Top 5 Picks for 2023
“When the facts change, I change my mind - what do you do, sir?”
John Maynard Keynes
As we entered 2022, we said on our CNBC interview on 12/29/21 that the S&P “down 20% is very likely at some point during the year if not more” despite the S&P hitting new all-time record highs. This view combined with flexible thinking allowed us to make money in 2022, while many funds struggled.
When thinking about my top picks for 2023, the first thought that came to mind was how volatile this upcoming year could be. There are many potential variables, both positive (eg. potential peace in Ukraine, China exiting zero Covid, Japan exiting yield curve control) and negative (eg. higher than expected wage inflation, real-estate implosion, tech demand slowdown) that are changing at a rapid pace. The speed and impact of these constant changes on the market brings to mind the investing environment of the Global Financial Crisis and the Tech Bubble.
Whether it is inflation numbers, growth data, or large market moves, each new piece of information requires me to evaluate my current position and adapt. To paraphrase Charles Darwin in the Origin of Species, “It is not the most intellectual or strongest of the species that survives, but the species that is best able to adapt and adjust to the changing environment in which it finds itself.” This focus on flexibility on a DAILY basis has helped us to generate positive returns in 2022 for my Satori hedge fund while others of my species died.
In summary, my two overarching investment themes from 2022 remain for 2023:
The reasoning behind these two investment themes is the persistent issue of inflation staying higher than expected, which is the #1 enemy for the Fed and consequently your investment portfolio. 55% of core PCE inflation (the Fed’s preferred measure) is services excluding housing, which is driven by wages increases (AHE +5.1% y/y). These wage increases are being driven by the 1.7x more job openings (10M+) than unemployed (6M+). While we are hearing a lot of headlines from big tech names laying off employees, it is important to remember that over 75% of jobs in the US are not from public companies. As a result, you will probably need a hard recession to kill 4M "excess" jobs to drive down wage inflation.
What does a recession mean for the stock market?
A bear market performance for the S&P without a recession typically averages just under a 30% loss. The S&P declined 25% from its peak on January 3rd to its closing low on October 12th.
If in 2023, we do not get a recession or it is mild, we may have seen the lows already for this downturn. However, we do think we will get a recession and it is likely to be closer to severe given there are 4M “excess” job opening that will need to be destroyed to get wage gains under control.
A bear market that is accompanied by a recession typically results in an S&P decline of over 40%, indicating that we have not seen the lows for this downturn yet. 3000 is our single point estimate on the S&P in this scenario with 2400 being our downside case.
Our Top 5 Picks for 2023 are:
Given our expectations of the S&P hitting 3000, these are hedged with shorts in:
We expect initial guidance to be horrible for 2023 when companies report poor Q4 results, especially in the technology sector. For example, we think it is likely that high profile stocks like $AAPL will pre-announce negatively in the first week of January. In a similar vein, we expect $TSLA to miss Q4 delivery expectations. How the market and these two stocks react to these events will determine how we position for Q1 results. Do we get another bear- market rally to start the year or do we head back to the lows in October driven by poor Q4 results?
We actually bought $TSLA on the long side for the first time since 2019 in December. We made money on both our short and long position in 2022 though we do not own it currently.
We believe demand will take another step lower between now and the end of 2023 given
There are also negative tail risks from
There are only two drivers that determine the price level of the S&P, earnings and the multiple applied to those earnings. Multiples began to contract early in 2022, with earnings estimates peaking in June and then starting to decline for the first time in two years. Looking at the behaviors of these drivers both historically and presently has been a major factor in our thought process when evaluating how early 2023 will look.
Multiple contraction due to rising interest rates has primarily driven the drop in the S&P up until now. The S&P trailing PE peaked at 32.3x in March of 2022 and it is now 18x.
But, during high inflation environments, the trailing PE for the S&P is much lower than average:
Based on this data, we believe that reductions in S&P earnings estimates and further multiple compression will drive the next market move lower. Earnings estimate reductions started for the first time in two years with the Q2 earnings season results and Q3 guidance. The EPS in 2021 for the S&P was $193. The estimate for CY22 is for EPS to expand to $219, which is down from the prior estimate of $229 before the Q2 earnings season. Similarly, the estimate for CY23 is for EPS to expand to $234 in 2023, which is down from the estimate of $252 at its peak in June before Q2 earnings.
We think the estimate for CY23 will eventually be closer to $200 from its peak of $252 when looking at earnings reductions during prior recessions. In 2022 these estimate cuts led to drops in the stock market and we believe the same will hold for 2023.
Our single point price target for the market bottom on the S&P is 3000 derived from 2023 S&P EPS of $200 with a 15x multiple. At the low end we can see the S&P reach 2400 based on a 12x multiple which is not unreasonable at inflation levels above 5% historically.
However, it is important to note the decline downwards is rarely a straight line, as rapid and significant rallies in the S&P often occur during bear markets. While the S&P went down 49% during the tech bubble and 57% during the Global Financial Crisis, there were five rallies between 18-21%. Each time, people were quick to call the bottom despite the fundamentals still getting worse. To put this in perspective, the compound annual price return for the S&P over the past 70 years is under 8%.
Even during 2022, we saw the S&P rally seven times with an average gain of 9% while it finished down 19% for the year on a price basis.
With so much complexity and volatility in today’s investing environment, how should investors be positioned to start the year?
TOP 5 PICKS FOR 2023
#1) CASH IN 3 MONTH TBILLS
#1) Cash - This remains our favorite investment in 2023 just like it was in 2022. While the singular focus of my fund is to maximize reward while minimizing risk by trading the market daily, not everybody can trade daily. Particularly for those of you who cannot trade this market daily, cash is king. Sitting on cash allows us the flexibility to reinvest if the S&P goes lower in 2023. Rather than guessing whether stock prices have gone down enough, cash allows us to wait for the fundamentals to bottom and make calculated investments that maximize reward while minimizing risk. Moreover, that cash can also be invested in 3-month treasury bills earning about 4.3% per annum to start 2023 versus just 0.03% to start 2022. You are essentially being paid for your patience to wait until the risk to reward is in your favor.
#2) $XLV - No one wants to die and many of us (including myself) have put off going to the doctor since Covid. The healthcare sector typically outperforms during recessions. When the S&P dropped 37% in 2008, the healthcare sector dropped 23% while the riskier S&P biotech subsector dropped 8%. Over calendar 2000 & 2001, the S&P dropped 19% over this 2-year span, while the healthcare sector gained 22% and the biotech sector gained 19%. In 2022, the S&P dropped 19% while the XLV dropped only -4% while the XBI was down a hefty 26%.
On a single stock basis, we are interested in companies focused on obesity, Alzheimer’s, and cancer. However, many of these names have already performed relatively well in 2022. Therefore, we believe the diversity provided by the healthcare ETF $XLV helps minimize this potential downside risk for the average investor. For those comfortable with a higher risk strategy, $XBI is our preferred biotech ETF given its greater than market drop in 2022.
#3) $URA - Commodities should continue to do well as a result of underinvestment in capacity expansion over the past decade. In particular, we like uranium, oil, and copper.
Since the disaster at Fukushima in 2011, nuclear as a source of energy production was significantly curtailed over the next decade. However, with Russia invading Ukraine, the world is looking again to nuclear for clean energy and as a means of gaining further energy independence from Russia. We expect Uranium related names like to perform well and the $URA ETF is a great way to get diversified exposure to the space.
We like $USO for oil as The Strategic Petroleum Reserve is down to the lowest level since 1984. Beyond that, the Biden administration has initially talked about refilling reserves at around $70 although recently this changed to $80. This was a top 5 pick of ours to start 2022 and finished up 29%.
Lastly, we like $FCX to get exposure to “Dr. Copper” as it should benefit from the ramp in EV sales as the world moves to clean energy.
We like commodities in general as China, the world’s largest buyer of most commodities, now exits their zero Covid policy, but we think these spaces should benefit the most and $URA is our top pick.
However, picking the right entry price point for a commodity is essential for successfully investing. Unlike stock prices that can go up infinitely, commodity prices operate more cyclically. High commodity prices destroy demand, which then lowers that commodity’s price, which in turn helps increase demand.
#4) $MUFG - Japanese banks should be significantly more profitable as their treasury yields go higher. On paper, shorting Japanese government bonds (JGBs) over the past two decades made sense as government debt exploded higher. However, the Bank of Japan (BOJ) continued to cut rates to below zero as deflation was their main enemy while at the same time buying JGBs. These two behaviors in tandem were the primary drivers that allowed JGBs to soar higher despite fundamentals suggesting otherwise. As a result, shorting JGBs was commonly referred to as “the widow maker trade.”
As of late December, we think that trend changed. The BOJ finally seemed to acknowledge rising inflation by loosening their yield curve control. At the same time, they raised their inflation forecast to 2.9%, the highest annual rate since 1989. As a result of these changes, we believe rates will eventually rise, especially with the appointment of the next head of the BOJ in April.
With this looming change in mind, we believe that buying Japanese bank stocks presents a potential opportunity for equity investors. For two decades, Japanese banks have had to contend with JGB 10- year yields consistently below 2% and occasionally straying into negative yields. Since listing in Japan on April 2nd of 2001, 8306.JT (Mitsubishi UFJ Financial Group) is down 27% while the Nikkei is up 102% & the S&P is up 235%. However, this December saw JGB 2Y yields turn positive for first time since 2015. Therefore, Japanese Banks should now be finally able to make decent money lending. To position our own fund for this opportunity, we own a basket of names including Mitsubishi UFJ Financial Group ($MUFG) which is the ADR of Japan’s largest bank.
#5) $META - Meta looks to be a solid long as we believe the stock is undervalued relative to what it should be. We think the biggest contributor to Meta’s undervalued stock price is how much money they are spending, which has negatively impacted the company’s valuation, as it trades at an 11x CY22 PE vs the S&P at 18x and the largest internet advertising-based company, $GOOGL, which trades at 17x.
We would also note that META has suffered arguably more than any other company from:
However, Meta’s Instagram Reels product (which competes with TikTok) went from an annual run rate of $1B in revs in their June quarter to $3B in revs in the September quarter of 2022, with user growth and engagement remaining surprisingly solid.
Moreover, the spending that offsets META’s earnings, particularly spending on the Metaverse, is fully within their control to regulate. Their recent actions including cutting spending plans just two weeks after giving guidance indicate that future spending will have more scrutiny going forward.
While we are wary of tech stocks in general, particularly those related to advertising spending (which declined over 20% during the 2008/09 recession), META is worth owning on the long side. The stock is down nearly 70% from its highs and Meta may be one of the few companies that sees its multiple expand while multiples for the market decline in 2023. But both $DIS and $NFLX starting an ad supported streaming tier in Q4 will take away online ad revenue dollars from existing players including $META. As a result, we are hedging our risk by pairing a long position on Meta with short position in online & offline advertising related companies with higher valuations.
My General Investment Strategy & Outlook for 2023
To decide whether my investment advice is suitable for you, I believe it is important that you understand my investment style. My goal is to produce good RISK ADJUSTED returns while minimizing downside risk during periods of severe stock market declines. In keeping with this principle, our net exposure (% of fund invested in long positions minus % of fund invested in short positions) has averaged just ~25% over the lifetime of the fund but produced over 80% of the return of the S&P.
Our end goal is to be greedy long term. It is easy to take on enormous amounts of leverage/risk and speculate on meme stocks, crypto, concept/innovation stocks and other volatile sources to make enormous short-term returns in a bull market. However, the risk of losing multiple years’ worth of returns when the market turns is extremely high. At the Satori Fund, we emphasize disciplined risk adjusted investing to ensure that investors not only are protected, but can even profit in both bull and bear markets.
For example, on a total return basis including dividends:
The math behind our philosophy is simple: if you lose 50%, you must be up 100% to get to even. Therefore, risk management is crucial to ensure long-term success. Having come off a 13-year-old bull market fueled by unprecedented fiscal and monetary stimulus; risk management is going to become ever more important as we move forward.
Our commitment to our principles of risk management and disciplined investing has allowed us to consistently succeed against the Hedge Fund Return Index while many other hedge funds have come and gone. As of now, we have almost doubled its return since our inception over 18 years ago.
When I can, I try to update major changes to my thinking that I can disclose on Twitter under @DanielTNiles with more expansive thoughts on my website danniles.com.
For those of you who want all the information available including fund performance, we can only disclose this if you meet the government criteria for being a “qualified or accredited investor.” Please go to https://invest.thesatorifund.com/register to see if you qualify or use the following button below.
All the best for you and your investments in 2023,
Dan & the Satori Team
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We are removing Google from our Top5 Picks for 2022 and recommend investors stay in cash. As a result of their greater market share of the total ad market today, we believe estimates for advertising based internet companies like Google & Facebook are more at risk than is commonly believed.
In 2021, Google reached $258B in revenues (29% of ad industry rev) while Facebook was $118B (13% of total ad industry rev) with digital ad spending in total have grown from 12% share to 2/3rds share of the total $900B ad market over the past 12 years.
During the Great Recession of 2008-2009, Google revenue was only $24B or 3% of ad industry rev while Facebook at $777M was 0.5% in 2009. Both companies were able to grow during that downturn as the internet was gaining momentum as an advertising medium with only ~12% of ad spending online.
But both traditional and digital ad spending is likely to get hit over the next 18 months during a recession. During the 2008-09 Great Recession, US ad spending declined by 6% in 2008 and by 18% in 2009. This decline for two consecutive years last occurred in 1940. Digital ad spending, however, was up slightly in 2008 and down only mid-single digits in 2009. I believe history has skewed peoples view of the resiliency of the online ad market. Google in fact saw revenues increase by 31% in 2008 and by 9% in 2009 as the internet economy gained share. The much smaller Facebook saw revenues grow 78% in 2008 and 186% in 2009.
The launch of the iPhone in January of 2007 also helped shift viewing habits online as you could essentially surf the internet from anywhere versus from just your PC. This drove even more ad dollars online despite a recession.
We thought Google should have been able to outperform the overall market even during a down 30-50% decline in the S&P during a recession given their prodigious cash generation, reasonable market valuation and focus on future innovations. However we believe the dollars available to all online ad companies going forward including Google will also be less than we originally thought due to share gains over the near-term at:
1) TikTok (~$4B in revs in 2021 and projected to do $12B in 2022),
2) Amazon ($31B in ad revs in 2021 & up 33% in Q4 as it ramps its focus on their ad business)
3) Apple (~$4B in ad revs and up over 3x in 2021 driven by privacy changes)
4) Netflix (coming before year-end which could be a big drain in ad dollars given they have over 20% of US streaming audience share).
Netflix on the margin tipped it for us with our Google recommendation as some people will switch to a cheaper ad supported tier during a recession. Netflix has 222M global subscribers currently. That is a fair bit of ad inventory that could potentially be added to the market. We have already seen the damage TikTok has caused at Facebook.
Finally, with the world slowly opening up, people are spending time away from their screens as they go engage in leisure & travel activities. This will cut the amount of time consumers are on the internet and reduce monetization opportunities for Google.
In summary, as a result of our belief in 1) an impending recession, 2) online advertising share gains at TikTok, Amazon, and new entrant Netflix, and 3) less time spent by consumers online as they engage in travel & leisure activities, the ad sector (both traditional and online) is an area where we have short positions currently. We think street consensus of 34% revenue growth at Google and 22% at Facebook over the next two years is optimistic to say the least.
At some point in 2023 when the market hits its ultimate bottom, Google will be one of the first names we buy for the long-term given their culture of innovation, solid cash generation and reasonable multiple compared to their long-term growth potential.
Top 5 stock picks for 2022
Recap of our top 5 Stock picks for 2021
Our top 5 picks for 2021 are up a solid 25% on average through 12/28/21 following a powerful 60% return in 2020 for our Top 5 picks. While our top 5 picks for 2020 were technology focused ($AMD $DIS $FB $LITE $NVDA), our top 5 picks for 2021 had a value reopening bias and were $XLE $JPM $ORCL $MGA $BETZ (replaced $GAN on 1/19/21)
$XLE (up 48% YTD) benefitted from oil prices that rose over 50% in 2021 as investors gained more confidence in the world surviving the global pandemic and slowly reopening. We see Covid by late 2022 being more transmissible but less lethal with each mutation as is common with most viruses. Furthermore, we will have the development of more vaccines, including oral pills, and home testing capabilities. A year from now, we see Covid being viewed much like the flu which still kills 30-40K people each year in the US but is an acceptable risk of living life. When global mobility returns and manufacturing bottlenecks ease, crude consumption of roughly 96M barrels per day in 2021 could rise in 2022 to surpass the pre pandemic record of 99.6M in 2019. At the same time, supply will be restricted by environmental considerations. This should pressure oil prices higher in 2022. We continue to like this sector but with a different investment as you will see in our Top 5 Picks for 2022.
$JPM (up 25% YTD) benefitted from 10-year treasury yields that rose from 92 bps to 148 bps as investors gained more confidence in the world surviving the global pandemic and slowly reopening. As easy monetary and fiscal policies get dialed back in 2022, corporations and individuals will increasingly have to turn to the banking system for their financing needs going forward. In addition, as rates head higher in 2022, this will allow banks to lend at higher levels and increase their profitability. Valuations at a discount to the S&P combined with solid dividend yields should enable the sector to be also more defensive during market turbulence. We still like exposure to the banking sector for 2022. We continue to like the financial sector but with a different investment as you will see in our Top 5 Picks for 2022.
$ORCL (up 37% YTD) saw investors rerate their valuation multiple higher based on improving prospects for their cloud business as we predicted. Their pending acquisition of $CERN has disrupted the upward momentum in their stock driven by their cloud business. However, we believe at some point the stock will bottom and have a solid 2022 given the longer-term merits of the acquisition on their earnings, cloud revenues and healthcare business.
$MGA (up 13% YTD) surged to start the year (up 47% by 6/4/21) as a cheap play on Electric Vehicles but gave back most of those gains as semiconductor shortages affected production. We still like exposure to the EV theme over the longer-term but are exposed to it through a long position on $GM (0.6x 2022 EV/Sales) hedged with shorts on the more speculative EV car manufacturers (OEMs) (~25-30x 2022 EV/Sales.) These shorts we trade frequently given their high volatility and retail investor driven moves. Overall, we believe that EV industry revenues will continue to grow at over 25% per year for the next 5+ years as countries and OEMs try to reach their EV goals. We prefer a value-oriented approach to investing in the EV space in 2022 as Central banks raise rates which is likely to compress multiples in the market for long duration, unprofitable names with high valuations. In addition, even industry leader Tesla had to struggle with issues when they ramped manufacturing. Supply chains today are still challenging with the traditional car manufacturers all trying to ramp their EV vehicles as well. This is likely to create manufacturing issues for the newer pure EV public companies.
$BETZ (down 5% YTD.) We replaced $GAN, up 16% from 12/31/21-1/19/21, with $BETZ, up 11% from 12/31/21-1/19/21 (see danniles.com/articles/01-19-2021) as a top pick given our concerns around $GAN or any individual investment in the space. The combined return was flat YTD ($GAN up 16.4% from 12/31/21-1/19/21 minus $BETZ which lost 14.4% from 1/19/21-12/28/21). In hindsight, we should have been more concerned. $BETZ was our worst pick and went from being up 27% on 3/15 to down 5% YTD. This was due to a combination of: 1) a high tax rate in New York on online sports betting; 2) intense price competition for customers; 3) greater variability on sports book profits; 4) pushed out profitability on greater investments; and 5) China regulatory and Covid related issues in Macau. In particular, the increasing focus on profits by investors in 2021 offset the positives of ongoing strong revenue growth of the industry. For example, sports betting bell weather $DKNG should see revenues roughly double this year while the stock is down 39% YTD. We also think tax loss selling and window dressing by portfolio managers has also punished the space into year-end. However, we still see many tailwinds for the sports betting space despite stock price performance this year. State legalization of sports betting is at nearly 30 states today with roughly 20 allowing online betting. Continuing legalization and more in game sports betting will be a tailwind for the next several years. Much like the surge seen in e-commerce names following the shakeout during the tech bubble ($AMZN’s stock went from $106 to $6 from peak to trough) we think the same recovery will occur in online sports betting as the space continues to mature and the path to profitability becomes clearer for the long-term winners. Internally, our investments are more focused on the data providers to the sports betting companies hedged with shorts in the unprofitable sports betting operators.
Top 5 stock Picks for 2022
As we look into 2022, our portfolio is built around 4 themes: 1) inflation remaining higher than expected following multi-decade highs; 2) the removal of unprecedented stimulus and subsequent raising of rates; 3) the stock market valuation compressing from record levels; and 4) the acceptance of Covid as endemic.
With this as our backdrop, our top 5 picks for 2022 are: 1) $USO, 2) $KRE, 3) $FB, 4) $GOOGL and 5) cash.
$USO: As noted earlier in our recap of the $XLE, we believe oil prices will continue higher as demand in 2022 could surpass the record levels seen prior to the pandemic while supply remains restricted by environmental concerns. We debated staying with the $XLE for the reasons noted earlier in our recap but note 43% of the ETF is comprised of just $CVX and $XOM which are up 50% and 41% YTD, respectively. This is not the same setup as in 2020 when they were absolutely hated and down 30%/41% respectively versus the S&P gain of 16%. As a result, we recommend the $USO which tracks the price of West Texas Intermediate crude oil as a top 5 pick for 2022.
$KRE: As noted earlier in our recap of $JPM, we believe rates are headed higher and loan growth will pick up as easy money from fiscal & monetary policies get dialed back. We debated continuing with $JPM as a top pick for 2022 given our belief that it is the best run bank in the world. However, we prefer more domestic banking exposure this year to avoid any potential pitfalls from divergent central bank policies globally. In addition, there is the growing risk of international conflict with: 1) Russia over the Ukraine; 2) China over Taiwan; and 3) Iran over nuclear. $JPM has roughly 25% of its exposure to international markets. Super regional banks are certainly an option which is how internally we have created our exposure to the banking sector. However, there is company specific risk. As a result, we recommend the $KRE which is a regional US bank ETF which is well diversified with a 2% position as its largest holding for those investors who want diversified, less risky exposure to financials. Most investors track loan profitability by watching the 10-year minus 2-year or just watch the 10-year as a shortcut. However, we would recommend watching the 5-year minus the 3-month treasury yield which more closely tracks loan profitability. The second factor to watch is loan growth which should pick up with easy monetary and fiscal policies being reduced.
$FB: If you believe in the metaverse, why not invest in the company that has gone “all in” on the space. Facebook’s expense guidance for 2022 is being driven by investments in the metaverse with operating costs for 2022 guided to $91-97B, up ~33% from 2021 while capital expenditures of $29-34B were guided to rise ~66%. However, with street expectations for revenue growth of just 19% this has driven EPS growth expectations to just 3% in 2022. Historically, Facebook has guided conservatively and therefore we believe expense growth will come in lower than expected. Furthermore, the monetization of newer properties such as Reels and Shopping will help drive revenue growth in 2022. Additionally, the stock has a depressed multiple at 22x that is roughly the same as the S&P at 21x. This is due to: 1) expense concerns; 2) ad tracking issues; 3) engagement concerns due to competition such as TikTok; and 4) regulatory pressures from the US and abroad. We believe most of these issues will slowly improve as 2022 progresses resulting in multiple expansion.
$GOOGL: As economies reopen, Google will benefit from Covid affected industries, that comprise 10-15% of revs, fully re-opening by the end of 2022. In 2021, Google suffered from increased regulatory pressure and ad revenue from travel, leisure, and services space still being impacted due to Covid. By the end of 2022, we believe people will adjust to Covid being endemic much like the flu which kills 30-40K people every year in the US. As a result, we believe Google will benefit from the complete reopening of industries that are currently being impacted by Covid. Google also has a CY22 PE multiple of 23x that is only at a slight premium to the S&P at 21x. In addition, Google offers exposure to other high growth themes through its “Other Bets” division such as Artificial Intelligence (DeepMind), Health (Fitbit and Verily), and Autonomous Driving (Waymo.)
Cash: We believe that we will be able to pick up great stocks at much better prices in 2022 and that the value of cash is highly underestimated during periods of turmoil. Despite cash being a poor investment in a high inflation environment, it is probably our favorite investment to start the year due to the flexibility it will give us later in the year to invest at better prices. We believe that in 2022, the S&P will see a significant correction due to: 1) inflation staying uncomfortably high; 2) a Fed that is behind the curve on inflation and more aggressive than expected; and 3) most valuation metrics near record highs that are likely to compress. For example, the market cap of the entire US stock market divided by US GDP is at 1.9x versus a peak during the tech bubble of 1.4x and an average of 0.8x. We would also note that market multiples are typically below average in periods where inflation was over 3%. We plan to invest this cash later in 2022 in a more value-oriented name in a sector such as networking, streaming, or e-commerce.
Best wishes for your investments in 2022,
Dan Niles is founder and portfolio manager for the Satori Fund, a tech-focused hedge fund.