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Here’s a preview of what we’ll cover this week:

● Macro: Inflation Tamed, Fed Cuts, Small Caps, ‘97 Repeat?

● Markets: Our Small cap rotation, Mag7 Gamma Squeeze

● Company Earnings: Strong on Banks, Mixed on Consumer & Industrials

● AI: Lumida Curations - AI Bubbles, AI Tech Value Stacks

This week I had a chat with Nic Carter, Founding partner at Castle Island VC.

Nic is a Philosopher turned Investor who is constantly challenging himself.

His work has been published in Coindesk, The Block, Harvard Business Review, New York Magazine, and Bankless.

Nick shares his personal journey into combat sports, including boxing and Karate Combat, and how these disciplines influence his investment strategies and daily routines.

Nic lays out this thesis on CoreWeave - he was a seed round investor in one of the best investments of the last 10 years. (Lumida is an investor as of November, Nic beat us to the punch 🙂)

 - Coreweave, AI Investments, & Data Centers

- Digital Asset ETFs, & market cycle

- Nic's Investment process and successes

 Check out the full video here. Don’t forget to subscribe.

Spotify | Apple

Time Stamps:

00:33 Nic Carter's Personal Transformation

02:52 Boxing and Investing: A Parallel Journey

11:28 From Philosophy to Bitcoin

15:12 The Birth of Castle Island Ventures

16:47 Navigating the Bitcoin Community

21:00 The CoreWeave Investment

31:47 The Future of Compute as a Commodity

38:52 Investing in AI: Strategies and Concerns

39:35 The Future of AI Models and Regulation

43:46 AI's Role in the Post-Truth Era

47:14 The Intersection of AI and Blockchain

01:10:50 Crypto Market Trends and Challenges

Macro

Here’s a video we recorded last week making the case that Small Caps are set to rally as soon as Fed Rate cuts are in sight.

 Give it a quick listen.

I've been writing about how small caps are poised to ramp as Fed rate cuts come in sight.

This week, we saw a benign CPI print that shows all three pillars—including stubborn shelter inflation—are at levels that allow the Fed to make ‘insurance cuts’.

Not a full easing cycle, but an insurance cut to help psychology and the housing sector.

Last month, Mr. Market gave us a clue as to what would rally when inflation is beat. We saw small caps ramp dramatically after the June CPI report.

Mr. Market was previewing his intentions.

The chart below shows the performance of small caps this past Thursday.

The main question is: Is this a new trend, or is it a head-fake?

Small caps, after all, haven’t gone anywhere at the index level in three years.

And after the benign CPI print last month, we saw a one-day wonder small-cap rally that gave back most of the gains.

Our answer: This is a trend.

The breadth and the magnitude of the rally this time is significant.

Each day, our CIO team reviews dozens of charts and data, testing our hypotheses and worldview against incoming data.

The breadth and strength we see in small caps are similar to what we saw in November and December - the last strong small-cap rally.

That rally faded when Mr. Market said the Fed would not cut rates in December (or January, March, April, May, or June - or even July).

However, Lumida is now of the view that we will see September rate cuts.

Those of us following for a while know we have been skeptical of rate cuts and fading Mr. Market’s hopes of a pivot. That has worked quite well.

However, it does now make sense for the Fed to make modest one-off rate cuts rather than start an aggressive easing cycle by being late.

Why We Believe Rate Cuts Are Coming

Simply put, inflation has returned to target.

Take a look at this data and highlights from Bespoke.

What will rate cuts mean for the market?

Looking beyond August and September seasonal weakness - heightened by policy uncertainty - we think it’s quite bullish.

The setup reminds us of 1997.

You have the Fed easing…and there’s no recession.

The rally will broaden to small and mid-caps. That lets the bull market expansion continue.

Even today, there are so many individuals that are offsides hiding in Treasuries…

The top will be when they get back in the market.

Markets

Take a look at Brazil's EWZ.

The red line is when we said in December Brazil is overbought.

The green line is when we bought into the market - via our pick Pag Segeuro (Ticker: PAGS)

We did that by watching the US Dollar and rate cycles.

This was a satisfying entry.

Some of you have asked - why not buy Nu Bank or Mercado Libre.

it's really simple: those names—and they are great businesses (especially Meli)—have limited room for multiple expansion.

Multiple expansion is the primary driver of returns. We can own PAGS for 10 years and let it compound without paying taxes. This is what makes Buffett such a great investor…

If we bought Nu Bank, it would be fully priced within a year or two, say. Then we would need to rotate and pay taxes.

If you can find a great entry in a great business and hold on to it for a long time, you are creating wealth.

People will talk about Pag Seguero in ten years like they talk about Nu Bank or Mercado Libre now.

That said, if we had a major correction and these businesses were trading at 50% off, you can bet we would buy them.

Small Caps: A Check-In on M/I Homes

On April 23, we wrote, “Do you own homebuilders?” and shared our pick of M/I homes.

We wrote about M/I Homes in our April 14th newsletter. Here’s an excerpt:

M/I Homes outperformed the other homebuilders we track - KB Homes, Lennar, DreamFinder, etc. - on this small-cap rally. No surprise - it’s cheap, has growing earnings, has buybacks, focuses on starter homes, has financing incentives…

What’s not to like?

Here’s M/I Homes, our April buy call, and where it is now.

That’s a 17% gain in the last 3 months.

This was a difficult hold for us. Internally, we had many debates about the deterioration in multifamily housing.

Multifamily incompletion rates are rising, and starts are slowing.

On the other hand, rate cuts are coming, and it’s a great asset.

We could have done better by waiting for better technical support from the 200-day moving average.

The ideal entry would have been 8 days ago, but you would only have had a 2-day window, and we might have missed it.

In fact, there’s another small cap where we were looking for an ideal entry. We saw it last Thursday, and it gapped up 5% as we spotted the entry. Apparently, others in the market were looking at it at the same time, so we missed that.

The stock is up 21% in two days. It’s quite painful as we saw this and were actively stalking it. We’re reluctant to chase, and we’re quite patient.

So, in one case, our style benefitted us, and in another case, we missed an opportunity.

The only thing we can really do here is reflect on those scenarios and see how we might have improved our decision-making.

Hindsight is always 20/20.

Someone looking at this last week might have also said that the name broke support after all.

Why We Love Small Caps 

I love the small cap rotation for quite a few reasons.

Please look at an earlier Lumida Ledger where we make the case that small caps will have a strong 2024. We lay out various technical studies showing small caps are poised to rally.

What those studies miss is that macro backdrop. Now, the Fed Rate cuts are in view.

Take a look at the relative valuations of large caps to small and mid-caps:

Valuations are cyclical time series, representing the psychology and animal spirits of investors as well as the business cycle.

Small caps can run quite a bit from here and are below historical average.

Another reason is that analysts don’t cover small caps much. Back in the day, the best analysts would cover small caps. The junior analysts would cover large caps.

A lot has changed since then.

If you can spot a good business model, moat, management team, catalysts, and sustainable business – you have an edge in small caps.

Institutions are like whales - they get exposed to small caps via indices over a stock selection

It takes months for institutions to position into small caps. They have to start by purchasing ‘macro products’—indices and futures outright.

So, if you’re not BlackRock, you can front-run them.

Small caps are also a type of growth equity investing Understanding these businesses is a lot of fun.

Over decades of history, small caps have delivered higher returns than large caps. That phenomenon has not been true in the 2010s, the age of mega cap tech.

However, as mega-cap tech approaches the high end of its valuation range, we expect those names will increase share price via earnings growth rather than multiple expansion.

We can get both in small caps!

People underestimate the return potential in small caps.

Take a look at American Public Education.

This stock is one of Lumida’s Stocking Stuffers. It’s up 85% YTD and 285% in 1-year.

Those returns blow Mag 7 out of the water. And the forward PE ratio is still 12x.

You still have to get your picks right, and if the name doesn’t work, sell the stock and don’t look back.

One mistake we made that was also on our Stocking Stuffer list was Zoom Communications (ZM). That was a Covid darling.

It throws off a lot of free cash flow and has a cheap valuation.

But it hasn’t worked. We were wrong on that one. We sold it within a few weeks and moved on.

Cutting losers is crucial.

Here’s another small-cap idea: Jackson Financial (ticker: JXN).

Jackson was a spin-out of Prudential.

They sell annuities and other products to retirees. We like that because we believe this is a Boomer economy. (Look at Cruise lines, restaurants, travel, and healthcare spend…)

Their business model is simple to understand, and they have a strong customer value proposition. Boomers want income and become risk-averse as they age.

Jackson has a free cash flow/enterprise value yield of 50%.

They are buying back 6% of their stock. We like buybacks for the same reason Warren Buffett does. You own more of the company for doing nothing.

The stock is up 50% YTD and 140% in 1 year. It has momentum and a strong trend.

That means institutions are buying this, likely via a VWAP order.

And the Forward PE ratio is 4.4X.

So, this can compound for many years.

Take a look at the chart.

A stock like this has many of the qualities we look for:

- On theme (boomers)

- Good factor exposures: profitable, value, momentum

- Strong customer value proposition

- Free cashflow + buybacks

- Quality customer: boomers

- Demographic tailwind

We are “stacking edges” in quite a few ways here.

We noted in May that there are quite a few opportunities in insurance.

This is one of several bets we have in the insurance space.

Remember how Auto insurers passed on a 24% CPI to consumers? That’s the sign of a strong business model and revenue growth.

No one is talking about Insurance - except for Buffett, who bought Chubb. (Our edge over Buffett is we don’t need to hunt elephants - Buffett could never buy a name like Jackson - it’s too small.)

Mag 7 Call Gamma Squeeze

There’s been a tremendous amount of call option buying on every Mag 7 name.

There is a call option gamma squeeze. Speculative traders are front-running earnings.

Put/call ratios were at record lows.

We believe a lot of those recent calls will expire worthless on next Friday’s options expiration.

The technical factor of call option buying - combined with real earnings revisions - played a role in the rally.

And you have strong positive seasonality the first two weeks of July.

You can see that call gamma squeeze in Tesla here:

You can read the original post here.

Company Earnings

Q2 Earnings cycle has started, here’s a quick curated review of the trends and insights from Q1: Lumida Earnings Review Q1 2024

Here’s an analysis of important earnings from this week - you can read more about them on our news website, by clicking on the company name below (bookmark for daily updates).

Consumer Staples: 

● Pepsi (PEP): Revenue growth might be slowing down due to volume decline in key segments

● ConAgra (CAG): International segment growth is a positive sign but revenue from core business segments down

Industrials: 

● Delta Airlines (DAL): Revenue growth is positive but rising costs need attention

Financials: 

● JPMorgan Chase (JPM): Strong overall performance but Banking & Wealth Management revenue decline

● Wells Fargo (WFC): Improving credit quality but YoY revenue growth is stagnant

● Citigroup (C): Strong investment banking growth indicates a positive trend

AI:

Lumida Curations of the Week

In case you missed it, here are some of the best curations from Lumida Wealth on Twitter.

Be sure to follow Lumida Wealth on Twitter, and on Youtube, where you can get more such curations.

Instead of watching hour-long market podcasts - we distill the key insights in 1 min shorts and serve them in threads.

The goal is to maximize insight per unit of time.

Here’s Beth Kindig from I/O Fund on Realvision on AI, Crypto & NVDA

Here’s Wharton Professor Jeremy Siegel & Wisdomtree CIO Jeremy Schwartz on AI bubbles, small caps, and inflation.

Lastly, here are our friends Michael Parekh & Howard Lindzon on AI Tech Value stacks:

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Quote of the Week

“The stock market is there for you to make money, not to show you how clever you are.” - Peter Lynch

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