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Firefly Capital Update - 2024 Q3

2024 Q3 results

September 30th

$ change

% change

Firefly Capital

$615,612.74

$674,717.37 *

$59,104.63

9.94%

S&P500

$5,475.09

$5,762.48

$518.71

9.89%

Difference

0.05%

Year-over-year results

October 1, 2023

September 30th, 2024

$ change

% change

Firefly Capital (Normalized)

$146.57

$193.80

$42.32

27.94%

S&P500

$4,288.39

$5,762.48

$1,312.10

29.48%

Difference

-1.54%

There are no rows in this table

⁠

* We are currently at $95,764 in cash.

We had a decent quarter that exploded with one of our long-term bets getting a little bit of momentum right at the end, bringing us up to match the market returns for the quarter. We also closed one of our other arbitrage opportunities that unfortunately was a small loss or just about even, but we have the cash back now to reinvest into future opportunities.

That said, 10% returns in a quarter is still outlandishly high and we should expect both the overall market and our own fund to have negative quarters soon. As to when, that is never something I like to predict.

“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie [Munger] and I continue to believe short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.” - Warren Buffett

To drive this concept home a little further, take a look at this chart showing stock forecasters’ estimates and their results.

⁠

Interest rates lowered, what does that mean?

On September 18th, the Federal Reserve (the Fed) gave us our long-awaited “

supersized 50 basis point rate cut⁠

” to 4.75%-5.00%. You can take a look at

Firefly Capital Update - 2022 Q3⁠

for a quick refresher on the dual mandates that the Fed has: namely, to keep inflation low, and to keep unemployment low. These tend to be two sides of the same coin and both are controlled through the Fed’s primary tool: interest rates.

Mandate 1: Low unemployment

If we have high interest rates, money is considered “expensive”, and businesses spend less money because borrowing costs them more. Inversely, if we have low interest rates, money is considered cheap, money can be borrowed inexpensively, and businesses tend to hire more. After the Great Recession of 2008, with the huge loss of jobs, the Fed lowered interest rates to try to incentivize businesses to create more jobs.

Mandate 2: Low inflation

Inflation by an imbalance in supply and demand. If too many people want to buy a product, and there is too little supply, the price goes up to match. If there is too little demand and too much supply, the price goes down until people are willing to pay the price. Using interest rates, if money “is cheap”, i.e., low interest rates, then people are more willing to spend money and more likely to cause inflation. If interest rates are high, people are less likely to spend money and buy, and so less likely to cause inflation.

It’s also important to note that most governments want 2-3% inflation because they believe it incentivizes an expanding economy, which they use as a rubric for general wealth of the nation and its people.

⁠

With these mandates combined...

The Fed has a primary tool that they use as a balancing act between their two mandates. They started seeing signs of inflation in 2022 and started hiking interest rates to combat the inflation. As long as unemployment remained low (their other mandate), they could maintain high interest rates.

You can see this pattern here. The blue line is unemployment (lower is better), and the red line is interest rates:

⁠

You’ll notice that unemployment is starting to trend just a little bit higher in the last few months. In previous updates, I’ve noted the mass amount of layoffs and how the layoff numbers can be skewed so they are likely much higher than we actually predict.

I’m drawing a lot of attention to this because it’s a pretty big warning sign when the Fed has decided to react to unemployment measures. They are hoping to find the happy place between inflation and unemployment, but it could also go the other way, where unemployment goes much higher.

US household debt has increased⁠

, although it’s still considered stable, and Jamie Dimon, CEO of Chase, still

sees a recession ahead⁠

This cut also gave a spike to the overall market because it’s “easier to get returns” when money is cheaper.

China also cut their rates⁠

which also caused Chinese stocks to spike.

Climate damage

Something that has started to pop its head up more and more and beginning to enter the financial space is climate change and its effect on the economy (something that turns most people’s heads). The amount of large storms and large bills attached to the storms, attributed to climate change, are increasing.

⁠

The trend seems relatively clear. At this moment, Hurricane Milton, potentially the “

storm of a century⁠

”, is hitting Florida. Florida hasn’t fully recovered from

Hurricane Helene⁠

just the week prior.

The

US hit its 4th hottest summer on record⁠

, while the world as a whole hit its hottest summer on record (though our records aren’t that long).

⁠

San Francisco Bay Area, my home, just broke records yesterday on the hottest October 5th in history.

Other than the obvious concern for our planet, it has begun to affect investing decisions.

Would you buy a house property in Florida? Are you invested in any insurance companies that might have to pay out more weather damage? Is buying appliance companies (that make AC) a good buy for places like the Bay Area, where historically the houses were built without them? Does it make sense to invest in “green”, climate-focused funds to help combat the problem?

I don’t have answers to most of these right now, but I’m certainly thinking about them.

Upcoming presidential election

While presidential elections don’t necessarily have an impact on investing, tax policies do. Trump is generally considered to have “much better” tax policies for business (tax less) and Harris has tried to create a“tax the rich” policy by taxing unrealized gains (something I’m viscerally against, even though it doesn’t affect me. Here’s a decent breakdown of why it’s a

bad idea to tax unrealized gains⁠

.) Looking at CEOs and other famous millionaires and billionaires shows that

they are pretty split⁠

on who they support.

Some other funny things happen with new presidential candidates. Oftentimes, if one candidate is threatening to do something like take aware firearms, firearm companies will see a huge surge in buyers and those companies’ stock price will shoot up.

AI hype

AI has been the word of the year in pretty much every major company. If you want to get investors interest, say the word “AI”:

⁠

The question is, does the value match the cost? Sequoia Capital is one of the longest-running and best-performing venture capital funds that has ever existed, and they wrote a really poignant piece called the

AI’s $600B Question⁠

which uses rough math to illustrate that we should be seeing about 600 billion dollars more in value then we are seeing right now, per what we are paying. This shouldn’t actually be a surprise, through most technological breakthroughs you can expect people to pile in money and run into a bubble, which then “pops” at some point. That doesn’t mean the technology wasn’t valuable (think of the late 90s and .COM bubble), it absolutely is, but we might be overpricing where it’s at.

There has been a huge burst of new AI companies, but most of them are shallow ideas with no real backbone. In fact, on venture firm

returned its money to its investors⁠

because they couldn’t find good companies to invest in.

The lion’s share of revenue is split between Nvidia and Open AI, and both have some potential future problems. Nvidia, which makes the main chips that are used in AI, might be hitting a saturation point. At the end of 2023, the demand was much higher than the supply, but end of 2024, most companies have all the chips they need. Pricing is coming down, and while they will continue to make better chips, it seems unlikely that a giant push will be maintained throughout the coming years.

Open AI, on the other hand, faced a coup earlier this year where they removed the CEO Sam Altman for being deceptive with the board, but then the entire company backed him up and he was back as CEO five days later. That said, there have been many complaints that Sam Altman has been neglecting the safety aspect of AI — the idea that AI can cause significant harm to the world at large if not safely guarded against and part of its original charter. In addition, OpenAI started as a non-profit, and in the last week moved to make itself a for-profit company. With this change came a

wave of execs leaving the company⁠

One of the original founders who left when Sam Altman returned as CEO started his own company, specifically targeting AI Safety, and it gained major backing very fast.

⁠

All of this to say is that there is a lot of hype around AI, and it’s unclear if the value will back it up. At the same time, there is tremendous concern over the safety of AI and the tremendous potential that AI could bring us. If you’re interested in books, here are two:

⁠

The Singularity is Nearer⁠

by Ray Kurzweil - a positive outlook

⁠

Superintelligence: Paths, Dangers, Strategies⁠

by Nick Bostrom - a negative outlook

Until next time

It’s been great investing this last quarter, and as always, please send me any questions or comments you may have.

Cheers, Kerry

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