This week, we’ve started to see the price of passive ETF investing. A rising number of ETFs have funneling money into the same large cap tech stocks leading to elevated valuations. These flows are now reversing and we are discovering the inherent problem of ETFs aiming to trade near the market close. ETFs promise to replicate an index, which means trying to match the closing price and not really caring about getting a better price earlier in the day. This was ignored on the way up, but we are feeling the unpleasant opposite effects now. With many of the most popular ETFs notably overvalued, there’s a long way to normalizing, as we show below.
As the past two Dispatches reiterated that crypto assets wouldn’t be spared if market correlation rose. This week, the VIX spiked closer to 30, correlation rose and a broad-based crypto asset selloff ensued. Continued downside should provide attractive long-term entry points for decentralized blockchains with exponential growth outlooks. However, only a small minority of the >7,000 tokens in circulation is likely to see sustained network growth. As a result, there is significant risk in the wider digital asset ecosystem. Bitcoin on-chain metrics show limited signs of excess, but that won’t spare the asset in a correlated selloff near term.
Dispatch #2 on January 21st, 2022, has the following line up of stories.
- The price of passive ETFs
- Crypto scams rose in 2022
- Saquon Barkley on preserving wealth with bitcoin
- NFT owners have large tax liabilities
- Is a competitive bitcoin mortgage possible?
- The supply side case for energy upside
- Fuel efficiency standard raised:
- Volvo study on XC40 EV vs ICE carbon intensity
The price of passive ETFs
The chart illustrates the surging valuation of large cap Indices as passive ETF flows dominate. The industry has churned out lots of new ETF strategies most of which include the same sub-set of large tech stocks that dominate the S&P and NASDAQ. As the tide goes out, we could have real problems as all of these ETFs try to sell the same stocks. The ETFs’ trading behavior of selling near the close of daily trading is likely to further expose lack of liquidity. If you believe the S&P 500 is not expensive, the chart below should cause you to think again.
On a positive note, stocks outside the main indices remain attractive, especially on a relatively basis.
Getting exposure to these non-index stocks requires time-consuming research or, at a minimum, looking at what’s inside each ETF. For example, at the end 2021, the stock with the largest weight in the popular Russell 2000 small cap ETF (Ticker IWM) was AMC Entertainment.
Source: ishares
Investors think they are getting small cap companies with attractive growth prospects, but instead they get a stock inflated by the meme-stock trading madness. Readers can imagine where The Dispatch is spending time researching ideas.
Finally, the chart of retail margin borrowing shows that these ETF flow contain leverage.
Crypto scams rose in 2022
As a believer in decentralized blockchains, we aim to educate readers on the pitfalls of the technology. The absolute value of crypto scams increased in 2021 as asset prices rose. This data will be fodder for critics of private blockchains. What these critics don’t address is that the bulk of the world’s fraud and dark activity takes place in cash, which is untrackable. Blockchains built with open-source software provides an open ledger for all to see. This is how blockchain analysis firms, like Chainalysis, can accurately measure scams and other dark market activity.
A “Rug Pull” is mostly in Defi where a project raises money via a token or project, and then disappear with the funds.
Source: Chainalysis
Saquon Barkley (NY Giant’s running back) on preserving wealth with bitcoin
Barkley’s tweet thread had a simple message and struck a chord with The Dispatch. The tweet has been liked 23.6K times, which speaks to the network effects from public figures’ adopting digital assets. A few tweets from his seven-tweet thread are shown below.
Source: via Twitter
NFT investors have large tax liabilities
As with many things in crypto, the rules aren’t exactly clear. That does not mean you can skip disclosing, filing, and paying taxes on gains. This Bloomberg article discusses the issues and risks. If you were lucky, or smart, to get into NFTs and cash out at a profit, you need to make sure you file taxes accurately. The IRS has contracts with blockchain analytics firms to audit user wallets. The Dispatch is not a tax advisor, so please speak to a tax professional.
Is a competitive-priced mortgage backed by your bitcoin finally possible?
Miami-based fintech lender Milo says it will offer a competitive mortgage product where borrowers can pledge bitcoin as collateral. The Dispatch is skeptical that a small fintech lender with just a $6m seed funding round will be able to offer a competitive interest rate on a crypto-backed loan, even with 100% bitcoin collateral. The view here is that, without cheap deposits or access to the US MBS market, the bitcoin mortgages will be significantly more expensive than a standard mortgage that is available from the traditional system. The announcement may provide a lot of free publicity to help a higher valuation for a series A round!! This Bitcoin Magazine story has details. The Milo website has more details.
There are plenty of entities that offer bitcoin loans. Blockfi and Unchained Capital, for example, offer loans without a credit check as they are overcollateralized with bitcoin. The rates, though, are higher than what a typical mortgage would offer. Perhaps with >100% bitcoin collateral, plus the collateral of the house that takes loan-to-value to below zero, there can be a competitive interest rate. This is especially likely if Milo gets to generate a yield on the $ value of the bitcoin collateral.
The supply side argument for owning energy assets
The chart below from Topdown Charts best supports our bullish long-term view on energy prices. Yes, the demand side will be buffeted by potential global GDP slowdown and possibly a faster transition to EVs (see next story), but investors are not paying attention to the supply side. A combination of ESG, economics and politics has sharply lowered capital investment in the sector. Demand remain robust as developing markets energy intensity rises as those countries progress up the development path.
With a bullish energy view, the notable risk comes from some form of windfall tax implementation in OECD countries. We saw some emerging markets rush through windfall tax regimes during the 2007 commodity bull market. This time, those measures are likely in OECD economies too, and taxes on energy companies are likely to prove broadly popular even if it further exacerbates the supply shortage. For the Dispatch, the investment conundrum is how to minimize the taxation risk, which points to riskier non-OECD domiciled companies.
High Fuel efficiency standards will drive switch to EVs
The structural bear case for energy demand hinges on consumer transportation switching quickly to EVs. The Biden administration raised fuel-efficiency standards recently: Auto makers must meet a US fleet-wide standard of 55 mpg by 2026, up from the 43 mpg standard previously set by the Trump administration. This is a good example of how politics and policy drive long-term demand and supply dynamics. The new standard will push automakers to electrify more of their fleet as it’s hard to achieve 55 mpg with ICE vehicles alone. As we have said before, lower mpg does not = lower carbon intensity. EV vehicles are more energy intensive to manufacture compared to ICE (internal combustion engine) vehicles.
Volvo report on carbon intensity of XC40 EV vs. ICE vehicle
On the issue of life cycle carbon intensity of EVs vs. ICE vehicles, Volvo has released a report outlining the comparative carbon intensity of their XC40 ICE vs. XC40 EV vehicles. As the chart below shows, at today’s global electricity mix, the EV model comes out 6.8% better after 200,000 kms (124K Miles). That advantage improves with EU’s electricity mix and even more if electricity is 100% renewable.
The assumption of 200K kms seems excessively high and an unrealistic threshold for purchase decisions. We are curious how many of our readers have driven any of their vehicle for more than 123K miles. We’d love to hear if you have. Also, what about battery degradation at these high miles? Despite these questions, we applaud Volvo’s research effort. We have not seen a better comparison on this subject.
The Dispatch was briefly encouraged that the average age of the US light vehicle fleet has been rising for the past decade. Doesn’t that mean we are using fewer resources? Unfortunately, the WSJ article suggests the rising age is due to households adding extra vehicles to their fleet. Annual new vehicles sales, as the article points out, hit new highs pre-Covid.
Higher carbon intensity of EV manufacture is rarely discussed
Ultimately, we rarely hear about the higher carbon footprint to manufacture EVs, with much of the increase embedded in the battery. We are served a narrative that EVs will miraculously solve our carbon problems, when Volvo’s analysis shows that is far from reality. Instead, we blindingly push electrifying heavy passenger vehicles like Hummers and Ford F-150 trucks. This WSJ article explains the flaws in America’s current fuel economy standards.
Source: Autoweek
The Presidential endorsement: Curb weight 9,046lb with a suggested price of $108,700. That’s about three Honda Civics in weight and four Honda Civics in price! It will take a 200kWH battery to move the Hummer. In contrast a Tesla Model 3’s battery size ranges from 50kWH to 82kWh and the Volvo XC40 has a 78kWh battery.
This is poor carbon policy but excellent domestic policy! Carbon policy won’t help as much as domestic policy come the November mid-term elections. The Dispatch would not be surprised if auto industry lobbying removes any vehicle weight, fuel efficiency and/or price restriction to qualify for EV purchase tax credits proposed in the Build Back Better plan. This is not a partisan rant, this is sadly how the world functions! The democrats are at least trying.
Crypto School
Bitcoin on-chain metric
The charts below are from Glassnode as of January 17th, 2022. This shows network trends before the decisive break below the $40,000 level.
The chart below puts bitcoin at a level from where it has previously rallied. However, note that in March 2020, during the Covid crash, the yellow line went even lower.
The chart below shows no signs of rising short term holders. Rising short term holders have previously happened near a macro top.
The HODL wave is one of The Dispatch’s favorite long-term charts. It shows little sign of elevated activity this week. That does not mean prices can’t go lower, just that there no sign of new holders coming into the asset class, which has been a reliable indicator of prior long term tops. As we say regularly in finance, the past is no guarantee of the future.
The one chart that shows elevated risk is the still high future open interest.
The 4hr-chart of the BTC open interest at Binance, the largest futures exchange, shows that open interest did drop about 11% from peak to trough (arrow placed by The Dispatch) from the early afternoon on Jan 20th to late evening on Jan 21st.
Binance futures open interest
Stay safe, stay warm and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. |