looking past the potential for short-term volatility and are taking advantage of this unique market situation to purchase value stocks at an unusually high yield. Therefore, we aim to become close to fully invested.

Closing Words

Thank you for all the continued support! I am super excited for the fund's future as I see a unique opportunity in value stocks that we are actively taking advantage of.

I, additionally, have been wrapped up researching a specific unloved apparel stock that Wall Street views as out of date and therefore hates. However, I have been realizing the product is suddenly becoming very popular on social media and amongst high schoolers…more to come on that later.

I look forward to the future of the fund! 

!עם ישראל חי

Thanks,

Blake Zilberman