Performance & Fireside Chat - 2025 Q1
Q1 Performance & Fireside Chat
Welcome to J&S Capital's first newsletter.
We performed well during the first quarter of 2025, the first quarter of J&S Capital, with a return of +3.58% while major US indices pulled back.
During Q1, the S&P 500 index declined 4.59%, the Nasdaq 100 index declined 8.28%, and the Russell 2000 index declined 9.79%.
Additionally, while the first few trading days of Q2 have not been fun, we have not been “liberated” from our capital to the same degree the indices have been.
Portfolio Overview
At J&S, our investment strategy contains two different buckets:
The first bucket consists of deep value investments, in which we purchase companies or securities that are trading either at fractions of tangible book value or with very high and sustainable free cash flow yields relative to our purchase price. With asset-based investments, we want to have an ingrained catalyst that will result in an earnings inflection or an ability for the company to realize the value of its asset base.
The other bucket consists of “event-driven” investments, as well as certain other investments that we believe not only have strong return potential but also less correlation to the broader market. Together, this bucket serves as a hedge against market decline, while still providing upside.
When the market is overheated, we will tend to have a larger proportion of our portfolio allocated towards “event-driven” investments and investments less correlated to the broader market. When the market is depressed, we will tend to have a larger proportion of the portfolio allocated towards deep value investments.
It should come as no surprise then that our top performers in Q1 came from the “event-driven” bucket. One such investment combined both an “event-driven” thesis with a business model already predisposed to benefit from market turbulence.
Flow Traders (“FLOW”) is an electronic market making firm based in the Netherlands that focuses largely on the Exchange Traded Products in Europe, the US, and Asia-Pacific. FLOW cut its dividend in July 2024 in order to build its trading capital, which it has historically been able to deploy at 50%-80% ROE. FLOW believed it had the ability to deploy substantially more capital without sacrificing returns. Due to the highly fixed-cost nature of the electronic market making business, a 10% increase in trading capital, for example, should result in considerably more than a 10% increase to average through-cycle earnings.
Furthermore, FLOW’s main drivers of returns beyond trading capital are volume and volatility, and thus FLOW also functions as a hedge against market volatility. Volatility has an exponential rather than linear effect on trading income, and thus higher volatility dramatically increases FLOW’s earnings.
We thought that the Trump presidency would broadly increase volatility in global markets, a prediction that so far has been correct. Higher volatility leads to dramatically higher income. That higher income is retained to boost trading capital. Higher trading capital leads to higher income.
We think the market broadly hasn’t caught on to this feedback loop yet and that Q1 2025 and Q2 2025 earnings, especially considering the volatility environment, should force investors to pay attention to the dramatically increased earnings power and growth potential of the business.
Market Commentary
The first few trading days of Q2 2025 have seen market panic as a result of Trump’s tariff announcements. This has resulted in margin calls, an unwind of leverage, and indiscriminate selling as investors are forced to sell anything they can, irrespective of price.
The market entering Q2 was still bifurcated, with parts of the market considerably overvalued, in our view, and parts of the market fairly valued or simply inexpensive. After April 3rd and April 4th, the formerly inexpensive stocks are in many cases trading below COVID lows while the formerly expensive stocks still largely remain expensive. We believe this has created incredible entry points into very solid businesses.
Once the “sell everything” panic unwinds, we expect many recent additions to our portfolio will see very strong returns, even if the indices continue to decline towards a more rational valuation.
We believe we’re in a very good position to turn a sell-off into a very strong 2025 and 2026. Granted, we’re not going to get too excited too soon, because Trump can be erratic and unpredictable. We could describe our mindset as “cautiously optimistic”.
General Commentary
Q1 was a whirlwind, and the first few days of Q2 have not disappointed either. Prior to launching J&S' new strategy in January, we discussed the overconcentration of both passive and active investment in US large cap growth stocks, the concerning amount of leverage in the system from both retail and professional managers, and the potential “house of cards” effect that may follow when the market was presented with a sufficient catalyst.
In short, a disproportionate amount of global capital has been flowing into the S&P 500 index and the Nasdaq 100 index, amongst others, irrespective of price, via passive mechanisms such as index funds. Studies have indicated that 60% of stock investment is made via passive strategies and also that as much as 80% of passive equity ETF flows globally have gone to US-listed funds.
This dynamic has served as a tailwind for the individual constituents of those indices, and naturally, as passive investment drove up prices, active management jumped on to ride the momentum.
Adding fuel to the fire, retail investor participation is at an all-time high and is largely aimed at the same group of stocks. We believe that the increasing percentage of global capital tied to US-passive investment strategies, combined with many remaining “active” strategies largely mirroring US index funds, has created something resembling a bubble in the S&P 500 and Nasdaq 100 indices and their constituents. We believe this is especially prevalent in technology, AI, and “growth” stocks.
In short, many investors now have implicit overexposure to a narrow group of U.S. large and mega-cap stocks despite believing they have a safe and diversified investment strategy via index funds such as the S&P 500 index. We suspect most professional managers think the same, even if they’re trying to play musical chairs and time the market.
Bubbles typically run until an event causes them to end. That seems like a pretty self-evident statement, but the point is to say that bubbles don’t typically run out of steam on their own. Something causes the steam to run out. In the case of the 2000 tech bubble, Fed tightening, after years of easy money, led to its demise. During the Nifty Fifty bubble, stagflation led to fed tightening and, again, to the end of the bubble.
Our view was, and is, that at some point, a negative catalyst will trigger a sell off. We’ve already had interest rate increases. Maybe tariffs will be that catalyst that finally causes the pop. Or maybe they won’t be and the market will quickly pop back.
Regardless, J&S’s view is that the S&P 500 index is not the “safe and diversified” investment that it’s made out to be. In fact, we think that ironically the overwhelming perception of the S&P 500 index as “safe and diversified” has caused it to instead be “risky and concentrated”. Instead of getting 500 companies, investors largely get exposure to the 8 largest technology stocks, which made up ~35% of the index’s concentration entering 2025 and are trading at valuations that have historically proven unsustainable.
Recall, leading up to 2008, the commonly accepted “safe” method for building wealth was to buy homes, as it was believed that home prices would only go up. We believe that buying the S&P 500 index as a “one decision portfolio” started out as good advice, just as buying homes as investment properties began as good advice.
This is all to say: We think the opportunity isn’t where everyone else is investing, proudly irrespective of price. Generally, this type of setup creates the most risk. The opportunity is where there is less competition. In our view, as less and less capital flows towards active strategies that do not mirror the indices, the greater the opportunity becomes.
J&S Fireside Chat Ep. 1 - April 9, 2025
In additional to this newsletter, we are starting a "fireside chat" series. This will be a short form recording in video & audio to share a little more behind the scenes of what we are looking at, how we're thinking about different events, and any other topics top of mind.
Our first one is now LIVE on...
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