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Daily Analysis 1 February 2022 (10-Minute Read)

Hello there, A terrific Tuesday to you as Asian markets head off for the Lunar New Year holiday break while U.S. markets continued with a surge on Monday as dip buyers came back in full force. In brief (TL:DR)

  • U.S. stocks opened on Monday continuing to rally higher with the Dow Jones Industrial Average (+1.17%), the S&P 500 (+1.89%) and the Nasdaq Composite (+3.41%) all up strongly as investors rotated into tech stocks to buy the dip.

  • Asian markets were mostly closed on Tuesday for the Lunar New Year holiday.

  • Benchmark U.S. 10-year Treasury yields dipped slightly to 1.791% (yields fall when bond prices rise).

  • The dollar edged higher.

  • Oil gained with March 2022 contracts for WTI Crude Oil (Nymex) (+0.43%) at US$88.53 posting its biggest January gain in 30 years in line with inflationary pressures and geopolitical uncertainty.

  • Gold continued to rise with April 2022 contracts for Gold (Comex) (+0.06%) at US$1,797.50.

  • Bitcoin (+5.42%) rebounded to US$38,300 bringing some Lunar New Year cheer in Asian trading hours, in line with dip buying in U.S. tech stocks.

In today's issue...

  1. Innovation is on Sale, Should You be Buying?

  2. Too Soon to Call Curtains on the Meme Stock Craze

  3. Cryptocurrencies Too Big to Fail for Emerging Markets?

Market Overview

To all celebrating the Lunar New Year, a very Happy and Prosperous Year of the Tiger!

American and European markets remain open and dip buyers were out in full force, betting that the rout in tech stocks had been overdone and taking the opportunity to pick up equities of growth firms on the cheap.

More dovish comments by the U.S. Federal Reserve's Kansas City President Esther George, a longtime hawk, also helped to reassure investors that the central bank would not play dice with the economy and by extension, the markets, noting that it's in "no one's interest to try to upset the economy with unexpected adjustments."

Her more dovish counterpart, U.S. Federal Reserve San Francisco President Mary Daly noted that policy moves "have to be gradual and not disruptive."

Investors interpreted the comments to mean that policymakers were unlikely to ratchet up rates aggressively, but rather provide some degree of predictability.

Asian markets rose on the first day of February with Tokyo's Nikkei 225 (+1.16%) and Sydney’s ASX 200 (+0.46%) higher on Tuesday morning, while South Korean and Hong Kong markets were closed for the Lunar New Year break.

1. Innovation is on Sale, Should You be Buying?

  • Closer study of constituent stocks of ARK Innovation ETF reveals that a vast majority of them have grown revenues at a record clip

  • Selling of companies developing disruptive technologies may have been indiscriminate and overdone, there may be jewels among the wreckage that can be polished for value

“A fool is someone who knows the price of everything and the value of nothing.” – Oscar Wilde With Cathie Wood’s flagship ARK Innovation ETF now trading at around a 56% discount from its peak last year, some investors may be wondering whether to take notice of her clarion call to buy innovation which is on “sale.” Speaking last Tuesday at Ark Investment Management’s virtual Big Ideas Summit 2022, following a big drawdown from her flagship ETF, Wood declared, “Innovation is on sale and it will be really important to investors to get to move towards the right side of change, given the amount of disruption that we do expect.” In a certain sense, Wood is right. Examining the 50 stocks that constitute the ARK Innovation ETF, all but one, Intellia Therapeutics, which develops medicines using Crispr gene-editing technology, are down since last February. On the one hand, some investors might view this data as confirmation that betting on disruptive technology and the future is a dead end. But on the other hand, the data also seems to reveal that selling in these companies has been as indiscriminate as the buying was back in 2020. What’s sauce for the goose is sauce for the gander – investors can’t just choose to blindly look at one side of the coin based on how it suits their purposes. If (as alleged) the buying in these so-called disruptive tech companies was misguided on the way up, it appears just as misguided on the way down, which means there’s likely to be at least some mispricing either way. Taking a closer look at the revenues of ARK Innovation ETF’s constituent stocks also reveals that annual growth for those that have revenues (a small handful do not) has been incredible. Nine of the fifty ARK Innovation ETF’s holdings have grown revenues at over 100% per annum, while including those that have grown revenues at a rate of over 50% brings the total number to 21, just under half of the 50 stocks. And while stock-picking is undeniably hard, somehow Wood and her team has managed to pick a whole bunch of winners. By venture capital standards, Wood’s picks would be stellar, the equivalent of hitting five home runs in a single outing. And it’s not like Wood’s picks are even big secrets either – take Zoom Video Communications for example, which grew its revenues by 35% in the last quarter and is profitable, with free cashflow exceeding its net income – its share are down 65%. Twitter, whose shares are down some 40%, grew its top line at almost 40%, while Spotify, down by nearly 50%, grew revenues by 27% in the last quarter. These are not bad numbers by a longshot, even if many companies in Ark’s stable are. Taking a leaf out of legendary value investor Warren Buffett’s playbook, in 1997, the Oracle of Omaha asked shareholders, “A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?” In a similar vein, if investors want to harvest the fruits of disruptive and indispensable technology for the long-term, would they want the shares of these companies to be higher or lower?

2. Too Soon to Call Curtains on the Meme Stock Craze

  • Some meme stocks have raised monies through stock sales and debt issuances that could provide them the necessary resources to stage dramatic turnarounds

  • Excess short seller activity may yet re-ignite the flames of retail investors looking to perform just one more short squeeze for the road

Given the volatility in risk assets of late, investors could be forgiven for assuming that the darling of risk-taking – meme stocks – should be all but dead by now. But these investors would be mistaken in their assumption. While battered investor sentiment has beaten-down meme stocks, solid economic and earnings growth could give them a second lease of life. Let’s not forget that meme stocks from the likes of movie theater operator AMC Entertainment to video game retailer GameStop, were able to not just sell their shares at ridiculous prices, they also used the opportunity to line their pockets with cheap debt to sustain comebacks. Take Hertz for instance, a car rental giant that filed for Chapter 11 bankruptcy protection and was assumed to be left for dead when a stunning revival and now a mega deal with Tesla to rent out electric vehicles has seen a swift reversal of fortune. Many stocks that peaked early last year amid a retail-trading frenzy are significantly far off their highs as concerns grow about the impact of U.S. Federal Reserve rate hikes and inflation. Consumer sentiment is also turning sour and a gauge of retail investor favorites from Nomura Holdings and Wolfe Research has slumped over 30% from a high last November. Overall, stocks once popular with retail investors, have fallen into a bear market, and it’s unclear how long it will take for them to turnaround, if ever. The situation for meme stocks has deteriorated so much that short sellers who once tried to obfuscate their bearish positions are calling open season on target companies, without fear of retaliation from retail investors. Even if these meme stocks manage to turn their fortunes around, it isn’t clear that they will reach their previous glory, but writing them off completely as going concerns on the other hand, may be premature.

3. Cryptocurrencies Too Big to Fail for Emerging Markets?

  • Cryptocurrency usage has blossomed in emerging markets with weak financial systems and large numbers of unbanked citizens

  • Increasing correlation between cryptocurrencies and equities is disconcerting for the IMF, which is calling on more comprehensive and consistent national and global regulation

It may come as no surprise that the countries where cryptocurrency transactions are most prevalent are in emerging markets. From Vietnam to the Ukraine, locals are finding that using cryptocurrencies for a variety of transactions helps to make up for deficits in the existing financial system, which has tended to leave large swathes of the population unbanked. And the growing popularity of cryptocurrencies is threatening to have a “destabilizing” effect on capital flows in emerging markets, especially when they have been used as a substitute to national currencies, at least according to the IMF’s Tobias Adrian, the IMF’s Financial Counsellor and Head of Monetary and Capital Markets Department. In an interview with the Financial Times, Adrian noted, “Crypto is being used to take money out of countries that are regarded as unstable. It is a big challenge for policymakers in some countries.” Last week the IMF urged El Salvador, where Bitcoin was declared legal tender in September last year, to stop recognizing the cryptocurrency as such because of “large risks” posed to the stability and integrity of the country’s financial system. Yet in a country where the vast majority of the population are unbanked and the U.S. dollar has long been used as legal tender, just because Bitcoin is volatile in and of itself does not exclude it from consideration as legal tender. If nothing else, Bitcoin isn’t at the mercy of the whims and fancies of a foreign government, whereas the dollar is. Undeterred, El Salvador’s President Nayib Bukele, which is seeking over US$1 billion in financing from the IMF, also plans to raise money by selling bonds linked to Bitcoin. The IMF’s Adrian has observed that some emerging markets and developing economies are already facing “immediate and acute risks” as a result of their existing established currencies being replaced by cryptocurrencies, a process that has been dubbed “cryptoisation.” According to Adrian, “Capital flow management measures will need to be fine-tuned in the face of cryptoisation. Applying established regulatory tools to manage capital flows may be more challenging when value is transmitted through new instruments, new channels and new service providers that are not regulated entities.” Part of the problem for emerging market governments is that years of neglect have led to a spirit of self-reliance and in many cases, a grassroots led effort to use cryptocurrencies without prior consultation or consideration from leaders. Take the use of non-fungible tokens from blockchain game Axie Infinity for instance – entrepreneurial Filipinos and people from other emerging markets, took to playing the play-to-earn game when income from other sources dried up during the course of the pandemic. If nothing else, the experience has shown them that governments couldn’t be relied upon to provide support during periods of economic difficulty, yet the cryptosphere was able to provide them with sustenance during these challenging times, even in some cases exceeding their previous wages. While the IMF has urged national and global regulators to establish a coordinated and consistent approach to regulating cryptocurrencies, the odds of achieving that in sufficient time are slim. The Biden administration is looking to take front and center in the U.S.’s cryptocurrency regulations and the U.S. Securities and Exchange Commission’s Chairman Gary Gensler has been rattling his saber for some time now to properly regulate what he’s termed the “Wild West.” But given the speed at which cryptocurrencies develop and their movement into mainstream finance and their effect in that sphere, regulators are likely going to have to be playing catch-up than necessarily pre-empting the consequences of any unintended fallout. The IMF’s Adrian notes, “The correlation between crypto and equity markets has been trending up strongly. Crypto is now very closely tied to what is happening in equities. We can’t just dismiss it.”



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