Updated: Sep 5
By Laozi and Bernard at IntuitEcon
IntuitEcon will be posting weekly updates on our subscribers only page every week. Brain Trust members are welcome to contribute. Join us at 7pm EST to discuss via the Zoom link below. [UPDATED: Podcast now on Monday 6PM EST]
Our Crypto bottom call continues to look strong. Our investments in this space were concentrated in Ethereum until Monday when we bought shared in DeFi Technologies. We composed a lengthy piece detailing why we bought shares amounting to 6% of NAV. This position should be considered very risky with a potential for total loss of capital, but with the potential for 10-100x return over the next two years...especially if they allow our team to advise them on how improve the structure of their exchange traded products (ETPs).
China's stock market made headlines this week with a crackdown on powerful tech companies and for profit education industry in particular. We view this as a buying opportunity, but only because our exposure was so low and only for large tech companies that we believe to be essentially monopolies and thus are unlikely to remain depressed so long as the CCP is able to navigate their desire stay in complete control without destroying free markets. Specifically, we will be looking to buy shares in Alibaba, Tencent, and JD next week totaling a combined 2% position. This leaves room for adding substantially should prices fall further.
Stocks in the USA continued to rise to near all-time valuations. The S&P 500 cyclically adjusted price to earnings (CAPE) ratio stood at 38.39 at yesterday's close. This is higher than any point save the peak of the Dot-Com Bubble. One important difference is the yield on bonds. Treasury bond yields have been falling with the 10 year now at 1.24% compared to just over 1.7% at the end of March. During the Dot-Com Bubble the yield on Treasury Bonds was between 5% and 6%. The disparity on bond yields now vs the Dot-Com Bubble make it more challenging to compare valuations given competition between stocks and bonds for investors. For this reason we continue to see risks to bonds and "value" stocks as being at far greater risk than our investments in the #2ndTechBubble thesis. One of our largest holdings, Stride ticker $LRN, appeared to suffer during the Chinese crackdown of education companies. We believe this to be the result of Algo-Efficient Markets and thus bought more shares to take advantage of the mis-pricing.
Real yields on bonds fell this month to a new record lows. Ten-year breakeven inflation rates are have risen this year to a close of 2.43% yesterday. This is higher than any point since 2013. That puts the real yield at -1.15% this week based on the difference between the yield on treasury bonds vs treasury inflation protected securities (TIPS). These are the lowest real yields on record in the USA. Over the last 12 months, the CPI for all items rose by 5.4%, the largest 12-month increase since August 2008. There is some debate over the transitory nature of inflation during the reopening. Should recent CPI prints prove to be more persistent … expectations for breakeven inflation expectations have room to move higher. For these reasons we believe bonds to be irrationally priced. We also have concerns about the Correlation Regime as mentioned previously. To position for this we put a large short position on investment grade corporate bonds via ticker LQD to the amount of about 80% of NAV.
Federal Reserve officials declared that although the U.S. has made “progress” towards its policy goals, it has not made a steady drive towards a timeline for reducing its $120bn in monthly debt purchases. The Federal Reserve also announced the formation of two standing repo facilities to support money markets. We believe the Fed will continue to follow the path of least resistance until persistent inflation becomes widely recognized by not just market participants, but also households and corporates. If when that happens we believe we will enter a new correlation regime in which bonds and stocks move down in price together. Our best guess is that we are at least four months out from such a scenario, but it could also take years. Much hinges on how lax the Federal government is in providing additional fiscal support at levels exceeding that of WWII. Our short on corporate bonds is how we plan to hedge the challenge in timing such as event.
The Delta variant continues to dominate headlines. Scientists estimate that it is around 50% more contagious than the Alpha variant, which itself is more contagious than the original Coronavirus. We covered this in last week's Market Update, and continue to see little risk of a broader equity sell-off as a result.
China's Stock Market...
China’s sweeping overhaul of its $100bn private education industry, which bans firms that teach school subjects from making profits, sent shockwaves through Chinese equity markets. Following government-led damage control efforts, most Chinese equities (outside of private education) have partially recovered.
China's stock market has fallen nearly 30% from the peak and is technically in a bear market according to the largest ETF available in the USA, the iShares MSCI. The peak occurred in mid-February which is not surprising given how the Chinese stock market is now as dominated by "tech" companies as the USA. One key difference is that China's stock market still trades as a substantial discount relative to the USA as a result of perceived country risk. That risk has proven this year to be warranted given the China's Communist Party (CCP) unilateral crackdown of some sectors.
Our Brain Trust contributor Laozi, who focuses on China provided our team with some specific insights on the crackdown. She pointed out that there are logical reasons driving the focus of the CCP crackdown. The primary driver is the risk of losing control. A secondary driver is relating to education and a recognition of the #2ndCognitiveRevolution.
Big tech companies are highly intertwined with the strength of the CCP. Resistance to CCP control is perhaps best illustrated by Beijing’s breaking up of Jack Ma's empire. According to some sources, Beijing is now doling out some of the most lucrative slices of Ma’s business to new “partners” of its choosing. This seems likely given the incentives at play. As a result, Chinese tech has been hit even harder and is now down around 40% from its peak.
China has been a tricky investment over the past two decades for the same reason...it is both a growing and powerful part of the world economy, but fundamentally it is subject to enormous risks fundamentally stemming from the one party system. These risks are both near term and long term.
The near term risk we witnessed this week with the unilateral move to remove for profit education companies. Such a move is highly disruptive and allows for no due process. This fundamentally damages both the free market mechanism, but also the ability of the CCP to remain in power. The more the CCP unilateral moves to impose its power on industries and its people the more it strains its own legitimacy.
The long term risk is to creative IQ ... arguably the most valuable resource in the world. Our new creative, personalized, digital, global economy is becoming more complex at an ever faster rate. The most brilliant and creative minds are going to increasingly create the most value. Where these people go and what they choose to do will have profound impacts on the power of countries...and China is not likely to win the hearts and minds of their most creative and brilliant minds if they erode the free market system and attack basic liberties like freedom of speech.
By Laozi and Bernard at IntuitEcon
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