In early 2021, Dinakar Singh, the founder of Axon Capital, warned investors in a client letter that interest rates would be rising, “and massively.”
“We think sharply rising rates is both an opportunity and a risk,” Axon said in the letter, obtained by Institutional Investor at the time. “Ultimately, it is the key factor that will challenge soaring equity market valuations, and that is already starting to happen. Therefore, whether for offense, or for defense, one must be positioned for rising rates.”
At the time, the firm also predicted that by late 2021 and into 2022, “travel/leisure/service companies will not just recover, but likely experience several years of extraordinary business, well ABOVE typical and normal levels.”
Sure enough, Axon finished 2021 up 24 percent, after being up 30 percent in the first two months of the year. And the firm has continued to surge this year, gaining another 14.72 percent through May, according to a person who has seen the results, at the same time that the widely followed stock benchmarks have fallen by double-digit rates.
“Despite the wild mood swings of markets and investors, our views have been quite consistent for much of the past 18 months,” Axon told clients in its first-quarter letter recently sent to clients, excerpts of which have been viewed by II. “Looking back at our investment outlook from early 2021, it’s been remarkable how fortunate we were in some of our predictions.”
Singh is a former Goldman Sachs partner who co-founded TPG-Axon Capital Management in 2005. He ran as much as $13 billion in 2007, but a string of losing years sent investors scurrying for the exits.
Recently, however, the firm — now called Axon Capital, with Singh and Kori Estrada serving as co-CIO and co-CEO — has been on a roll. It was up 17 percent in 2019, 73 percent in 2020, and 24 percent last year, and this year’s gains have come despite the market selloff. In fact, at the end of the first quarter, the firm, which manages more than $700 million, had devoted only about $43 million to just eight U.S. long positions.
Axon told clients in the recent letter that gains this year have been driven by three strategies.
First, since late 2020, Axon has made several different bets on 30-year interest rates rising sharply. These include “swaptions,” which Axon explained would pay off if rates rose above 2.5 percent, which has happened.
Looking ahead, Axon expects 30-year rates to be in the 4 percent to 5 percent range by year-end. “With the Fed no longer suppressing rates, logic will now prevail,” it explained. “Simply put, if short-term rates rise to even just 2.5 percent, and structural inflation settles down at 2 percent, then obviously long-term rates like the 30-year will be at 4.5 percent or higher.”
Axon has also benefited this year from shorts in markets and in various stocks, according to the letter. “As we became more cautious last year, we generally reduced our market exposure levels substantially, and particularly avoided countries/sectors/companies that we expected would be losers in the changing environment,” Axon explained. “In particular, that would include low-margin companies of all kinds, but particularly retailers and low-margin manufacturers.”
Finally, Axon has benefited from what it deems to be “opening” investments, especially travel-related companies, which Axon still thinks “selectively provide significant upside.” It pointed to Playa Hotels, the all-inclusive resort owner. Since its early April 2020 low, the stock has swelled more than five times.
Axon said it has also taken sizable stakes in payments companies “that are both winners from inflation” and “specifically linked to travel trends.” Fidelity National Information Services, its second-largest U.S. long, is one example.
“At the simplest level, staying long attractively valued companies with high margins and high-quality franchises [that are also] positively impacted by inflation and reopening, while avoiding exposure to companies that were low-margin and linked to goods manufacturing and production, has been very fortunate for our portfolio,” Axon added.
Looking ahead, Axon said that it’s “a bit more sanguine on the overall market outlook” than it has been since mid-2021.
“Rates will rise further, and growth will slow, but much of that is now understood,” it explained. “We still wouldn’t just be ‘long the market,’ but one can now find many stocks that are cheap by almost any standard, and have great long-term prospects.”
And although Axon expects long-term rates to rise to 4 percent to 5 percent, it stressed, “we don’t think that is the end of the world,” noting that that’s where they were in 2005 and even 2012.
Axon also believes that inflation will subside, particularly in goods prices, but conceded that we’re now in a ‘new era’ where labor and infrastructure limitations will result in a persistent level of moderate inflation. “We think it will be an extraordinary stock-picking environment, given the huge skews in economic and company performance,” Axon added.
