What Mattered #13 – Betting big

Welcome to the October edition of What Mattered. A collection of narratives and stories driving the markets every month.

October was a stellar month for equities across U.S, Europe and the UK as positive earnings news-flow and commentary leading up till the end of the year drove up major indices. Higher inflation numbers did stoke up some tapering fears. But the strong recovery in the economies worldwide and a robust consumer demand might be able to absorb the expected price increases due to inflationary pressures. At least that is the narrative doing the rounds currently.

Here’s how the major index based ETFs performed in October:

ETF returns for October, Source: Koyfin

The S&P 500 had its best month since November 2020 with all sectors contributing positively.

We’ll get to Big Tech and Financials in a bit, but first, an event that might be going into the financial history books.

Everyone remembers the first one

October marked the month when the first every crypto ETF was finally approved in the largest financial markets in the world – the Proshares Bitcoin Strategy ETF.

The ETF is does not directly invest in Bitcoin as spot BTC ETFs haven’t been approved yet. It holds futures contracts linked to BTC traded on the Chicago Mercantile Exchange (CME).

Like every crypto move these days, it broke some long standing records in the ETF world. It became the fastest ever ETF to get to 1bn in AUM (2 days) beating GLD – the largest gold ETF in the world (3 days), thus breaking an 18 year record. For those of you who have adopted the ‘digital gold’ narrative for Bitcoin, this must have been great to see.

For context, some $276mn were traded in just 30 minutes of $BITO listing on the exchanges.

But this is not your ordinary ETF which buys the underlying stocks when you buy the shares of the ETF on the exchange. It holds one-month bitcoin futures and rolls them over to the next contracts when they are nearing expiry.

Bitcoin futures trade on the CME, referencing the bitcoin one day rate aggregated from major exchanges. The problem with buying futures based ETFs is the underperformance due to the negative roll yield. That basically means it pays a premium to buy one-month future and sells them at a lower price as they approach expiry. According to some, this negative roll yield could detract roughly 10-11% returns annualised from the performance of the ETF.

Such high demand for the product has pushed the price of near-month bitcoin futures up farther away from the spot-price, creating a gap, an arbitrage opportunity for professional traders looking to profit.

A “simple cash and carry trade” of buying bitcoin and selling futures that trade on the Chicago Mercantile Exchange provides an annualised return of about 30 per cent, said Stéphane Ouellette, chief executive and co-founder of Canadian hedge fund and broker FRNT.

The line-up of Bitcoin ETFs looks quite promising, with major ETF providers coming out with their bitcoin based products soon. One might wonder why exactly would you need a bitcoin futures ETF? Why not buy bitcoin or any other crypto directly from a Coinbase/Binance account.

Maybe the answer lies in convenience and ease of access. Imagine trillions of dollars of retirement portfolios linked to major ETFs, with thousands of model portfolios and advisors allocating to different asset classes. This could be a new asset class sitting alongside your long-term portfolio, a simple product for which you just place a buy order on your investing app, without worrying to store your keys to the crypto wallet, or worrying about safety or security.

As we have seen many a times in the past, convenience usually comes up ahead when it comes to adoption.

Big tech propels the markets higher

Big tech and financials made it to the headlines with their quarterly earnings, as always. The former, as they make up almost a third of the S&P 500, and to keep tabs on the software spends and digital economy. The latter, to get a pulse of the real economy, via credit growth, deals, payment spends etc.

The FAANG+ has gone from strength to strength since last year. This quarter it did well to keep the momentum going. $TSLA and $GOOG were the standouts for me, showing an impressive revenue growth of 57% and 41% respectively. $TSLA’s prospects seem to improve every quarter, which has turned this stock into a BIG long from a highly shorted name as it now joins the $1T club.

Here’s a brief overview:

$MVRS ($FB) delivered 35% revenue growth YoY with Daily active users reaching 2.91bn (+6% change). Increased spending on capex (especially on developing the METAVERSE, amounting to $10bn) got a lot of investors fretting. You’ll now probably see them split up into two camps, the naysayers and the ones who believe in Zuck’s vision. The company will break out Facebook Reality Labs numbers from now on shedding some more light on the developments. The stock is up 21% YTD

$GOOG showed the strength in the online advertising market, with search and Youtube both growing at a significant rate. Advertising revenues were up 69% with Youtube now as big as $NFLX’s quarterly revenue. The stock is up 66% YTD.

$TSLA ‘s total revenue reached $13.76bn with a record 30.5% gross margins. The company guided to 50% growth in vehicle sales. The stock has seen a parabolic move lately, and is now up 60% YTD (after being down 20% down on the year in June).

$NFLX came out with a solid subscriber growth of 4.4mn with the lineup of content being better than ever before, according to the management. Netflix’s shows seem to have become a greater part of our culture, with content like Squid Game adding to the sway it has over the viewers. The content flywheel looks to be well set in motion: better content → more viewers → more content supply being generated at better terms –> better content. The stock is up 26% YTD.

$MSFT overtook $AAPL as the most valuable company in the world, a remarkable achievement indeed. Its revenue grew 20% with Azure, its cloud division, growing 50% YoY. For those who see Microsoft as a B2B or enterprise software play, LinkedIn now generates more revenue than Snapchat, Pinterest and Twitter…combined! The stock is up 48% YTD.

$AMZN ‘s sales growth slowed down from 15% to 37% in the same quarter last year. The company expects higher costs going forward due to higher wages and supply chain issues. But…This was the first time in history sales from Amazon’s services businesses (which includes $AWS, advertising and Prime) surpassed retail sales. $AWS is the cash cow that allows the company to reinvest in future. Its cash pile is now touching $100bn. The stock is up 2.5% YTD.

$AAPL ‘s revenue grew 29% YoY mostly led by its service division which grew 26%. Apple has seen a significant pickup in hardware sales since last year, which is driving sales of its other products along with it. The stock is up 13% YTD.

Its incredible how these tech companies are matching growth rates of young high growth businesses. Whatever you want to call it, moats, competitive advantages or walled gardens, these companies have had a long-term vision, led by great management teams who have executed to perfection.

Their focus on reinvesting in growth is commendable, with capex spends more than the market cap of most companies. Here’s an interesting stat: Facebook, Google, Amazon and Microsoft will deploy a combined capex of around $120bn next year, thats as much as the biggest telecom companies did at the peak of the dotcom bubble. Here’s the better part: most of the latter was funded by debt, which crushed the balance sheets when the prices collapsed. For Big Tech, almost all of it is being funded by operational cash flows. Beautiful.

I’ll leave you with a chart which shows how the valuations stand for these great businesses.

Growth vs Valuation Scatter plot

It was a good looking quarter for banks and financial services sector as well. The biggest lenders in the U.S and Europe not only benefited from the economy rebounding but also by record dealmaking and trading fees, a trend that has continued from last year on.

U.S investment banks delivered an average revenue growth of 19%. Overall loan growth has been sluggish, but these banks have found other attractive areas like M&A, asset management and trading to generate growth.

IB revenues, Source: Financial Times

The financials ETFs have done pretty well this year, both in the U.S and Europe.

U.S and Europe financials ETFs, Source: Koyfin

Financials have also attracted more flows as a part of inflation related trades and ‘value’ plays. Quite fascinating.

Atomic idea of the month

Lets call this edition’s Atomic idea of the month as Betting on the Captain.

I saw a lot of people dismissing Facebook’s pivot towards AR/VR as highly risky or unnecessary. Some investors do not want to hold the stock anymore as they believe it is moving away from its cash generating core business towards an unproven territory, and also spending a ton of money in the process.

Meta Platforms (Facebook) has now become a bet on Zuck’s vision and his ability to execute on it. For the non-believers, when has investing in Facebook ever not been that?

Then, how was buying $AMZN back in 2007-08, a money losing books retailer not a bet on Bezos? How was $TSLA below $100/share on the brink of bankruptcy not a wager on Musk’s ability to turn it around? I’m not saying that if Bezos and Musk did it, so will Zuck. I believe the markets are not giving enough credit for the optionality that lies inside the stock and the track record of the man and the management around him to think extremely long term and deliver.

Its hard to untangle the risks that come with, political or regulatory. But it trades at decent valuations, it is a great business, and the time could be just right to Betting on Captain Zuck!

Disclosure: I’m long.

The November edition of What Mattered should have more interesting stuff. Till then, stay tuned!

The Atomic Investor

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