BITO: Rising Tensions in Europe Creates Opportunities for Bitcoin

At launch time, the cryptocurrency was valued at $65K compared to $38.7K today. However, after the dip to the $35K level suffered in the final week of January, things are looking better for BITO, which, it must be mentioned does not invest in bitcoin directly. Still, as seen in the orange chart below, the ETF’s share price is closely correlated to bitcoin‘s, depicted here in purple.

Comparison
Comparison of price performance

My aim with this thesis is to analyze BITO’s performance in the last month when it gained 15.63% compared to the S&P’s negative 2.39% (-2.39%). This period coincided with the Russian aggression against Ukraine and the imposition of economic sanctions by the United States and its allies.

Invasion and economic sanctions benefiting bitcoin

First, the concept of an economic sanction against countries that go against U.S interests whereby their foreign currency reserves are frozen is not something new. Some of these sanctions remind us of the ones imposed on Huawei two years back and which hit the Chinese telecom giant so hard that it lost billions of dollars of sales. Iran has also been previously impacted by sanctions which severely curbed the ability of its banks to trade in foreign currencies.

This time, America and its allies have gone a step further by punishing Russia which happens to be the world’s eleventh-largest economy by nominal Gross Domestic Product and a giant natural gas exporter. Some of the country’s banks have been barred from utilizing the Swift banking network, which severely limits their ability to receive or issue payments worldwide.

Other measures include drastically limiting Russia’s access to European capital markets and crucial technologies including semiconductors, electronic components, and software. Additionally, sanctions that were intended to hit individuals in Mr. Putin’s circle of power like freezing of their assets mostly in European territories have unfortunately reverberated on ordinary citizens as they queued to withdraw foreign currency from local banks.

Moreover, Russia which has about $630 billion of reserves in dollars is being prevented from accessing it. This is a huge amount and means that the idea of the dollar being viewed as a worldwide reserve currency plus a safe store of value is now jeopardized and only applies to countries that abide by U.S. values and interests. This level of currency weaponization is something unprecedented and paves the way for alternative means of transacting or stores of value, with one of them being cryptos.

Also, many are turning to cryptos because of practical benefits.

First, in light of their own currency losing value similarly to ice melting in the sun, crypto represents a safe store of value for Russians and Ukrainians alike. Second, if you are a Ukrainian refugee, it’s easy to transport as people only need to memorize the seed phrase. In comparison, gold and paper-based currencies like dollars or the European euro can be easily stolen by corrupt border guards. Storing bitcoins on an exchange constitutes some risk but is still better than transporting paper or metals.

Furthermore, cryptocurrency donations have poured in to support pro-Ukraine groups with NGOs, and volunteer groups have received 30 million dollars in form of cryptocurrencies since the Russian invasion. Bitcoin donations are also pouring in to support Ukraine’s military because it’s quick and easy, as it bypasses national financial and monetary regulations.

Thus, crypto-assets have emerged as an alternative funding method as they enable cross-border donations that circumvent financial institutions that might otherwise block payments. Also, at this stage, it is hard to see any action by U.S. regulators which may impede the flow of money into Ukraine.

BITO both as investment and trading tool

Increased flow levels led to higher bitcoin demand, but, BITO’s underlying fund does not invest directly in the digital coin as I mentioned above. Instead, as the first U.S. bitcoin-linked ETF, it provides exposure to bitcoin futures contracts. Now, a contract is normally a term used for the commodities market and allows investors to speculate on a product’s future price in order to gain from short-term price movements without holding it. In the case of BITO, it is bitcoin.

As per the fund managers, BITO “also offers investors an opportunity to gain exposure to bitcoin returns in a convenient, liquid and transparent way”.

However, historically speaking, the fund has failed in its objective to provide capital appreciation, at least for those who have held it from inception as illustrated by an initial investment of $10K being worth less than $7K today.

capital appreciation
Growth of $10K invested in BITO (www.proshares.com/our-etfs/strategic/bito)

Still, due to the liquidity factor and the fact that it is volatile, BITO can enable traders to achieve considerable gains. An example is an investment done around October 27 when the share price was around $38 being valued at $43 just two weeks later.

For this matter, BITO’s average daily share volume at 8 million is nearly eight times more than the Valkyrie Bitcoin Strategy ETF (BTF) which was incepted just days after BITO and also holds future contracts. The ProShares ETF has $676 million of assets under management compared to only $33.58 million for its peer. Both ETFs charge fees of 0.95%.

comparing
Comparing BITO and BTF (seekingalpha.com/symbol/BITO/peers/comparison)

Thus, investing in bitcoin futures contracts through BITO allows investors to better profit from short-term price movements regardless of the long-term direction and this is helped by the fact that crypto enjoys international recognition, making it suitable for everyone at anytime and anywhere in the world.

The risks and the long term rationale

However, keeping and paying with bitcoin comes with risks as the value of a currency is largely dependent on people’s trust. The trust level shot up with the events in Ukraine mainly due to erosion in confidence in traditional or fiat currencies caused by uncertainty. However, cryptocurrencies remain largely unregulated, extremely volatile, and not completely immune to hacker attacks due to the fact that they are digital in nature.

Still, relativizing risks, I consider that in view of heightened tensions in Ukraine, high-inflation concerns in Europe due to rising energy costs, and the euro losing ground against the dollar, there are more opportunities for bitcoin which is based on blockchain software residing on a decentralized network of computers around the globe.

Thus, virtually available bitcoin now looks relatively less vulnerable compared to physical currencies sitting in central banks whose dollar assets may not prove useful when most needed, depending on whether their leadership is aligned with the West.

The above factors should gradually contribute to making crypto assets more central to finance and payments.

Therefore, given the possibility of other countries being sucked into the conflict, there could be wider adoption of crypto somewhat similar to El Salvador where there was a decision to adopt bitcoin as legal tender last year. Even if governments do not go that far, some Eastern European leaders may order their central banks to diversify some of their dollar assets into bitcoins as a precautionary measure.

There is another factor that should increase demand for digital assets.

For this purpose, in addition to the crowd funding aspect, whereby the objective is to raise funds from common people for supporting Ukrainians, there are also projects based on Non-Fungible Tokens or NFTs.

Thus, OpenSea, the largest NFT marketplace is hosting a collection of unique artworks by Artists for Peace and collectors can bid for about 60 pieces in Ethereum (ETH-USD) with the proceeds going towards supporting the Ukrainian people. Now, Ethereum is different from bitcoin, but, as the second cryptocurrency by market valuation, its wider usage should give support to the crypto world in general.

Coming back to BITO, for those who have held to their investments, the ETF represents a safe way to remain invested in the cryptocurrency without risk of theft or misappropriation.

Finally, my bullish stance is firstly reinforced by crypto breaking its correlation with (or decoupling from) the tech sector as I had initially pointed out in my article on the Grayscale Ethereum Trust (OTCQX:ETHE) two weeks earlier. Hence, BITO (in blue) is now outperforming the Invesco QQQ Trust (QQQ).

Chart Data by YCharts

Second, according to Zero Hedge, there are reasons to think that the surge in bitcoin’s value and by ricochet BITO’s share price was more the result of investors expecting a surge in demand from Russia than an actual increase. Thus, more crypto demand should sustain the ETF’s upside. Meanwhile, demand for gold as a safe haven asset is up showing that established hedging mechanisms still work.

Taking into consideration these factors I am bullish on BITO for the long term, but do not exclude a surge to $30 by mid-2022, a level last reached at the end of December. This should be also driven by more support from institutions like Citadel, the largest U.S. market maker which is now more favorable to bitcoin.

Finally, at $23.53, BITO is currently available at a slight discount to NAV of $0.03.

Choosing Between Ethereum and Bitcoin Amid Heightened Macroeconomic Risks

As for cryptos, while it’s hard to know where prices will end up over the short to medium-term, not all of them have been impacted in the same way. This is evident by comparing the one-year price performances of the two with the largest market cap, namely Bitcoin and Ethereum. For this purpose, instead of looking at individual companies, I analyze the performance of the Grayscale Bitcoin Trust (GBTC) and the Grayscale Ethereum Trust (ETHE).

Here, the Ethereum trust has been outperforming its Bitcoin peer by nearly 50%.

Source: Trading View

With assets under management of $23 Billion, GBTC tracks the Bitcoin (BTC) market price and charges fees of 2%. As for ETHE, it covers Ethereum (ETH), exhibits $7.5 billion of assets and carries 2.5% of fees. Both are investment vehicles which have attained the status of an SEC reporting company, with one of their advantages being ability to provide investors with exposure to BTC or ETH in the form of securities while avoiding the challenges of buying, storing, and safekeeping cryptocurrencies directly.

Coming back to the difference in price actions, this needs to be understood in the context of their individual uses, but, first, I bring some clarifications as to the concept.

Analyzing the cryptocurrency concept

Although the concept of the cryptocurrency shines with its allure, it remains obscure for many people until they hear about its aptitude at providing sky-high gains, and, conversely, also suffering from vertiginous drops. For this matter, there is also a lot of publicity around crypto being a Ponzi scheme, which is far from the truth.

Had this been true, reputable institutions would not have invested their money in digital coins. Moreover, in contrast with Ponzi schemes that require a constant flow of new money to survive, Bitcoin and Ether have not only survived several crashes but there are other new coins that are minted every single day.

Pursuing further, those who have put their money into Bitcoin in mid-2021 and before are still up, despite all the latest volatility. Still, people primarily invest in cryptocurrency due to its high-growth feature and thus its ability to multiply the value of their financial assets in terms of dollars rapidly. This said, Bitcoin still has to strike the right balance between a means of payment and a financial asset. This virtual currency is above all a potentially profitable investment.

Gauging the marketplace, Bitcoin remains very popular with retail investors who, in addition to the ETF or trust formulae, can buy it from dedicated cryptocurrency platforms or mainstream brokers, just like the purchase of shares on the stock exchange. Looking further, FinTechs like PayPal (NASDAQ:PYPL) also offer services like crypto wallets.

Scanning the corporate space, Bitcoin has been adopted by some financial institutions for boosting up their balance sheets. Aware that the risk factor is inseparable from Bitcoin as evidenced by the current volatility, these institutions including Tesla (NASDAQ:TSLA) have not sold their crypto assets. Others like MicroStrategy (NASDAQ:MSTR) have even bought the dip. This shows a high level of trust.

Now, the crypto market is a large one, and, as shown in Coinmarketcap, there are hundreds of coins, with those boasting the ten largest market cap listed below.

Source: Coinmarketcap.com

As for Ethereum, it is used for a variety of innovative applications in finance, gaming, Non Fungible Tokens (NFTs), and supply chain management.

The investment case for Ethereum

With its ability to be used in smart contracts, Ethereum enables decentralized apps which are at the base of DeFi or decentralized finance. Thus Ethereum offers more relative value compared to Bitcoin and other altcoins.

Exploring further, DeFi offers another opportunity where value-oriented, low-multiple, strong cash-flow generating financial institutions exist, with one of them being Silvergate Capital (SI) for example. This crypto bank has been out of favor over recent months but could benefit from the rising rate environment in the same way as the traditional financial sector. However, regulatory risks exist as lawmakers increasingly want to regulate the crypto space having in mind the interest of investors.

In this case, the boom in companies offering cryptocurrency loans and high-yield deposit accounts like for staking USDC and USDT is viewed as disrupting the banking industry and leaving lawmakers scrambling to catch up.

Remaining with financials, DeFi eliminates human intermediaries like brokers, bank clerks, and traders, and instead uses algorithms to execute financial transactions, such as lending and borrowing. As such, it is largely immune to the problems being faced by many Wall Street banks currently. These may have to increase fees to justify raising the bankers’ remunerations in order to hold onto talent in a labor market where inflation has made the cost of living expenses.

Now, as opposed to previous periods of high inflation when there were only banks, in the current one there are also FinTechs now using a higher dose of technology in financial transactions as well as blockchain-based solutions to reduce costs. Consequently, it would be difficult for regulators to remove them completely out of the equation, but, we cannot rule out more stringent rules.

Thinking green, with rising energy costs, crypto miners that are not highly efficient will be gradually pushed out of business. This brings us to another advantage of Ethereum: it is less energy-intensive than Bitcoin. Thus, with more uses as well as being more energy-efficient, it is Ethereum that should eventually benefit from more cryptocurrency demand in the future. For this matter, again consulting the price action, it is ETHE has shown more progress during the last five days when compared to GBTC, with some respite also observed for the wider tech sector (QQQ).

Investing In Long-Term Innovation

I see crypto innovation continuing to accelerate around Ethereum and believe that it remains in its early innings. Volatility will continue to be challenging though, but crypto investors are accustomed to wild fluctuations in prices, and know how to search for opportunities when they occur. At current levels, an investment into Ethereum through Grayscale makes sense.

As for Bitcoin, its future trajectory will depend on the Bitcoin for Corporations panel to be hosted by MicroStrategy’s CEO Michael Saylor on February 1, an event which will also include Block’s (SQ) Jack Dorsey and Silvergate Capital’s Alan Lane.

Finally, it is interesting to note that geopolitical risks like for Russia-Ukraine and China-Taiwan have been historically beneficial for cryptos, despite their typical behavior as risk-on assets.

Disclosure: I/We are long SI. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

How To Use ETFs like TQQQ, SQQQ, QLD and QYLD during Volatile Times for Tech (QQQ)

For those who are still wondering about the reason for the fall of the mighty Nasdaq Composite Index, the chart below says it all. It basically shows the shares of the Invesco QQQ ETF (NASDAQ:QQQ) which tracks the Nasdaq 100 Index going steeply down as from January 3 with the fall coinciding with the rise of the 10-year treasury interest rate, which climbed to the 1.69% mark, a level not reached till January 24, 2020, or nearly two years back.

Looking back in hindsight, the volatility was already evident from the second half of 2021, as a result of QQQ (in blue) being inversely correlated to the 10-year rates in Orange.

Source: Initial charts obtained from Ycharts.com

Now, tech did stage a rebound on Wednesday with QQQ up by nearly 2.75% during the day, but the gains fizzled out after the Federal Reserve said it is likely to hike interest rates in March and reaffirmed plans to end bond purchases. There is also an indication that inflation risks are still present, as the U.S. central bank chief also mentioned the battle to tame inflation will have to be a sustained one.

Making sense of this new market regime

Now, inflation, especially high-inflation with the U.S. CPI (Consumer price index) at record highs is an issue for the whole economy, but more for tech stocks which normally exhibit higher growth but carry higher valuations as well. Thus, they are expected to deliver faster profit growth in the future to justify their high price to earnings multiples. This is in contrast to more “value” stocks coming mainly from the consumer staples sector possessing more pricing power to better face periods of inflationary pressure.

Still, during periods of high volatility as on Wednesday, QQQ, with its tech-heavy names ended the day in the green, slightly up at 0.08% while the Dow Jones Industrial Average which includes the more traditional sectors of the economy like cyclical more likely to benefit from the economic recovery, lost 0.38%.

Now, while some analysts think that it is too early to buy the dip, others at Goldman Sachs (GS) say that some tech sectors like semiconductors have been unduly punished while some defensive sectors have been rerated too much. Exploring further, results from a survey by Bank of America’s (BofA) Global Fund Manager reveals a bullish stance on stocks and expect inflation to fall in 2022.

Therefore with Wall Street analysts not aligned, this new market regime is likely to continue playing the yo-yo. On some occasions, you start by seeing the NASDAQ up by 1%-2%, but then, it finishes the day with only slim gains. At other times, the NASDAQ starts the day by being down by over 1%-2% and then finishes the day by reversing the losses.

These volatile market conditions constitute fertile grounds for traders.

Tools for trading

One solution, in case you have a trader profile, is to use highly leveraged ETFs like the ProShares UltraPro QQQ ETF (TQQQ) or the ProShares UltraPro Short QQQ ETF (SQQQ). First, TQQQ’s objective is simply to deliver triple the daily returns of Nasdaq-100. On the other hand, SQQQ also tracks the Nasdaq 100, but inversely at 3 times. This means that theoretically, if the QQQ jumps by 2%, TQQQ would deliver 6% of gains, and conversely, if QQQ falls by 2%, SQQQ would deliver 6% of upside. These are whopping gains considering that they can be obtained within a day or over a slightly longer period, but traders will obtain less than 6% in practice due to the compounding effect which is inherent in leveraged ETFs.

Consequently, due to compounding effects, do not expect TQQQ to deliver exactly three times the gains on the NASDAQ. The same is applies to SQQQ when tech names fall. Furthermore, far from forming part of a buy-and-hold investment strategy, these two leveraged ETFs are instruments best used over intraday time frames, and those betting on them should monitor news and economic indicators likely to sway the market. They should also be prepared to exit with a loss or, be “risk-tolerant”.

The two charts below show the 3%-4% gains made possible by these two leveraged tools, but here as seen by the rapidity with which the ups and downs occurs, timing is key in order to make a gain.

Source: Prepared by author using data from finance.yahoo.com

I now introduce two other ETFs for investors who are less risk-tolerant.

QLD and QYLD

My purpose for introducing the ProShares Ultra QQQ ETF (QLD) and the Global X Nasdaq 100 Covered Call ETF (QYLD) together is that they both have delivered exactly the same one-day performance on Wednesday, at 0.2%, outperforming QQQ by 0.12%.

Source: Ycharts.com

First, QLD offers 2x daily long leverage to the Nasdaq-100 Index, which is less than TQQQ’s 3x. This ETF becomes interesting in current market conditions where QQQ’s daily price actions suggest that in addition to being highly volatile over a daily period, it is not producing much uptrend on a longer-term basis. In this case QLD, by providing two times QQQ’s gains over the same period of time can more rapidly “aggregate” these small daily gains, making QLD a powerful tool for investors with a bullish outlook. However, as a leveraged fund, QLD is also impacted by compounding and is better traded on a short-term (one-month maximum) with constant monitoring of daily performance.

Exploring further, there is the QYLD, which follows a “covered call” or “buy-write” strategy, in which the fund managers buys the stocks in the Nasdaq 100 Index and “writes” or “sells” corresponding call options on the same index. For this purpose, it tracks Cboe Nasdaq-100 BuyWrite V2 Index. This is more of a long term buy-and-hold investment vehicle as it is designed to provide protection in periods when the NASDAQ falls. Thus, while QQQ fell by 13.4% since the start of this year, QYLD’s downside has been more moderated, at 8.7%. In addition, it pays regular monthly income with dividend yields of above 14%, which is really enticing.

Conclusion

Finally, these four ETFs could form part of an equity portfolio strategy where the aim is to provide some hedging (protection) while investors continue to be invested in tech or already own shares of QQQ. In this respect, one strategy which worked well in the last twenty months consisting of dip-buying is no longer working in this new market regime. Thus, instead of buying the dip in the hope of an elusive upside, it would be better to seek alternative strategies in view of the 10-year yields not having gone down yet and QQQ having dipped below its 200-day moving average last week.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

Funds Providing Exposure to Industrial Metals Are Proving to Be Resilient Against High Inflation

Their advantage is that they offer investors relatively easier exposure to the metals markets compared to the need to have to go through future contracts where a commodity is bought at an agreed price before being actually paid for.

Two of the funds are the iPath Series B Bloomberg Industrial Metals Subindex Total Return ETN (JJM) or the Invesco DB Base Metals Fund (DBB). These two investment vehicles are oriented towards broad industrial metals and both provide investors with exposure to a basket of metals composed of copper, zinc, and aluminum.

JJM and DBB have delivered YTD performances of 4.99% and 4.39% respectively in sharp contrast to the underperformance of the SPDR S&P 500 ETF which provides an idea of investor’s sentiment towards the broader market.

https://static.seekingalpha.com/uploads/2022/1/25/49663886-16431638737250772.png

Source: Trading View

Now, in addition to this short-term outperformance, there are other reasons which make industrial metals attractive.

The rationale to invest in industrial metals

Industrial metals like copper, zinc, aluminum are at the heart of the global construction and manufacturing industries. This is the reason why they form part of the cyclical industry, or one dependent on the economic cycle, which can be either at a recovery or recessionary stage. I believe that demand should be upheld due to three main factors.

First, prices are mostly tied to the economic woes of China, the world’s largest consumer with its massive factories which use these metals as raw materials for churning millions of cars, washing machines to electronics. Now, the post Covid recovery in industrial activity in China had already enabled copper, nickel, and, to a lesser extent, aluminum to rebound. In 2021, the upturn in demand was more global and the prices of these metals continued to rise. After a slowdown at the end of last year, due to some issues in the Chinese real estate sector, prices fell but still remain relatively high.

Now, China’s central bank has announced monetary easing (in contrast to the U.S. where there are more talks about tightening) to support the real estate sector, there are reasons to be cautiously optimistic about the prospects of commodities in general in that country, sufficient to create enough marginal demand to cause the price of industrial metals to move higher.

Second, industrial metals are most likely to benefit from decarbonization and infrastructure programs. Here, the production of renewable energy systems, like solar and wind power can imply consumption of five times more copper than conventional energy systems. Metals like Lithium are also used for the production of electric vehicles (EV). With many countries and regions in the world now stepping up their climate ambitions, the demand outlook for industrial metals has received a boost. In this respect, a study by SPGlobal entitled “Green energy revolution – Boost for industrial metals demand” forecasts that just electric vehicle market growth will boost copper demand to 1.84 million tons by 2025.

Third, there is the $1.2 trillion infrastructure plan converted into law by the U.S. President back in November last year which involves funding for road and rail transportation, telecommunications, and power grid projects. These would in turn require hundreds of thousands of tons of metals in addition to concrete. There are also tens of miles of lead pipes that have to be replaced to upgrade the water distribution system.

Therefore, demand should be sustained for many years and this is the reason many analysts are convinced that industrial metals are going to play a role as an inflation hedge. Now, together with precious metals, industrial metals form part of the commodities group, which have performed relatively well during periods of low and rising inflation.

Pursuing further, in addition to opting for funds providing exposure to a basket of industrial metals, one can also choose to invest in metal-specific funds.

Choosing individual metal funds

I provide three such investment vehicles, for aluminum, zinc, and copper respectively.

First, there is the iPath Series B Bloomberg Aluminum Subindex Total Return ETN (JJU) which holds aluminum. This ETN (Exchange Traded Note) offers exposure to futures contracts and not direct exposure to the physical commodities.

Second, there is the Wisdom Tree Zinc (ZINC), an ETC (Exchange Traded Commodity) designed to gain exposure to total return investment in zinc through tracking of the Bloomberg Zinc Subindex. ZINC is quoted in London.

Third, the United States Copper Index Fund (“CPER”) is an ETS (Exchange-Traded Security). It tracks the SummerHaven Copper Index Total Return. CPER is designed to be a convenient, cost-effective way for investors to access the returns of a portfolio of copper futures contracts.

These three investment vehicles have produced different YTD returns with JJU (aluminum) outperforming at 10%, somewhat compensating for its 2020 underperformance. Nonetheless, the other two have produced positive returns for 2022 too.

https://static.seekingalpha.com/uploads/2022/1/25/49663886-16431638738664603.png

Source: Trading View

In addition to the metal-specific option, there is also the possibility to invest in individual names.

Choosing individual stocks 

Here, investors can also opt for the large diversified miners, such as Rio Tinto (NYSE:RIO), Vale (NYSE:VALE), or BHP Billiton (NYSE:BHP). There are also metals producers such as Alcoa (NYSE:AA) for aluminum. However, before investing, it is important to do research on each of these individual stocks, pertaining to rewards and risks.

Finally, industrial metals should benefit from three tail winds in 2022 and beyond, but, the transition to a carbon-neutral world is likely to be gradual and, therefore, patience is key. Investors should also be able to withstand temporary headwinds pertaining to the commodities sector in general in the aftermath of inflation-related news.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

TLT: Making a Parallel with 2018/2019 Points to a Temporary Upside for This Long Duration Bond ETF

During the week ending January 21, 2022, both the NASDAQ and S&P 500 were down by 5% and 3.9% respectively as shown in the charts below, while the Vanguard Total Bond Market (BND) was up by 0.72% showing investor preference for fixed-income over equities. More important, the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) as shown in green below was up by a whopping 2.52%.

Source: Ycharts

Now, as its very name suggests, TLT seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. In short, it provides exposure to long-term U.S. treasury bonds.

Why invest in TLT

Quoted on the NASDAQ, TLT aims to replicate the performance of the ICE U.S. Treasury 20+ Year Bond Index. The fees for the ETF are 0.15% and the total assets under management are around $16.45 billion. There is also a dividend distribution policy encompassing yields of 1.54%. There are alternatives, one of which is the Vanguard Extended Duration Treasury ETF (EDV). This ETF, which I elaborated upon at the end of December, has delivered an even higher one-week gain of 3.33%.

Coming back to TLT, one of the advantages of this ETF is that it captures the long end of the yield curve in a very liquid fund. Thus, for investors who want long-term exposure to the U.S. Treasury, the quality of these bonds makes this ETF a safe haven in times of doubt. For example, during the financial crisis of 2008/2009, TLT rose by 28.3% while the S&P500 suffered a drop of 38.5%. For those who trusted it, TLT again provided portfolio protection in March 2020’s Covid-related market crash due to the fact that it is inversely correlated to the broader market.

Still, adopting a cautionary posture, as from the end of April 2020, when it was evident that the U.S. economy was exiting recession and the S&P 500 started its unrelentless uptrend, TLT started to underperform as investors moved away from the safety of long-duration bonds. Additionally, one should be aware that TLT is very sensitive to fluctuations in long-term interest rates given that it exclusively holds bonds over 20 years old.

For this purpose, extending the time horizon from one week to include 2021and January this year, one will notice that TLT’s share price (in orange in the chart below) moves inversely to the U.S. Treasury 10-year yields in the blue chart.

Source: Trading View

In addition to being interest rate-sensitive, TLT is also impacted by inflation as its yields remain moderate compared to higher yield bonds like BND which pays higher dividends of 2.16%. But, BND, in the same way as the S&P 500 suffered during the March 2020 market crash and in current market conditions, rising rates could overpower coupon returns.

One of the reasons I find TLT to be attractive at this particular moment in time is that it is in some way tied to the strength of the U.S. economy, not necessarily one which is growing at full steam, but rather one which is growing healthily with a balance between growth, on the one hand, and, inflation on the other. It is precisely this economic setup that the Fed is aiming for with the forthcoming normalization of monetary policy. Also called policy tightening, the aim is ultimately to reduce inflation while maintaining a reasonable growth potential.

I now make a parallel between events back in 2018-2019 and 2021-2022, with Jerome Powell heading the Fed during both periods.

Making a parallel with 2018/2019

Back in 2018, the performance of TLT (orange chart below) was highly negative or -10.5% from January to October as marked by the brown circle. However, there was a subsequent strong rebound of +7.7% since the beginning of November 2018, which also coincided with a fall in equity indices.

Source: Trading View

At that time, this was linked to growing uncertainties about the U.S. and global economies. Some of you may remember that the Fed, with Mr. Powell at its helm, remained firm on his intent to raise rates, more concerned about inflation rising than the weakening of U.S. growth.

Well, this is exactly the same today, except for the fact that inflation is already high.

Still, one of the lessons which can be learnt from 2018/2019 is that after 20 months of uninterrupted growth, the market is worried that the U.S. economy could take a pause in the coming months. To this end, the recent upside seen in TLT’s share price suggests that more investors are opting for long-term government bonds, which play the role of safe haven at times when the equity market corrects sharply.

Now, given the uncertainties, some of which revolve around the number of rate hikes, their economic impacts and what would be the market reaction, TLT may deliver a sustained upside. However, this will not be to the same degree as observed in 2018/2019 when there was a 25% upside over six months (the difference between the blue and brown circles). Moreover, contrary to 2018-2019, the consumer price index (CPI) is much higher today.

Pursuing along the same lines, TLT’s performance will also depend on how the markets digest the news during the forthcoming meeting of the Fed’s policymaking arm. That first meeting for 2022 is scheduled for January 25-26 and on Wednesday, Mr. Powell will conduct a press conference in what is expected to be the biggest such event since expectations about interest rates rising emerged. Consequently, we can reasonably expect long term bonds to continue performing well, at least till Wednesday.

Finally, TLT can be considered to be very useful as part of a risk-limitation strategy to mitigate for volatility in the equity market during periods of strong turbulence, but, for long term investors, it is important to note that it works better during periods of low inflation.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

CGW: Invest in Natural Resources for the Long Term Through the Invesco S&P Global Water Index ETF

These resources which exist independently of mankind comprise wood, gold, oil, water, and others. As for water, it can also be consumed directly.

Thinking globally, this high growing world requires more and more natural resources with awareness campaigns by conservation groups in various parts of the world making us aware of their importance and scarcity. Now, in economics scarcity is synonymous with value and what we often consider as unlimited and take for granted are in fact limited and highly valuable.

Envisioning this in the case of water, or pure water, which does not contain any pollutants, we can easily see why despite the fact that it is relatively more present than oil or gold, it is still not less valuable as it is essential for our good health.

Now, there are organizations that are in the business of water, whose shares we can purchase through a broker, but there is also the ETF option where the fund managers make a selection of the stocks to include in their portfolio based on specific criteria.

Investing in water

For this purpose, three of the top-performing water ETFs are the First Trust Water (FIW), Invesco S&P Global Water Index ETF (CGW), and Invesco Water Resources ETF (PHO). These funds invest in companies operating in the treatment and purification of water, as well as its distribution.

Comparing their performances for the last one-year, CGW has exceeded its two peers by at least 2%. As for the one-month and three-month periods respectively, the ETF has delivered less underperformance and this shows its ability at better withstanding volatility. Consequently, I proceed with CGW.

Source: fxempire.com

This ETF tracks the performance of the S&P Global Water Index, which selects stocks based on operations in the materials, water equipment, utilities, and infrastructure sectors.

CGW’s composition

A key criterion considered by the fund managers at Invesco for inclusion of a particular stock into CGW includes a market capitalization of at least $250 million. Therefore, the ETF does not solely include large caps like the S&P 500, and it is this exposure to smaller caps that makes it more volatile than the broader market. Some notable names include American Water Works (AWK), Xylem (XYL), and Veolia Environment (VIE FP) a French-based company.

Now American Water Works’ stock which constituted 9.41% of the fund’s total assets as of January 20 has lost nearly 16% of its value since the beginning of this year after being downgraded by Wall Street analysts. On the other hand, CGW has dropped by only 10.5%, and this brings us to the rationale of owning the shares of a company through the ETF formula, which is synonymous with more diversification and fewer downside risks.

Source: invesco.com

Looking ahead, catalysts for an upside are constituted by the infrastructure bill which the U.S. President signed in November. While most people talk about its high-speed internet component, the plan includes significant investments for the water infrastructure or $48.4 billion over five years for drinking water and wastewater spending. Two of the sectors which should benefit from these investments are industrials and utilities which, when combined, form more than 90% of CGW’s assets.

This said, with only 52% of U.S. exposure, the Global Water ETF should benefit less from the infrastructure plan than PHO and FIW which contain relatively more American stocks, but, here, CGW’s broader geographical diversification may prove to be an advantage in 2022 due to more inflationary pressures building up in the U.S. In this respect, the inflation rate in the U.S. is at its highest in the last forty years. Additionally, individual holdings do not weigh more than 10% each signifying relatively fewer portfolio concentration risks.

Analyzing the price action before investing

The ETF reached its highest point on November 19, due to momentum induced by the Infrastructure Bill being converted into law. Its fall from the start of 2022 is explained by the fact that the U.S 10 year Treasury rates have surged and are now at 1.72%. The ETF’s share price is sensitive to the change in interest rates. Thus, CGW (orange chart below) has already undergone a 13% downside and this looks to continue.

However, due to only 5.68% of tech as part of its portfolio, CGW is not prone to be adversely impacted by the tech sell-off to the same degree as the Nasdaq Composite which lost 2.72% of its value on Friday alone and this, in the wake of the Federal Reserve getting more aggressive on monetary tightening.

Source: Trading View

Finally, water is an essential commodity and the ETF’s holdings have a long runway of organic growth due to the continuous increase in usage of water by people on a per gallon basis. There is also the Infrastructure plan and I also see increasing M&A activity in the water industry during the forthcoming years as U.S. states implement projects. Thus, I would advise a buy at the $50 level taking into consideration that CGW pays dividends with a yield of 1.76% which covers the expense ratio of 0.57%.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

Gold Has Started to Glitter but a Basket of Precious Metals Offered by an ETF Like GLTR Is Better

While the S&P 500 has lost 7.77% of its value since the beginning of the year, gold, currently at the $1,835 level, has gained 1.59% as shown in the blue chart below. This contrasts starkly with its one-year loss of 1.87% and has given new impetus to gold bulls whose primary argument is that the yellow metal is a hedge against inflation. Investigating further, another cause for the precious metal’s surge appears to be the U.S. 10 Year Treasury yields as seen by the orange chart below rising by 10.1% since the beginning of January 2022.

Source: Trading View

Moreover, gold remains a low-yielding asset, and those who have bought and held it for the last year at the first sign of the consumer price index rising, know that its role as an inflation hedge is questionable.

The role of gold during the current high inflation period

To make my point, only three months back, investment banking firm, JP Morgan Chase (JPM), was talking about Bitcoin being viewed by investors as a better hedge against inflation than gold. With the cryptocurrency world in disarray, one would think that they are having a change in approach towards the yellow metal.

Well, while inflation is generally supportive of gold prices, inflation-adjusted gold prices are already high, after having gained more than 19% since the March 2020 market crash. Then, even if inflation persists for a while, it may not impact gold prices by much. Thus, while current levels may persist for a few months, the price of gold could fall to around $1,750 per ounce in the second quarter of 2022 or in Q3 at most, as the Fed makes the fight against high inflation a priority through raising of interest rates.

On the other hand, for investors doubting the ability of the Fed to address inflationary pressures during 2022, especially after talks about transitory inflation were proved to be unfounded, I favor a mix of precious metals, including gold.

There are basically two reasons for this.

First, as seen in the chart below, the iShares Gold Trust ETF (IAU) has delivered a one-month (from December 23 to date) gain of only 1.49% compared to 6.07% for the iShares Silver Trust (SLV) and even a higher 6.32% for the Aberdeen Standard Physical Platinum Shares ETF (PPLT). As for the Aberdeen Standard Physical Palladium Shares ETF (PALL), it has delivered a whopping 11.35% upside.

Now, silver, platinum, and palladium have all produced much better performances than gold for the last month. The reason for this is, unlike gold, silver, platinum, and palladium are also used as industrial metals, and this, in addition to their roles as stores of value.

Source: Ycharts.com

For these same reasons, there are more price fluctuations in the silver, platinum, and palladium markets, which are by far, more volatile than gold. This is evident by both SLV and PPLT delivering one-year losses of 5.41% and 7.13% respectively, whereas it has been a painful -11.16% downside for palladium. By comparison, it was a slide of just 1.87% for gold.

Thus, I favor the Aberdeen Standard Physical Precious Metals Basket Shares ETF (GLTR) which has delivered a mid-way one-month performance of 4.12%.

Better opt for precious metals ETF like GLTR

There are advantages in opting for this ETF for current market conditions where we are amid an economic recovery, but some uncertainties are likely to emerge as the U.S. Federal Reserve tightens monetary policy. In this case, GLTR provides investors with the growth capability of silver, platinum, and palladium, with the added steadiness of gold.

Scanning the industry for alternatives, in addition to GLTR, there is the Invesco DB Precious Metals Fund (DBP), but it has underperformed GLTR for the past month, delivering a gain of only 2.28%.

As for GLTR, it is issued by Aberdeen Standard Precious Metals Basket ETF Trust. Its investment objective is to reflect the performance of the price of a basket of gold, silver, platinum, and palladium bullions, less expense. For this purpose, Aberdeen charges management fees of 0.60%, which is less than the Invesco fund. More details are shown in the table below.

Source: abdrn.com

Finally, GLTR is designed for investors who want a cost effective to invest in precious metals. Moreover, the shares are physically-backed by precious metals located in vaults in London and Switzerland. Another noteworthy point is that the ETF does not use any leverage mechanism.

The New Market Regime Demands High Quality Growth Stocks Available Through the ETF Formula

The market seems highly uncertain. At times it is the rotation from growth to value which is determining the direction of the markets. However, as evidenced by some of the sporadic upsides delivered by the NASDAQ, growth names have not capitulated yet. Using the ETF formula, whereby investors put their money into funds instead of choosing individual names, I compare two options for this new market “regime”. These are the American Century STOXX U.S. Quality Growth ETF (QGRO) and the SPDR Portfolio S&P 500 Growth ETF (SPYG).

The new market regime

In current circumstances, investors, mostly those who were used to benefiting from quick capital gains as the share prices of their growth names appreciated rapidly are now prone to headaches in trying to cope with the new market regime. To be frank, it is not easy to select the right value name, as in contrast to growth where you primarily look at revenue, there are more metrics to consider. These include profitability, forward cash flow, and valuations.

One solution is to opt for a value investment vehicle such as the SPDR Portfolio S&P 500 Value ETF (SPYV) where the fund managers have stringent criteria for selecting stocks. However, the choice between value and growth is not a straightforward one as there have been days like on Wednesday 19 when, in addition to impacting the high-growth names in the NASDAQ, the sell-off has been contagious to the Dow Jones Industrial Average whose holdings include many of the cyclical names with high profits and low valuations. Also, there are now talks of a “value asset bubble”.

The reasons for this market regime vary, ranging from high inflation impacting the financial sector, supply chain bottlenecks impacting industrials as well as fear caused by the Omicron variant potentially derailing the economic recovery.

Looking at a high growth ETF like QGRO

At the same time, analysts remain divided as to what stage we have reached in this growth to value rotation. To further complicate matters, many who were handsomely rewarded after trusting richly-valued tech or biotech stocks right after the spring 2020 market crash are buying the dips in the Nasdaq.

In these circumstances, for those willing to remain invested in growth, but through quality and rapidly growing stocks with better earnings, cash flow, operating income as well as lower valuation metrics, there is the QGRO.

Its main holdings include automotive, healthcare, and Information Technology plays with IT forming the largest sector with a weight of 41% as of January 18. It charges an expense ratio of 0.29% but pays dividends with a better yield of 0.31%.

https://static.seekingalpha.com/uploads/2022/1/20/49663886-16427325124856262.png

Source: ipro.americancentury.com

In line with my strategy to always look for alternatives, I scanned the industry for similar ETFs.

SPYG delivers better performance

I found the lower cost SPYG which comes with an expense ratio of only 0.04% and pays dividends with a higher yield of 0.68%. Now, SPYG is more passively managed, but it also comprises a significant amount of IT holdings or 43% of overall assets. Furthermore, with tech being in the line of fire because of high valuations concerns, I checked whether the SPDR ETF also suffered in the same way as QGRO, and this, through a comparison of their short-term historical performances.

This was not the case with SPYG’s three-month performance being at -0.56% compared to -6.19% for QGRO, which has clearly suffered more. Now, this period, whose beginning is denoted by the green marker below, has been characterized by tech sell-off, and the fact that the SPDR ETF has delivered less underperformance shows that it is able to withstand volatility better.

https://static.seekingalpha.com/uploads/2022/1/20/49663886-16427325128191688.png

Source: Trading View

This advantage may be due to its number of holdings exceeding QGRO’s by 37, implying fewer concentration risks, but SPYG’s real strength lies in the names held. These include the MANAMAT stocks, with the acronym standing for Microsoft (MSFT), Apple (APPL), NVIDIA (NVDA), Alphabet (GOOG), Meta Labs (FB), Amazon (AMZN), and Tesla (TSLA). Combined, these seven stocks represent 51.3% of SPYG’s portfolio.

Conclusion

According to SPYG’s fund managers, the index they track contains stocks that exhibit the strongest growth characteristics based on: sales growth, earnings change to price ratio and momentum. This has proved true with SPYG delivering a better one-year price return at 20.12% compared to QGRO’s 6.47%.

Consequently, the SPDR ETF is better based on historical performance.

Finally, to be fair, SPYG was incepted back in September 2000, while QGRO is much younger as it was created only in September 2018, and with the high level of market volatility looking to persist throughout, I will be watching closely at the American Century ETF. One of the items I will be focusing my attention on is the dividend yield as the fund managers lay particular emphasis on the profitability and cash flow metrics.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

XLE: You can Trust this Energy ETF, Both for Growth and Dividends 

Looking over a longer period comprising the March 2020 market crash, it is evident that the S&P 500 Energy sector as shown in the yellow chart below still trails the broader S&P 500 index. For its part, the SPDR Energy Select Sector ETF (XLE) has delivered an 11.56% gain during the last two years with most of the upside occurring in 2021.

Source: Trading View

Looking ahead, according to the U.S. Energy Information Administration (EIA), spot Brent crude prices are expected to average $79 this quarter. This is down from the current value of $87.7, but the EIA further adds that “developments in the global economy and the many uncertainties surrounding the pandemic” in the coming months could push oil prices up or down from its price forecast.

These uncertainties need to be understood in the context of the supply-demand paradigm.

The supply-demand paradigm

Here, the EIA’s statement that “U.S. natural gas consumption in 2021 was nearly the same level as 2020, and this will remain virtually flat in 2022 and 2023” is noteworthy as it means that there will be less oil-to-gas switching to clear any excess in the amount of oil produced. Thus, in addition to Brent’s spot price itself, the demand for natural gas also constitutes a tailwind for XLE. This said the ETF’s share price is also influenced by two other factors.

First, there is the ongoing sector rotation into energy, finance, and consumer sectors which have started in the second quarter of 2021 and gained momentum from November, which should also determine energy stock returns throughout this year.

Second, the global economic recovery after the drop in activity during the Covid-led confinements created a strong demand from September last year, while inventories, especially in Europe were low. These factors were responsible for the prices of natural gas skyrocketing in Europe as from October 2021 with the fuel-substitution effect being contagious to spot oil prices. This explains the bounce seen in energy sectors’ ETFs including the Vanguard Energy Index Fund ETF (VDE) from that period.

Gauging the supply side, a series of problems weighed on capacity including some countries seeing their production drop due to maintenance delays caused by the pandemic as well as failure to make timely investments in aging upstream infrastructure. This supply shortage was exacerbated by governments, (especially in China and Europe) giving priority to renewables projects and carbon credits while their “green energy” experts failed to foresee the imbalance between supply and demand.

The imbalance to persist

This imbalance is likely to persist in 2022, despite OPEC’s continued production increase and uncertainty associated with the Omicron variant impacting travel. Understandably, some smaller oil companies have been reticent to pump out more oil.

There may be some temporary respite in oil prices as from the start of February when China, together with the U.S. and some other major consumers, will release crude oil from their national strategic stockpiles. This coordinated action aimed at reducing global prices will induce some volatility in XLE, but this will be only for a limited period.

The reason is that the imbalance will persist with one of the reasons being the recovery in international travel.

In this respect, according to Statista, the total fuel consumption of commercial airlines worldwide which increased each year from 2005, reached a maximum of 98 billion gallons in 2019 before falling from 2020 due to Covid. It decreased to 57 billion in 2021. Now, there has been optimism that has been prevailing since the start of the year that the Omicron strain may prove to be less damaging to the health of people and by ricochet the economy.

This optimism is also backed by data, which indicates that despite Covid infection rates reaching an all-time high, the actual death rate is trending lower. Whatever the reasons for this, be it a higher vaccination rate or a less dangerous variant, more people are willing to take a flight. This is in turn proven by the number of international flight departures rapidly inching back up to 2019 levels according to the Bureau of Transportation statistics.

Thus, glancing back at the above chart, XLE could again climb back to its April 2019 high of $68-69 levels by the second quarter of 2022. Even if this upside is somewhat delayed due to volatility, the SPDR ETF pays substantial dividends.

The dividends

Holdings include oil supermajors Exxon Mobile (XOM) and Chevron Corporation (CVX) with a combined weight of 43.4% of overall assets. These are integrated oil and gas companies operating in every segment of the industry. Activities include extraction/production, midstream, petrochemical manufacturing, refining, and, even downstream activities like marketing and distributing refined petroleum products. People buy these companies primarily for their dividends.

The other holdings which are drilling, refining, or equipment provider plays also pay regular distributions to shareholders. This culminates in XLE paying a 3.62% yield. Here investors will notice that distributions that are paid on a quarterly basis reached the highest point in the fourth quarter of 2019 at $3.58.

Source: Chart prepared using data from Nasdaq.com

This was followed by a period of fluctuating quarterly payments around the $0.5 mark, before eventually rising from the third quarter of 2021. With oil prices remaining sustainably high, energy companies should continue to benefit from higher profitability which in turn enables them to sustain dividend payments and perform share buybacks.

Finally, with demand outstripping supply, the imbalance should persist in 2022. Inflationary pressures may slightly affect demand, but, here, recent fund flows indicate that XLE is inversely correlated to the broader market (SPX). Thus the energy sector ETF seems to be acting like an inflation hedge, a role which is also supported by its ability to pay above-average dividends yields. Consequently, XLE can be trusted for further upside and higher quarterly dividend payments too.

Disclosure: I/We are long XLE. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

Better to Get Chinese Stock Exposure Through the iShares MSCI Emerging Markets ETF Instead of MCHI

At $62.9 per share, iShares MSCI China ETF (MCHI) is more than 70% under its February 2021 high. In contrast, the one-month gain of 3.4% shows that there has been a regain of interest by investors for this ETF which mainly provides exposure to the Chinese consumer cyclical, communication, financial, and tech sectors. In comparison, the iShares MSCI Emerging Markets ETF (EEM) which includes about 34% of Chinese assets is up by 3.8%.

Source: Trading View

My objective with this thesis is to understand the reason for this timid rise in the value of MCHI and whether there could be a more sustained upside. I first start with China’s central bank actions which could be beneficial to the ETF’s financial sector holdings.

China’s central bank actions

The People’s Bank of China (PBOC) which had previously taken a restrained approach to monetary stimulus, appeared to change its stance on December 25, when it pledged greater support for the real economy, stating that monetary policy will be more forward-looking and targeted. One of the intended aims would be to “promote the property sector’s healthy growth as well as work to better meet housing demand”. By that time, MCHI shares had reached their lowest point, and the PBOC’s statement did produce a temporary relief for investors.

Interestingly, the central bank’s more recent announcement about lowering interest rates by 10 basis points to 2.85% on Jan 17 constitutes a more concrete step and may preclude other such actions as Chinese authorities try to mitigate the effects of the Omicron variant, and address the downturn in the property sector.

Now, the fact that the PBOC is easing monetary policy despite China’s GDP expanding by 8.1% in 2021, supposes that the economy still faces headwinds. At the same time, the U.S. and the rest of the world are looking more towards tightening. Thus, the PBOC may have a narrow window of opportunity to provide stimulus before it has to start tightening again. Hence, while there are near-term positives for MCHI’s bank and industrial holdings, the longer-term picture looks more uncertain.

Some big investors favor China for investment

Now, REITs constitute just 4% of MCHI’s holdings and the ETF provides exposure to giants like Alibaba (BABA), also referred to as the “Chinese Amazon (AMZN)”. Interestingly, Charlie Munger, the vice-chairman of Berkshire Hathaway (BRK.B) controlled by Warren Buffett has augmented his stake in Alibaba during the recent months. Now, Berkshire is considered as the “epitome of value”, and for this matter, MCHI’s uptrend also somewhat coincides with the rotation from growth to value stocks which has been gaining momentum from the beginning of this year.

Source: iShares.com

Along the same lines, billionaire investor Ray Dalio, who has reportedly raised $1.3 billion for its third China fund according to the Wall Street Journal is highly optimistic that the Asian country is winning the economic race against the U.S.

Now, Dalio’s remarks have sparked some controversy. To this end, those who have invested in Chinese tech and educational technology companies know something about the propensity of authorities in that country to bring in abrupt regulations, such as those implemented as from July last year. These quickly decimated the valuations of stocks operating in these sectors.

Exploring further, Dalio’s remarks are reminiscent of the 2005-2006 period when the U.S. had dropped from 4th to 13th position in the global rankings for broadband internet usage, all at the benefit of Japan and South Korea. At that time some Wall Street gurus predicted that this drop would result in the U.S. losing in productivity and innovation. Eventually, these predictions never materialized and twenty years later, the U.S is home to the biggest tech companies the world has ever known.

Thus, basing an investment solely on the moves of big investors makes no sense and anyone investing in China should be aware of the risks.

The risks

First, the delisting fears whereby NYSE and NASDAQ listed Chinese firms will be all removed and relisted in Hong Kong appear overblown as even if a stock delists from the U.S., possibly as a result of Chinese authorities stepping up supervision, it would eventually be converted to Hong Kong Stock Exchange shares, so one still owns the company. This was the case with ride-hailing group Didi Global (DIDI) at the start of December last year, but news about the event still trimmed some percentage points off MCHI’s share price.

Second, both the US and China are heavily invested in each other as the two countries’ supply chains are highly interdependent. On the one hand, with American citizens depend to a large extent on consumer items from China, and on the other, the latter’s factories depend on capital goods like semiconductor producing equipment from the U.S. Now, semiconductors remain highly sensitive items and the U.S. has brought in legislation which limits the type of chips which can be exported to China, out of fear that the Chinese military may use these to produce sophisticated weapons. These could be used against Taiwan, one of America’s strategic allies in the region.

Better to go for partial exposure through EEM

Therefore, in addition to economic and regulatory uncertainty within China itself, there are geopolitical risks that can impact the country’s trade with the U.S. This can result in MCHI becoming highly volatile. However, China remains the second largest economy in the world and value investors like Charlie Munger and venture capitalists like Ray Dalio have been in the game since a long time. Consequently, from the balanced risk perspective, partial exposure to Chinese stocks, either individually, or through an ETF start to make some sense.

Thus, for those wanting exposure to some of the specific Chinese tech names like Tencent (TCEHY) and Alibaba which are significantly undervalued with respect to their western counterparts, there is the EEM alternative, which is also diversified in Taiwanese, South Korean, Indian stocks as well as other countries. The ETF’s holdings should benefit from record high U.S. inflation favoring cheaper alternative products from emerging economies. This said EEM has a slightly higher expense ratio of 0.68% compared to MCHI’s 0.57% but has shown a better one-month performance.

Portfolio Hedging in Action Using the ProShares Short S&P 500 ETF

While I am no advocate of a market crash in a context where the economic recovery remains on track and unemployment numbers have dropped to their lowest since February 2020, I certainly have in mind that the highest inflation reading in nearly 40 years has raised the probability of occurrence of stock market volatility in 2022.

In this scenario, risk limitation to financial assets in the form of a hedging strategy is important, especially when investors have patiently built their portfolio over the years, and want to remain invested in equities. In this respect, there are many ways to hedge including treasury bonds and commodities ETF as well as derivatives, such as options and futures contracts.

In this thesis, I consider a hedging tool that involves taking an opposite position to a related asset and which worked during two of the most recent market crashes, namely the 2008-2009 great financial crisis and the 2020 Covid-related downturn. This tool is the ProShares Short S&P 500 ETF (SH) and it inversely tracks the broader stock market or the S&P 500. For investors, it is important to test its efficacy and show how it actually works using the SPDR S&P 500 ETF (SPY).

Testing SH’s efficacy to provide inverse market correlation

When SPY which straightly replicates the gains or losses of the S&P 500 plunged by more than 45% from 2008 to 2009, the ProShares fund conversely managed to gain more than 30%. This is shown in the chart below. Subsequently, when SPY lost 50% from Jan to March 2020, SH gained 25%. These two events are illustrated in the chart below and show the ability of the market shorting tool to provide inverse correlation to the broader market.

Source: Trading View

Pursuing further, some of you would have noticed that SH’s returns are not -1x or exactly the inverse of SPY. The reason for this discrepancy is due to the compounding effect which adversely impacts the performance of leveraged ETFs like SH, whereby the returns are significantly different than the target return for periods that exceed one day. It is for this reason that the fund managers at ProShares advise investors to monitor holdings frequently, preferably on a daily basis.

Being more specific, items to monitor are the performance of SPY itself, which if on a consistent uptrend has the potential to inversely cause a significant downside in SH’s share price, and by ricochet trim the gains one expects to obtain when shorting the market does not proceed as expected. Along the same lines, failure to monitor will certainly result in capital losses as evidenced by SH’s downtrend (blue chart) since inception in 2007 by nearly minus 90% (-90%). Thus, contrarily to SPY which is a long-term investment, SH is a market shorting tool that enables investors to benefit from a downturn without having to trim down their equity portfolio. This explanation would be incomplete without seeing hedging in action using a sample portfolio.

Illustrating how hedging works with a sample portfolio

For illustration purposes, I consider a $10,000 investment in equities made through shares of the SPY. This could form part of a 70/30 portfolio, with 70% equity and 30% fixed income.

The first scenario (scenario 1) which is un-hedged entailed a loss of $4,500 during the 2008-2009 great financial crash as SPY lost 45% on an investment of $10K. Next, the second scenario depicts the same time period but, this time with the application of a hedge in the form of a $1000 investment in SH, or 10% of the equities portfolio. As a result, $9000 was invested in SPY and the losses were reduced to $3,750.This excludes ProShares’ expense ratio of 0.88%, which make up for only $8.8 on a $1,000 investment. Ultimately, this shows that hedging using the ProShares ETF actually works. Now, the percentage at which a portfolio is hedged can vary, with 5% and 15% hedges being quite common.

Source: Prepared by author.

Pursuing further, I have provided two other scenarios for an un-hedged and hedged portfolio respectively and this time pertaining to the March 2020 market crash. Again, even after excluding ProShares’ fees which is minimal, hedging, as a damage limitation mechanism works, but, it is essential to monitor the performance for the period the market is shorted. For this matter, there is the need for “optimum timing” for entering and exiting a position in SH in order to capture the “best case” impact of the hedge.

On a cautionary note, bear in mind that historical performance is not a guarantee of future success and that each time it a different hedging scenario.

Finally, given high inflation with a CPI of above 7% and the CBOE S&P 500 Volatility Index (VIX) hovering between 19 and 20, the risk factors are certainly here.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

For a look at all of today’s economic events, check out our economic calendar.

Comparing Two Vanguard ETFs for Dividend Growth and Better Returns Instead of Just Focusing on Yields

One of a Wall Street’s firm’s chief economist thinks that the Fed will raise rates by a full percentage point, or 100 basis points, from the current range of 0%-0.25%, This is in response to high inflation, which should, in turn, induce further volatility to the stock market. Thus, stocks can underperform for a long time and it is here that the dividend rationale starts to make sense, not only for income-oriented investors but also for those looking to diversify away from growth.

The contribution of dividends to total return, which includes capital gains (share price appreciation) and distributions, is also higher, in contrast to capital gains alone.

Thus, total returns over a period = share price appreciation + dividends paid.

For the purpose of this thesis, I use two Vanguard ETFs. First, there is the Vanguard High Dividend Yield ETF (VYM) and second, the Vanguard Dividend Appreciation ETF (VIG).

Starting with the VYM dividend ETF

For illustration purposes, I provide the difference between the share price appreciation (price return as shown in the orange chart below) and total return of (VYM) which is trusted by many investors because of its low expense ratio of 0.06% and dividend yields of 2.7%. The ETF pays quarterly distributions and holds stocks from the Financials sector at 22.20% of overall holdings followed by Consumer Staples (12.60%) and Healthcare (12.50%).

Moreover, with 410 holdings and net assets of the ten largest holdings only constituting 24% of the total, the fund exhibits low concentration risks and as shown by the blue chart below, VYM’s with total returns of $184, exceeds its price return by nearly 70% and signifies that VYM has constantly paid dividends and not deceived investors for the last five years despite inflation whipsawing during that time period.

Source: Ycharts.com

Going one step further, it is equally important that investors just choose ETFs based on those paying the highest dividends, but rather make sure they are investing in those funds which also look for the quality metric when selecting holdings. It takes a lot of research to spot stocks paying high-quality dividends, whereby distributions made to shareholders increases with time.

The search can be very time-consuming, hence the interests of looking for an ETF like the VIG where the fund managers are experienced and spend time screening the market. Now, the ETF pays a dividend yield of just 1.59%, or 70% less than VYM’s 2.70% ((2.70-1.59)/1.59)*100), leaving the possibility of the ETF being easily overlooked.

Income potential of VIG

To verify whether lower yields translated into lower dividend numbers, I calculated the quarterly distributions made by these two dividend ETFs over a period of about seven years, from March 2014 to December 2021. Then, I plotted the figures in the chart below. Now, as expected, VYM’s chart (in red) is higher along the Y-axis (dividend paid) than for VIG due to the fact that it pays better yields.

Source: Computed by author through data from Nasdaq.com

However, things look different when calculating the total amount of dividends paid during this period. It is $20.16 for VYM while $16.28 for VIG, which is again normal, but upon computing the total amount by which VYM exceeds VIG, I found that the former paid 24% (((20.16-16.28)/16.28)*100)) more dividends than VIG. This is substantially less than the 70% figure by which VYM’s yield exceeds its peer.

VIG offers better total returns

Consequently, when computed over a period of time, VYM’s higher yields do not translate into the same percentage of income gains as provided by VIG. This signifies that VIG has been growing its dividend faster than its peer. Additionally, the Vanguard Dividend Appreciation ETF has produced a better five-year share price performance, or capital gains. As a result, it is VIG which has delivered better total returns by (116.4-78.15) or 38.25% as per the chart below.

Source: Ycharts.com

Furthermore, VIG offers exposure to Industrials (20.70%), Financials (15.00%), technology (14.6%) and Healthcare (13.20%), which means more sector-based diversification compared to VYM to better navigate inflation-induced volatility. Finally, increased contributions also matter more at times when the market is volatile as it helps provide income and security when it is needed the most, and especially in the current market environment where total return across any of the major indices is likely to be lower than in 2021.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

QQQ: The Downside Risks on the Nasdaq Seem Exaggerated

The performance of the Nasdaq now encompasses a higher degree of volatility as seen by the 5.5 to 9% corrections in the Invesco QQQ Trust (QQQ) which has now become the new normal in a macroeconomic environment where hawkish Fed hiking interest rates is seen as being unfavorable to high-valued and unprofitable tech stocks.

Source: Initial chart from Trading View

For investors, QQQ tracks the Nasdaq-100 Index which features Apple (APPL), Alphabet A (GOOGL), Alphabet C (GOOG), Microsoft (MSFT), NVIDIA (NVDA), Meta labs (FB), Amazon (AMZN), Tesla (TSLA), Adobe (ADBE) and PayPal (PYPL). These are the main holdings out of a total of 102.

Assessing the risks

There are certainly risks in 2022 in the context of being invested in tech equities, but, I would like to bring to the attention of investors that despite all the volatility, QQQ has gained 6%, and this shows that the market’s repositioning (amid the rotation from growth to value names) does not seem commensurate with the forthcoming pace at which interest rates will increase.

Exploring further, trades are no longer crowded as in 2021 as people look for income or other asset classes to diversify. However, this diversification away from tech seems not to have hit QQQ’s main holdings which constitute 52.73% of the portfolio. As per my observation, this has been the case from April through December this year when most of the market gains were just from AAPL, MSFT, NVDA, TSLA, and GOOGL.

Source: Ycharts.com

Given the fact that the rotation has lacked in breadth, I see the corrections in tech as a rather muted market reaction, and this also prompts me to discard fears that tech stocks will suffer in the same way as during the bursting of the Internet bubble back in 1999-2000. At that time, in the first phase of the bear market, the large-caps names were doing fine but a large percentage of Nasdaq’s other components crashed by more than 50%. Ultimately, all the components crashed.

However, that was a completely different Nasdaq with the top stocks of the time being Cisco (CSCO) followed by Microsoft then Intel (INTC), or from the networking, software and semiconductor sectors respectively. Today, it is more about social media, online advertisement, internet marketplaces, electric cars, the cloud, smartphones, and virtual reality. In short, tech is now fully integrated into all spheres of economic and social life compared to twenty-two years ago.

Considering the inflation factor

Moderating slightly, QQQ’s other holdings seem to be impacted as investors become more selective, putting more emphasis on quality (free-cash-flow, balance-sheet, economic moat, etc) and valuations. Still, here also, rising inflation, currently at above 7% compared to 3.75% in 1999-2000 could prove to be more difficult for value stocks like banks as their customers suffer from rising prices and are faced with the rising cost of doing business. For this matter, as shown in the chart below, Bank of America (BAC) and Berkshire (BRK.B) saw a more pronounced dip in their total return level in August 2008 than Apple or Microsoft when inflation was above 5%.

https://static.seekingalpha.com/uploads/2022/1/14/49663886-16421719831560977.png

Source: Ycharts.com

Industrials are also likely to suffer from soaring raw material and labor costs. As for tech, they should better withstand high inflation with their ability to make use of software, AI, and automation tools more rapidly than companies from other sectors of the economy. These tools enable them to reduce operating costs and better circumvent wage inflation. Examples are FinTechs like PayPal’s (one of QQQ’s current underperformers) ability to reduce money transfer fees for customers compared to traditional banks and companies making use of cloud-based collaboration instead of having to invest in costly infrastructure.

Tech should continue to outperform as digital transformation enablers

Furthermore, with relatively less dependency on physical interactions caused by variant-related uncertainty, tech stocks are less likely to see a reduction in profitability. Here, some will note that Apple’s revenue share from its App Store ecosystem is increasing more rapidly than for devices and Tesla is considered as an internet-of-cars company.

Historically, as shown in the chart below, big tech’s gross profit margins have either increased or remained constant during the last five years, which include 2021, a year characterized by rapidly rising inflation.

https://static.seekingalpha.com/uploads/2022/1/14/49663886-16421723117351067.png

Source: Ycharts.com

Thus, inflationary pressures grappling the economy as from 2022 is likely to put valuations on the backstage, with tech, especially the more profitable ones, likely to continue seeing positive returns. This said tech remains highly dependent on semiconductors, a sector that needs to be watched closely for some short term pain when some of the big names report earnings on the last week of January. Finally, looking at the performance of the Nasdaq in 2020 and 2021 when it gained 43.64% and 21.39% respectively, even a 10-12% gain in 2022 would put it in positive territory.

Disclosure: I am long Apple. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

The SPYX ETF is a Cheap Way to Get into ESG and Delivers a Better Performance Than the S&P 500 Too

Have you ever been stopped by a building? This building literally stopped me in my tracks as if it was trying to tell me something. It is the Oasis Hotel Downtown in Singapore with its entire 27-floor external facade wrapped in a natural vine-covered sunscreen. It also has four lush sky terraces, but these are not only for decoration purposes or demonstration of some green slogan, but serve some real purpose as they allow for good cross ventilation in a mostly hot tropical country and ultimately reduce overall energy cost.

This photograph taken on July 23, 2021 shows a view of the Oasis hotel in Singapore. - Green spaces have also been shown to improve health and...

Source: gettyimages.com

There are other green buildings around the world that have adopted principles of circularity, using recycled materials and green technologies for building design. These show us that ESG (Environmental Social and Governance) principles are not just about replacing fossil fuels with renewables or electrifying the whole fleet of internal combustion engines to electric vehicles or EVs. Neither is it just about investing massively in solar panels, whose production has often been highlighted by ecologists as being highly carbon-emitting due to the factories which produce them consuming coal.

For this matter, ESG is also about achieving better energy efficiency and cutting down on stocks that own oil reserves, instead of heavily relying on the success of solar or wind stocks at generating more revenues. For this particular purpose, there is the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX), one of SSGA’s thematic ESG funds.

The SPYX

The ETF tracks the S&P 500 Fossil Fuel Free Index, whose objective is to allow climate change-conscious investors to align the core of their investment strategy with their values by eliminating companies that own fossil fuel. Consequently, the main holdings which find their way in SPYX’s portfolio are the U.S. large-cap equities like the big tech names as per the table below.

Source: ssga.com

Additionally, the lists also include companies operating in the Financials, Healthcare and Consumer Discretionary, Material, and Industrial sectors. There are also REITs. Further down the list of the fund’s 489 holdings (of which just 23 are shown above), there are energy plays and utilities too, but which do not own fossil fuel or coal reserves for chemical byproducts, residential use, or pharmaceutical purposes. There is also Marathon Petroleum (MRP) which provides exposure to oil refining but has also entered into a joint venture for the production of soybean oil.

Better performance compared to the S&P 500 despite excluding oil giants

Oil giants with reserves are excluded from SPYX as the environment increasingly starts to surface during shareholders’ meetings of energy companies. At the same time, more stringent measures are continuously being applied by the U.S. authorities to tackle the climate change problem which has resulted in billions of dollars of losses in the last five years.

Now, to be realistic, policy decisions especially those related to renewables are subject to change with the different Presidential administrations and this may lead some investors to doubt the long term success of SPYX, especially given the fact that it relies on corporations’ green mandates instead of investing in building up solar capacity like the Invesco Solar Portfolio ETF (TAN) which bears an expense ratio of 0.66%.

Well, a look at the chart below shows that not only that the SPYX (in blue) has outperformed the SPDR S&P 500 ETF (SPY), with the gain in performance gradually increasing over the last five years, irrespective of what U.S. President was in charge.

Source: Trading View

Scanning the industry, there are other ETFs adopting the same strategy like the Etho Climate Leadership U.S. ETF (ETHO) which has produced roughly the same five-year gain as SPYX, but, the former charges an expense ratio of 0.4%. On the other hand, SPYX charges just 0.2% and suffers from relatively less volatility.

The rationale for SPYX instead of investing in individual names

Each of the fund’s holdings has its own way of contributing to the reduction in the use of fossil fuels with many having committed to carbon neutrality by 2050 as part of the United Nations Framework Convention on Climate Change.

While for Tesla (TSLA), its electric vehicles are proving handy to replace internal combustion vehicles consuming fossil fuels, Amazon (AMZN), through its online market place helps to reduce carbon footprint by enabling people to purchase goods without having to make the move to distant stores. As for Pfizer (PFE), it has a climate action plan aimed at obtaining sustainable energy accreditation for its administrative office buildings and using renewables.

Finally, even if you are a dedicated activist ESG investor, it will take considerable time to screen the list of 2400 names on the NYSE to choose an appropriate one. In this context, SPYX composed of essentially the same stocks as in the S&P 500 index funds, except for fossil fuel reserves owing ones, constitutes a valid option unless you have already zeroed in on a particular “green” name.

Disclosure: I am long Apple. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

SPXU: Harnessing Volatility in The S&P 500, to Short the Market With a Three Times Inverse ETF

Fed Chairman’s Powell reassuring statement on Tuesday and inflation figures for 2021 being in line with estimates on Wednesday seem to have appeased bearish sentiments resulting in the S&P 500 rising.

However, there are many different elements that are likely to impact stocks, such as the continuation of the economic recovery, corporate earnings, inflation, supply chain concerns as well as the likelihood of the Omicron variant stressing hospital services. These should result in continued volatility episodes as seen in the S&P 500 ETF Trust ETF (SPY) which tracks the S&P 500 index.

https://static.seekingalpha.com/uploads/2022/1/12/49663886-16420000045920553.png

Source: fxempire.com

In such conditions, people are normally risk-averse, or avoid trading and prefer to wait for some relative calm before looking at stocks. This is the case for most of us, but, there is another option which is to trade the volatility using a tool like the ProShares UltraPro Short S&P500 (SPXU) which inversely tracks S&P 500 at -3 times its daily performance.

This calls for enticing gains as a 5% fall in the SPY can “theoretically” bring you 15% gains, but my own experience has taught me that just putting money in the SPXU at the first sign of a market downturn is unproductive. Instead, I use the chart below which shows the performance of the ProShares ETF from January 2020 to date. It includes the spring 2020 crash subsequent to the World Health Organization declaring Covid to be a pandemic.

Investors will notice that I have calculated the amplitude obtained by subtracting SPXU’s daily low from the daily high. Then I converted the resulting value as a percentage that more vividly represents the volatility induced in the ProShares ETF’s through its daily variations.

Here, the March (spring) 2020 crash resulted in gains of over 30% but this was achieved over a period of many weeks. The second noteworthy point is the above-10% differences which, after occurring four times from June 2020 to February 2021, ceased till November last year.

https://static.seekingalpha.com/uploads/2022/1/12/49663886-16420000046728988.png

Source: Chart built by author with data from finance.yahoo.com

Then, came the December 1 market downturn, induced mostly by tech stock aversion, as investors increasingly rotated into value names. To be realistic, this high-volatility episode may prove to be a lone occurrence, but forthcoming events should constitute catalysts for further fluctuations.

First, the earnings season is to be kicked off by banks on Friday this week, and with investors having already placed a lot of expectations on the financial sector as the main beneficiary of the economic recovery and this, thanks to rising interest rates allowing an increase in net interest margins on loans.

This expectation may suffer if megabanks like JPMorgan Chase (JPM) Citigroup (C) and Wells Fargo (WFC) fail to provide any upside surprises in their fourth-quarter earnings reports. Others like the Bank of America (BAC) and Morgan and Stanley (MS) will follow suit. Then, it will be the turn of the big techs with Microsoft (MSFT) on Jan 25 and Apple (APPL) on Jan 29, with analysts being keen to observe for any effects caused by the semiconductor supply crunch.

Second, there is the VIX (Volatility indicator) also referred to as the “index of fear” whose methodology is based on the stocks forming part of the S&P 500. Higher is the VIX, more are volatility risks, and from its high of 35, the indicator is currently at around 18. Given that this figure is far from the VIX’s above- 85 spike during the spring 2020 market crash, a major downside does not seem imminent, but a near-20 value signifies that volatility is persisting.

This signifies that we are in an environment conducive for gains through the SPXU.

Pursing on a cautionary note, I deliberately used the word theoretically above when mentioning possible gains with the SPXU. In this case, a 5% loss in the SPY will not convert into a 15% gain in the SPXU as some percentage points will be lost due to the compounding effect which is a specific feature of highly leveraged ETFs. The net gain will ultimately depend on the degree of fluctuations (volatility) during the trading period. This discrepancy is evident in the one-week performance chart below where a -1.39% loss of the SPY has not translated into a 4.17% (1.39 x 3) gain in the SPXU, but only a 4.15% gain.

https://static.seekingalpha.com/uploads/2022/1/12/49663886-164200000530492.png

Source: Trading View

Considering the long term, due to the leverage, the ProShares fund has delivered a 55% loss and thus, a buy-and-hold strategy is to be avoided, and it is preferable to use this market shorting tool for the least amount of time possible, preferably one day as per the prospectus. This said I have held it for up to five days after gaining some experience selling it at a loss due to the unpredictability of the market. Looking at portfolio protection, some investors also use the SPXU as a hedging tool to gain from a falling S&P 500. Thus, by hedging, these investors hold on to their stocks instead of passively selling them and taking profit in the expectation of an elusive market crash.

Finally, my advice is to wait for the VIX to go above 20 before placing your bet, and this should happen this week or the next. Also, patience, rigorous monitoring and being prepared to exit with a loss are key ingredients for shorting the market.

Disclosure: I/We are long Apple. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

IPAY: An ETF to Profit From International Air Travel Recovery in 2022, With Some Risk Protection

More than one and a half years after closing its borders with most of Europe including the U.K., South Africa, Brazil, India, and China due to the pandemic, the U.S. opened them to fully vaccinated passengers from November 2021, thus paving the way for families and friends to be reunited, businessmen to finally have a face to face meeting with colleagues and travelers to explore new destinations.

Despite some pandemic uncertainty persisting whereby some U.S. airlines and other businesses reported a pullback in October, the travel sector is bouncing back from 2020 lows with the number of international flight departures steeply inching back up to 2019 levels as shown by the green chart below.

https://static.seekingalpha.com/uploads/2022/1/11/49663886-1641889722922848.png

Source: Bureau of Transportation statistics

Now, to profit from more international business travel, you can invest in airlines or in payment processors like American Express (AXP) whose revenues were severely impacted from mid-2020 after the cancellation of trans-Atlantic flights (as shown in the pale blue chart below) and has still not yet recovered from its pre-pandemic highs.

Using the ETF option instead of investing individually

Easing restrictions on international travelers should also be beneficial to Discover Financial (DFS), another company that has not regained its 2019 revenue levels, as well as MasterCard (MA) and Visa (V). These two companies, whose share prices have been rising since December, underwent a faster recovery by taking advantage of the move to cashless payment, a secular trend accelerated by the pandemic. This consists of effecting electronic payments instead of using paper notes and has been accelerated by the availability of smartphones using QR (Quick Response) codes. Supported by smartphone devices, the value of global mobile payments is forecast to climb from $1.5 trillion in 2020 to $5.4 trillion by 2026, according to data by Mordor Intelligence.

https://static.seekingalpha.com/uploads/2022/1/11/49663886-16418897230331607.png

Source: ycharts.com

Now, instead of individually investing in all the companies I have mentioned, there is the ETFMG Prime Mobile Payments ETF (IPAY) option. Incepted in 2015, it provides exposure to 55 stocks in the payments industry, which, through companies like Block (SQ) and PayPal (PYPL), is experiencing a shift from credit card and cash transactions to digital and electronic methods. As shown in the chart above, these two companies have enjoyed the largest quarterly revenue growth at 192% and 24.6% for Block and PayPal respectively.

Going deeper, the fund tracks the Prime Mobile Payments Index and the top ten holdings in its portfolio adding up to 53.29%, up from 48.62% in mid-2019. With its top ten holdings constituting more than 50%, this means that IPAY is subject to more concentration risks, which the fund managers have mitigated to some extent by adding 15 holdings to the 40 the fund included back in 2019.

The volatility impacting IPAY

Still, this has not prevented IPAY to be highly volatile in the last six months as shown in the green chart below with the ETF losing 19.99% of its value. Some analysts tend to associate this fall with the Nasdaq as payment processors that make use of financial technology are also referred to as FinTechs. However, this is not true as the woes of the NASDAQ date back to more recently, or November. The real reasons for IPAY’s fall seem to be related to two of its main holdings: PayPal and Square which both lost over 37% since August, thus dragging IPAY.

https://static.seekingalpha.com/uploads/2022/1/11/49663886-164188972338948.png

Source: Trading View

The market correction impacting these two stocks seems to have been due to their rich valuations, which were 161 (Block) and 61 (PayPal) in August as investors, increasingly aware of the growth-value rationale, have discarded high-valued stocks. Additionally, there are also fears that due to their advanced venture into blockchain technology and cryptocurrencies, these two stocks may be in the sights of regulators who have shown some signs of increasingly wanting to reign in the crypto world.

Lower valuations and timely portfolio adjustment

As per MorningStar, these two stocks are currently at half their August valuations. Furthermore, IPAY’s price-to-earnings ratio is currently at 20.47, which is below the category average value of 25.76.

Additionally, the fund managers who charge an expense ratio of 0.75% for this actively managed ETF have proceeded to a portfolio adjustment from August 25, 2021, to January 8, 2022, which I find to be appropriate. This consisted of increasing the relative percentage of MasterCard, American Express, and Visa shares held as part of total assets, at the expense of Block. These three companies should profit the most from the recovery in international travel as cross-border payments tend to be more lucrative than domestic payments for their payment processing businesses. Furthermore, after having been travel-constrained for the last one and half years and with a lot of savings at their disposal, both tourists and businessmen are likely to spend more.

https://static.seekingalpha.com/uploads/2022/1/11/49663886-16418897231171749.png

Source: etfmg.com

Pursuing on a cautionary note, there may be some headwind in case there are some interruptions in the momentum for digital payment adoption as seen in parts of Europe last year and in the event that consumer spending growth stalls in 2022 as a result of product prices increasing because of inflation. Hence, volatility may persist and investors may have to hold to the ETF for a longer time. Thus, scanning the industry, I came across the Tortoise Digital Payments Infrastructure Fund (TPAY) offering the same payment processing stocks, but with a lower expense ratio of only 0.4%. However, its three-year, one-year, and one-month price performances have been worse than IPAY.

Consequently, with a better track record, IPAY should profit from international air travel recovery in 2022, while at the same time, its fund managers should partially mitigate any uncertainty due to the emergence of a new and more dangerous Covid variant through holdings which already play key roles in digital transformation of the payment industry.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

EWY: Take Advantage of USD/KRW Strength to Trade the South Korea ETF

EWY encapsulates South Korean stocks with some global semiconductor names, while KRW/USD is the ratio of the South Korean Won to the U.S. dollar or the inverse of the USD/KRW currency pair. The mighty dollar is currently on an uptrend encouraged by a hawkish Fed and the U.S. economic recovery being well on track.

https://static.seekingalpha.com/uploads/2022/1/10/49663886-16418344883060296.png

Source: fxempire.com

Now, the USD/KRW pair forms part of the top 10 most traded currency pairs as part of the foreign exchange (Forex) market, which is larger than all stock markets of the world combined, but, whose volatility is only second to Bitcoin’s.

Many professional Forex traders trade this currency pair which, as seen by the abrupt fluctuations carries volatility risks, but, depending on the right timing, can also be synonymous with opportunities. Here, the undervaluation of the Won against the U.S. dollar signifies that there is potential for an FX gain since EWY shares are USD denominated while portfolio holdings are in the local East Asian country’s currency.

Pursuing further, South Korea was the first developed nation to raise its interest rate on August 26 by 0.25% to 0.75%. With the Bank of Korea (BOK) also incrementing its inflation projection from 1.8% to 2.1%, there could be further hikes. Now, with the U.S. and China being South Korea’s two main trading partners and the fact that both countries’ currencies have appreciated against the won, means that it may be easier for central bankers to drive another rate hike while still downplaying high interest risks for South Korea’s export-driven economy.

Assessing economic growth, the South Korean economy rebounded strongly from 2020’s Covid slump, which translated into EWY’s main holdings witnessing strong revenue growth as from July 2020.

https://static.seekingalpha.com/uploads/2022/1/10/49663886-16418344892311056.png

Source: Ycharts

Looking ahead, there may be some supply chain-related issues as well as inflation impacting the different sectors of the fund’s holding. Its over 37% exposure to IT is being adversely impacted by the contagion effect from Nasdaq’s fall. However, looking deeper, the IT names in fact consist of semiconductor plays like Samsung Electronics (SSNLF) and SK Hynix ( HXSCL) at 24.5% and 6.1% of overall assets respectively. In this respect, with chips being key components used in the manufacturing of everything from cars, electric batteries, solar panels to wireless 5G, its demand should persist for years despite the Korean government starting to reduce monetary stimulus. I also view the rate rise by the BoK for the purpose of normalizing policy as being more aligned with the economic recovery. It also comes at the right time in order to reduce macroeconomic risks like creating an asset bubble or letting household debt increase.

https://static.seekingalpha.com/uploads/2022/1/10/49663886-16418344883293347.png

Source: iShares.com

This said, to further support the fact that EWY constitutes an appropriate investment at this juncture is its underperformance of the iShares MSCI Emerging Markets Index Fund (EEM) (which includes holdings from China, Taiwan, and others in addition to South Korea ) by more than 10% for the last one year. As a result, based on its holdings, EWY is available at an average Price/Book Ratio of only 2.56 compared to 4.8 for EEM.

Finally, as a result of the sell-off in tech stocks, the Korean ETF could slide further, maybe to the $74.1 support level. Moreover, despite the BOK raising rates again in November, the Won has continued on its downtrend. This should prove beneficial for the country’s export-led economy and continue to promote revenue growth for EWY’s holdings.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

 

For High-Growth Tech Lovers, the Trend Indicates That it is Time to Consider Value-Oriented ETFs

Also, subtracting 2% due to “positive sentiment” induced by the Santa Claus rally, it can be inferred that the index actually fell by more than 8%. At the same time, a look at the S&P 500 (in orange) which holds more than 28% of technology assets exhibits a more neutral position, while the Dow Jones Industrial average (in blue), up by 1.52% indicates that the more cyclical names are being prioritized by investors, as potential beneficiaries of the economic recovery.

https://static.seekingalpha.com/uploads/2022/1/9/49663886-16417501192287376.png

Source: Trading View

Going further in the past, the weakness in tech started from the second quarter of 2021 when it became evident that the Fed was adopting a more hawkish tone and bond yields were on the rise. However, the adverse market conditions for technology were masked by the gains from these six most popular stocks, namely, Tesla (TSLA), Apple (AAPL), Microsoft (MSFT), NVIDIA (NVDA), Meta Labs (FB), and Google (GOOGL). Now, with the Nasdaq bearing a P/E ratio of 28, tech valuations remain high compared to the broader market, and the weakness in richly-valued high-growth names in the technology sector should continue, perhaps in the same way as during the Internet bubble of 1999-2000.

Growth to value rotation

Now, moving away from high-growth tech names to lower-valued cyclical names reminds us that the “rotation from growth to value”, which some analysts were invoking in 2021, has gained momentum. For investors, rapidly growing tech stocks with their high R&D and sales expenses primarily focus on growth while value names are more conservative in spending and lay more emphasis on profitability.

To further verify whether the growth to value shift is really happening, I make a comparison between growth and value ETFs as per the chart below. In this case, the iShares Edge MSCI USA Value Factor ETF (VLUE) and the Vanguard Value ETF (VTV) are both up by 5.6% and 3.9% respectively, while the Schwab U.S. Large-Cap Growth ETF (SCHG) and the Technology Select Sector SPDR ETF (XLK) are down by more than 3% each. This one-month performance confirms that value is up, while growth/technology is down.

https://static.seekingalpha.com/uploads/2022/1/9/49663886-16417501193779671.png

Source: Trading View

Looking ahead, in view of the uncertainty associated with Covid variants, supply chain issues, and inflationary concerns in the first half of 2022, there is no guarantee that the current trend favoring value will continue, but, at the same time, we cannot remain insensible to the new market regime. Moreover, for those who have been used to investing in growth made relatively easy due to the momentum induced by the mighty Nasdaq, it may prove difficult to screen the market for high-quality value stocks with appropriate free-cash-flow, balance-sheet, and valuations metrics.

The value-oriented ETF rationale

Hence, it is precisely for these tech investors that investing in value-oriented ETFs where the fund managers select the best stocks, makes sense.

In this respect, VTV with an expense ratio of 0.04% and paying dividends at a yield of 2.15% holds mostly Financials (22%), Healthcare (18.5%), and Industrials (14%) stocks as part of total assets. Finally, for tech lovers, better performing VLUE, with 30.85% of IT exposure, and paying a 2.41% dividend yield at an expense ratio of 0.15% is a better choice.

Disclosure: I am long XLK.

 

SPYD: A High Dividend ETF to Also Benefit From Return to Office

This level of change was unprecedented in the 200 years old history of industrialization and resulted in millions of square feet of prime office space suddenly becoming useless as cohorts transformed working habits in order to reduce Covid infection risks. Going a step further, government departments, as well as companies from Microsoft (MSFT) to Google (GOOG), extended the time period their employees could work remotely to more of a hybrid mode due to Covid variants.

WFH, Vaccination Efficiency and REITs

However, while WFH has helped to reduce costs, its contribution to productivity remains debatable, and with higher vaccination rates in 2022, the return to office momentum could be accelerated. This should in turn benefit office REITs or Real Estate Investment Trusts.

With 16.81% real estate exposure, the SPDR S&P 500 (SPYD), is a high dividend yield ETF. It also includes 19% of financials, a positive in a rising rate environment which should be favorable to banks. On the other hand, the ETF also has some exposure to IT, which depending on the valuations of the individual holdings, is currently suffering from a rotation away from technology names.

However, the fact that this exposure is limited to 5.75% still makes SPYD a more appealing choice when compared to the Vanguard High Dividend Yield ETF (VYM), for example, which includes 8% of technology stocks as part of its holdings. Additionally, the Vanguard ETF does not include any REIT stock as part of holdings.

https://static.seekingalpha.com/uploads/2022/1/9/49663886-16417204616864512.png
Source: ssga.com

I also like the SPDR ETF as it pays higher dividends, at a yield of 3.54% compared to its peer’s 2.74%.

Best REIT ETFs

Scanning the industry, in order to fully benefit from a return to office one can also choose the SPDR Dow Jones REIT ETF (RWR) or the highly popular Vanguard Real Estate ETF (VNQ), but, given future uncertainty as to the possibility of Covid variants impacting a full resumption of office work together with the diversification rationale, it is better to opt for an ETF with partial exposure to REITs like SPY. For this purpose, it follows the S&P 500 High Dividend Index and carries an expense ratio of just 0.07%.

In addition to providing higher quarterly income, SPYD, with a gain of 28.21%, has outperformed the broader market (S&P 500) by more than 5% in the last year. This outperformance has even been more pronounced during the last one month at more than 7% (6.82% minus -0.24%) as shown in the red and blue charts below, and should continue as investors pour more money on the cyclical sectors like Consumer Staples and Energy to bank on the economic recovery, at the expense of tech.

https://static.seekingalpha.com/uploads/2022/1/9/49663886-16417216689965916.png
Source: Trading View

To further make my point about SPYD benefiting from REITs and being less exposed to tech is its superior one-month performance compared to VYM’s 4.28% as shown in the orange chart above.

Finally, SPYD forms part of a list of ten high-yield ETFs for income-minded investors computed by Kiplinger, aiming for balancing risks and rewards in the quest for better-than-average yields.

Disclosure: I am long SPYD.

Analyzing the Underperformance of Three Bitcoin-related Asset Classes and Selecting the Best One

Still, after being adopted by some big names mostly to boost up their balance sheets as well as offered as part of new funds like the ProShares Bitcoin Strategy ETF (BITO) in October 2021, the cryptocurrency has still managed a one-year gain of 3.64%. However, the volatility which is associated with Bitcoin could result in either a continued downside in case U.S regulators plan some strict moves or a spectacular surge in the event of being adopted by a large institution.

Coming to the orange chart below, BITO, which provides investors with Bitcoin exposure through its futures (futures price increases), instead of owning digital coins themselves, has suffered by 37% in the last three months. This means more underperformance than the digital asset itself. According to the fund’s prospectus, this is explained by the “contango effect” and occurs when the fund sells the expiring contract at a relatively lower price and buys longer-dated contracts at a relatively higher price. Conversely, the fund can also benefit from the “backwardation effect” when it sells an expiring contract at a higher price than what it pays for a new longer dated contract.

Still, according to ETF Trends, despite the latest volatility, inflows into BITO have remained steady in January, signifying that those who have a long-term investment goal are choosing the ETF instead of having to own crypto wallets.

https://static.seekingalpha.com/uploads/2022/1/8/49663886-16416429413944204.png

Source: ycharts.com

Next, Marathon Digital Mining (NASDAQ:MARA) as a Bitcoin miner (or producing coins using computing equipment) as shown in the pale blue chart above has suffered from an even higher level of volatility, being up by a whopping 60% in the first week of November, but, currently down by a painful 40%. Looking across the industry, other miners like Riot Blockchain (NASDAQ:RIOT) have also been impacted. One of the reasons for miners’ pain is that in addition to minting digital coins, they also hodl (store Bitcoins) instead of selling them. Consequently, unless you have more of a trading profile, avoid miners.

On the other hand, Coinbase Global (NASDAQ:COIN), with its cryptocurrency exchange app designed to trade crypto has been less impacted, by -17.23% as shown in the green chart above, partly due to a reduction in platform exposure to Bitcoin, from 57% in 2020 to 42% in 2021. Investigating further, the company is diversifying revenues beyond retail crypto trading.

In this respect, non-trading revenues consisting of Subscription & Services which increased from 4% in Q3-2020 to 12% in Q3-2021, look to be on an increasing trend. Additionally, by offering services like blockchain rewards and Earn campaign, as well as planning an NFT (Non-Fungicible Token) platform to take advantage of decentralized finance (DeFi) products, Coinbase is one of the best Bitcoin-related investments one can think of currently.

To further justify my bullish stance, the crypto exchange boasts $6.3 million in its balance sheet, and more importantly, it generates an operating income, not a loss as is the case with most miners.

https://static.seekingalpha.com/uploads/2022/1/8/49663886-164164294137739.png

Source: SEC filings

Finally, with the current inflation outlook and the Fed reducing monetary stimulus, Bitcoin, in the same way as many richly-valued tech stocks, is no longer benefiting from an increase in the money supply. Thus, it is better to avoid exposure to monetary devaluation by investing in asset classes that are directly exposed to Bitcoin’s value like BITO and crypto-miners. Instead, an exchange like Coinbase that benefits from trading-based revenues and is diversifying into value-added services around the crypto ecosystem makes more sense. Thus, the company could surge to the $250 range as soon as it launches Coinbase NFT, a new product experience where users can mint, collect, discover and showcase their NFTs, all in one place.