Generation PMCA commentary for the first quarter ended March 31, 2025.
Countless articles over the last few weeks recommended doing nothing. While most were directed at investors considering selling out when uncertainties intensified, they argued strenuously for inaction - no buying or selling. In the heat of the moment, inaction might serve a purpose, perhaps to de-escalate an intense argument; however, it’s not an investment strategy.
Watch and Wait?
Wait for what? For a clearer outlook? That usually means higher prices. We often do wait but only when we anticipate lower prices, either because a stock price isn’t sufficiently undervalued, or because it’s yet to fall to a TRAC™ floor. But once both criteria are in place, especially if a high-quality company is trading at 65 cents-on-the-dollar, two TRAC™ bands bellow our Fair Market Value (FMV) estimate, we’d be foolhardy to wait. It’s rare that quality large-cap individual stocks trade cheaper. Our errors of omission have mostly stemmed from not reacting fast enough. Especially because when a high-quality stock dips, the rebound off-the-bottom is usually brisk. The market is often inefficient at pricing stocks properly but not for long.
By April 7, the S&P 500 had fallen 21% from its late February high. Clearly, there are going to be opportunities to take advantage of when stock prices have moved so much in a short period.
We covered some of our short hedges, bought new positions, and sold others where the risk-reward wasn’t as favourable.
Political Actions
Politicians are supposed to be as clear as possible with their policies, at least once elected. Treasury Secretary Bessent described President Trump's negotiating tactics as “strategic uncertainty” meant to keep other nations off guard. The high tariff rates and unusual announcements created havoc for the markets. But it grabbed everyone’s attention and many broad-ranging trade deals should be forthcoming. In the meantime, we’re stuck with high minimum tariffs - at least 10% - which inhibit growth and profits, while exacerbating inflation.
At the same time, despite DOGE, the U.S. government is about to pass a budget which could escalate the already high annual federal deficit from 6% to 7%, over the next several years - a record for any sustained period. There are also proposed tax cuts, a virtual halt to immigration (with dwindling immigration and high deportations), and threats to Medicaid as well as other social programs.
These policy changes are being proposed when markets are already fully valued, and the economy is susceptible to a recession. It’s not time for inaction. Others have recommended inaction as a strategy. Strategic inaction is an oxymoron - not a cute one like ‘act naturally’ or ‘jumbo shrimp’.
Lights, Camera, Action!
Some of the events we’re witnessing today are right out of a movie. Particularly because Trump’s approach is to make extreme pronouncements.
In the first scene, the U.S. is trying to “rebalance global trade.” As in all the scenes, viewers are left to interpret the dialogue. It appears to us that the objective is to eliminate all trade barriers, with the ultimate unstated goal of global free trade. That would be a massive positive outcome, particularly if it were to occur in short order. However, the longer it takes, the more harm it’ll cause. First, from actual tariffs which harm all parties and, second, from the indelible mark it could leave on international trade. Nations are already protectionist by nature, and the unilateral tariffs are causing harmful anti-American sentiment. It’s not just from economic policies. Other initiatives are calling into question rule of law in the U.S., something that’s set the U.S. apart.
The shower scene should have been scrapped, since the actors were hard to see after Trump’s removal of low-flow showerheads. And the location manager, who’s responsible for the scene illustrating a lack of danger, will now have too many coal mines to choose from for the canary.
The backdrop is already kind of set and won’t be easy to alter. Aside from the tariffs (which on U.S. imports now sit at 18%, up from under 3%), and fiscal (government spending) policies, both of which are deleterious, the already high total debt load has been suppressing growth. With gross federal debt hovering above 120% of GDP over the last few years, well above the 90% level where it suppresses growth, the growth outlook is dim. Rising interest expense on the debt, also a result of rising rates - a vicious cycle - doesn’t help either. Current monetary policy has negative implications too. Still fighting post-Covid inflation, the Fed has kept rates high and tightened money supply - a recessionary precursor.
Production costs should eventually fall - inflation is likely to be muted. The heavy indebtedness, shrinking money supply, and anemic growth should reign in growth, alleviating price pressures. Tax breaks and deregulation are also disinflationary. And other long-term factors are in place to suppress inflation such as poor demographics - low fertility rates in most developed countries which isn’t going to be assisted by immigration in the short term (the U.S. grew by 1% last year but over 80% was from immigration) - and technological advances, not the least of which is the pervasiveness of AI, which shrinks barriers to entry (more competition), enhances automation, and lowers costs generally. This should allow for lower interest rates over time.
The special effects are awful - high house prices have led to declining sales, lower capital spending intentions lead to lower shipments, tariffs lower global trade (duh), and terrible consumer sentiment implies an overall slowdown. Amazingly, consumer spending lifted 1.8% in Q1, even though GDP was negative, mostly because imports lifted ahead of anticipated tariffs.
The actors aren’t happy - U.S. consumers are pulling back. Starbucks endured a same-store sales decline (stores open at least one year) for a 5th consecutive quarter. McDonald's is also suffering from trading down. It had its worst same-store sales decline since 2020. Unemployment is still only 4.2% though, after a record 52 straight months of job gains, but job openings keep shrinking as does wage growth and weekly hours worked, and multiple jobholders (part-timers) are at a record high. Consumer delinquencies (credit card, auto, and student loan) are rocketing higher.
We need to hope for a fairy-tale ending.
Action Packed
We’re expecting further above-average volatility because there are significant countertrends afoot.
The stock market is rising again, the S&P 500 bouncing up off a TRAC™ floor, potentially rising several percent more to its next ceiling, despite being overvalued and likely to fall back again, particularly if a recession ensues and reduces corporate earnings.
Long-term interest rates are rising, and look to be headed even higher shortly, partly because tariffs have lifted short-term inflation expectations. Walmart suggested it’ll raise prices to offset tariffs. It’s now under pressure from Trump. Apple is considering raising the starting iPhone price for its latest version, for the first time since 2017, even after moving more of its production to India. This also caught Trump’s attention who then warned of a 25% tariff on iPhones sold, but not manufactured, in the U.S. Viral Knowledge Media joked that, “if the devices were manufactured domestically, they would probably cost more than what some BYD electric vehicles are priced at in China.”
Famous economists are now rolling in their graves. Adam Smith, the father of modern economic theory, believed that tariffs create domestic inefficiencies. So did David Ricardo, whose common-sense theory of comparative advantage suggests efficiencies for all if production occurs where resources are allocated best. U.S. corporations have spent decades outsourcing production to other countries, boosting returns, increasing the base of knowledge workers and, in turn, spurring demand for its products as foreigners gain wealth.
Demand for bonds has also fallen, because foreign holders have fewer U.S. dollars when trade volumes are down. Not to mention, there are investor concerns about the U.S. as a creditor and a place to invest when they’re less enamoured with the outlook.
But interest rate differentials highly favour U.S. government bonds relative to other jurisdictions, which should solidify demand for Treasuries and U.S. dollars. Also, lower long-term inflation expectations suggest much lower interest rate levels on the horizon.
Interest rates have surged elsewhere too. UK 10-year bonds yield slightly above U.S. equivalents. Japanese yields have also jumped (the 30-year yield recently spiking up over 3%), which could have broad liquidity implications given the size of the Yen carry-trade. When rates rise by this magnitude, it generally ends in a financial crisis.
With higher rates and lofty stock valuations, U.S. equites haven’t been this unfavourable relative to bonds since the dot-com bubble. For example, the 10-year Treasury is 4.5% while the expected equity return over the same period is virtually nil. Back near all-time highs, the paltry 1.3% S&P 500 yield, along with anemic economic growth, once again leaves little room for upside if valuation levels normalize. Furthermore, the 30-year yield is above the S&P 500 earnings yield (earnings/price) for the first time in over 20 years.
Rising interest rates and market speculation have also driven the margin debt carry load (stock borrowings times interest rates) significantly higher, to a level only seen at the market peaks in 2000 and 2007. Flows into leveraged ETFs are also occurring again at record levels.
In early April, market sentiment was awful. Now, it’s euphoric again. This, despite most companies reporting full-year guidance below analyst expectations, and many companies completely pulling guidance.
Our Strategy
In early April, we reduced our stock market hedge, covering some of the short positions held in margin accounts or selling a portion of the S&P 500 inverse ETF held in accounts not authorized to short.
At the same time, we added several new holdings, since market declines presented more opportunities.
The markets have lifted again and remain vulnerable because valuations are unattractive. A U.S. recession has yet to occur, even though our Economic Composite, TEC™, alert expected one about 21 months ago, and slowdowns or recessions have occurred in other jurisdictions. Perhaps the tariffs and rise in interest rates will shortly tip the U.S. into a recession.
Our Portfolios
The following descriptions of the holdings in our managed accounts are intended only to explain the reasons that we have made, and continue to hold, these investments in the accounts we manage for you and are not intended as advice or recommendations with respect to purchasing, selling or holding the securities described. Below, we discuss each of our new holdings and updates on key holdings if there have been material developments.
All Cap Portfolios - Recent Developments for Key Holdings
All Cap portfolios combine selections from our large cap strategy (Global Insight) with our small and medium cap ideas. We generally prefer large cap companies for their superior liquidity and lower volatility. The smaller cap positions tend to be less liquid holdings which are more volatile; however, we may hold these positions where they are cheaper, trading at relatively greater discounts to our FMV estimates, making their risk/reward profiles favourable. There were no material changes in our smaller cap holdings recently.
All Cap Portfolios - Changes
Changes to our large cap positions are summarized in the Global Insight section below.
Global Insight (Large Cap) Portfolios - Recent Developments for Key Holdings
Global Insight represents our large cap model (typically with market caps over $5 billion at the time of purchase but may include those in the $2-5 billion range) where portfolios are managed Long/Short or Long only. At an average of about 72 cents-on-the-dollar versus our FMV estimates, our Global Insight holdings appear much cheaper, in aggregate, than the overall market.
Global Insight (Large Cap) Portfolios - Changes
In the last few months, we have made several changes in our large-cap positions. We bought Grupo Aeroportuario del Sureste, Marvell Technology, Adobe, lululemon athletica, Patria Investments, Uber Technologies, and United Health Servies. We sold Abbott Laboratories and GSK after each ran up to TRAC™ ceilings and offered less upside relative to our FMV estimates, and Sun Art Retail Group after Alibaba Group sold its majority interest to a private equity group.
Grupo Aeroportuario del Sureste owns airports in Southern Mexico, Columbia, and Puerto Rico, servicing more than 70 million passengers per year. Results had been soft due to weak European and U.S. travel. Domestic travel also suffered from ongoing sewage problems at its Mexico City Airport, which reduced flight operations to 43 per hour compared to its full capacity of 75 operations hourly, and Pratt & Whitney engine issues which grounded hundreds of Volaris and Viva Aerobus planes. We believe these issues are temporary, and strong growth from its airports in Puerto Rico and Columbia should offset weaker growth from Mexico. Our FMV estimate is above $700.
Marvell Technologies is a leading provider of semiconductor solutions targeting data centres, carrier infrastructure, and the automotive sector. AI revenue (nil a few years ago) is estimated to hit $2.5 billion next year. Data centre revenue rose 78% year-over-year on strong demand from AI applications and new innovative products. Enterprise networking and carrier infrastructure demand appeared to trough in its previous quarter; both segments now posting sequential growth. Much of Marvell’s future growth should come from custom silicon wins from industry leaders such as Amazon and Microsoft. Project wins and losses will likely create volatility, as seen in early May when it was erroneously reported that Marvell lost some Microsoft business. Investors should be focused on the overall business, which we expect should earn over $3 billion of free cash flow by 2028. Our FMV estimate is $100.
Adobe has over 22,000 enterprise customers. Its Document Cloud (Acrobat), Creative Cloud (Express, Desktop apps, Firefly), and Experience Cloud (Data, Journeys, GenStudio) are the go-to tools for creators and creative professionals. Most of the company’s revenue is now subscription based. AI represents both a threat and an opportunity. Adobe estimates that AI-influenced apps are at a $3.5 billion annual revenue run rate and new AI-first products like Acrobat AI Assistant and Firefly are expected to exceed a $250 million run rate by the end of this year. However, new AI apps from competitors, like Google’s recently released Veo 3, which allow users to easily create virtually any image or video with a simple description, pose a threat to Adobe’s lock on the creative market. We believe Adobe’s lock on the enterprise market should continue due to its focus on AI compliance. Our FMV estimate is $480.
lululemon athletica, which we had sold about 3 months prior after it ran up to our FMV, was purchased again after it again declined about 40%. Since it produces in China, Vietnam, and Cambodia, it was caught in the crosshairs of the tariff threats. We believe it has sufficient gross margins to offset even the high proposed tariffs by somewhat increasing U.S. prices. Our analysis showed that a 10% increase in pricing, despite much higher proposed tariffs, would leave profitability intact. Yet the stock was once again trading at a 35% discount to our $400 FMV estimate, despite tremendous brand recognition and new store growth in Europe and China (where same-store-sales growth remains above 30%). Its high profitability, cash-laden balance sheet, and strong product lineup, offsetting concerns about rising competition.
Patria Investments is a leading Latin America alternative asset management firm with over $45 billion under management, most of which is under long-term lock-up agreements. Infrastructure and communications investment in the region are decades behind (e.g., Brazil ranks 78th in the world for infrastructure). We see a long runway for private and public investment in the region, spearheaded by Patria. Fee-related earnings should be $225 million in 2025. As with all alternative asset managers, results could be lumpy due to market volatility which influences performance-related fees. In August, Patria announced a repurchase program of up to 1.8 million shares, commenting that the “price of our stock does not come close to reflecting our robust long-term outlook.” The dividend yield at our time of purchase was a healthy 5.9% and our FMV estimate is $21.
Uber Technologies’ stock sold off in the post-Liberation Day market swoon despite no real vulnerability to rising global tariffs. Results continue to be impressive; Q1 bookings rose 18% year-over-year while its annualized EBITDA reached a record $3.1 billion. More importantly, the company is pursuing ‘healthy growth’—from engagement and frequency rather than price—to maximize free cash flow. Since the future of mobility is clearly in autonomous vehicles, Uber could face a serious challenge from Waymo, Tesla’s Cybercab, and other potential entrants. As the global leader in more than 30 countries, 30 million Uber One members, and a brand name that’s now a verb, we believe there is an opportunity for Uber to be a central aggregator for various mobility services, including autonomous vehicles. Our FMV estimate is $110.
Universal Health Services provides hospital and healthcare services, primarily through its Acute Care Hospital Services and Behavioral Health Care Services segments. Its stock trades at just 6.5x EBITDA, reflective of concerns about Medicare and Medicaid reimbursements and weaker numbers from its Behavioral Health segment. Regarding Medicaid, management believes the House Bill will be less draconian and is focused on a younger demographic which doesn’t make up the bulk of UHS’s utilization. We believe Behavioral revenue will reaccelerate, and Q1 results showed encouraging results. Meanwhile, strong expense controls and new hospitals in Washington and Las Vegas should drive top- and bottom-line growth. The company recently opportunistically repurchased 1 million shares. Since 2019, the company has repurchased 33% of shares outstanding. Our FMV estimate is $215.
Income Holdings
U.S. high-yield corporate bonds (ICE BofA Index) yield 7.5%. As noted above, long-term U.S. government bond yields are rising, and may head even higher, even though lower inflation longer term should bring rates down. U.S. high-yield corporate bond spreads are still too narrow, especially since a recession and its accompanying higher delinquencies would widen spreads considerably.
Our income holdings have an average current annual yield (income we receive as a percent of current market value of income securities held) of about 5.9%, and most of our income holdings—bonds, preferred shares, REITs, and high-yielding common shares—trade below our FMV estimates.
We recently purchased Patria Investments, described in our Global Insight section above. We sold Alexandria REIT because it fell below a TRAC™ floor.
Take Action
Maybe we should have written this quarterly letter in early April, when we had a brief period of optimism, since we’d prefer to have taken a positive slant for a change. Now that the markets have lifted, and with a still high probability of a recession, we once again find ourselves pessimistic.
Sometimes overall economic circumstances have too many moving parts and the market outlook becomes murky. That doesn’t mean all stocks should be shunned during those times, especially for more predictable companies whose outlooks are unchanged.
Furthermore, the prices of individual companies fluctuate more than the market, often presenting opportunities during stable periods, even in high-quality companies that become temporarily mispriced.
We are constantly on the lookout for investment opportunities, continuously using our proprietary tools to monitor economies, markets, and individual securities. Along with undervalued positions, our portfolios also currently hold some cash and hedges until more opportunities meet our criteria. Then we’ll pounce.
Randall Abramson, CFA
Generation PMCA Corp.
May 29, 2025
Read more hedge fund letters here
