There is definitely a ‘profit taking’ feel around things at the moment, as Oil and Crypto both sell off and Gold and the Dollar rally. New players are not only moving into trading Crypto, but also in owning parts of the new Internet 3.0 which is clearly emerging as an investment Theme for 2022. This will be a further nail in the coffin for traditional sector and geography approach and for the funds that passively track those indices rather than the active managers that use them as a benchmark, especially as the traditional indices become very Top Heavy with a small number of Megacaps
It looks like Bitcoin – and ETH for that matter – is not immune from the pre-Thanksgiving profit taking happening in a number of other areas, although as the chart shows, there is still plenty of room according to the Fibonacci retracement model that a lot of traders tend to use. The 38.2% retracement of the up move is usually seen as ‘key’ which would imply around 53,000 as the next level to watch. It is interesting to see that the Bitcoin day traders are now competing with ‘professional’ traders from other, more traditional, backgrounds in FX and currencies as well as derivatives who are now coming into the space. As such it suggests that new trading behaviours will emerge. Also with long term investors entering on a ‘buy and hold’ basis, this will also start to change market patterns, making Bitcoin behave more like gold.
New players in Crypto will lead to new ‘behaviours’.
Indeed, Bitcoin’s selloff has coincided with a breakout by Gold, repeating a pattern of inverse correlation we saw earlier in the year and reinforcing a view that some of the long term portfolio tail risk insurance role of gold has been taken on by Bitcoin. Perhaps we are seeing a booking of profits after the doubling in BTC since the summer with a switch back, at least partially, back to gold. It might also explain the rally in the Dollar that is also taking place.
The articles we are writing about Internet 3.0 are part of this build up of interest in the whole area for long term investors and asset allocators as well, with the issuance of some Crypto ETFs as investment houses start trying to put together baskets of stocks exposed to this area. This is also important in the context of the rapid growth in Thematic indices and the ETFs that track them, especially as many of the more traditional ways of creating diversified portfolios through geographic or Industry classifications are becoming so blurred, This was brought into sharp relief by an article in the Financial Times yesterday about the fact that S&P Dow Jones Indices and MSCI have launched a consultation on a potential revamp of the widely followed Global Industry Classification Standards (GICS) that determine which sector each company is placed in, and suggests a likely rebalancing of the GICS sector definitions that has potentially significant implications for the Tech and Financial sectors in particular, as it is proposed that MasterCard, Visa and PayPal be reclassified from Tech to Financials.
Moving MC, Visa and Paypal from Tech to Finance would make the Tech benchmark not much more than a two stock portfolio of Microsoft and Apple.
Apart from having meaningful rebalancing implications, it also highlights one of the problems with sector indices in generally and the ETFs and other funds that track them, to wit the lack of diversification and the concentration due to the skew in market cap weights. To take XLK, (the S&P tech sector ETF), as an example, the three stocks looking to switch sector, Mastercard, Visa and PayPal, together add up to almost 8.5% of the index, which would be bad enough, if it wasn’t for the fact that, between them, the top two stocks, Microsoft and Apple, account for 43%! Currently It doesn’t really matter what you think of any individual company with a small market cap than number 24 (of 78) in the portfolio, it is less than 1% of the total. Thus, in effect, only the top 1/3 of companies ‘count’ at all. It is reminiscent of the truly ridiculous nature of the Emerging Market Corporate Bond indices which are weighted by size of debt, you quite literally ‘reduce your risk’ by having most of your money with the company that has the most debt. Generally, but especially in High Yield (the category formerly known as junk) this is not a strategy that tends to work out very well in the long run.
This, of course, is why in Equities, we prefer to look at things on both a Global and a Thematic basis to allow for better diversification of idiosyncratic (stock specific) risk. Thus, while both Fin (XLF US) and Tech, (XLK US) have done well recently – especially Financials this last month on a relative basis – we would probably be looking to this latest pullback in the Crypto space and the selloff in some of the underlying stocks that we would consider to be long term thematic winners in the emerging Fintech and Internet 3.0 such as Coinbase, as an opportunity not so much to add a Fin or a Tech theme to our Thematic Model Portfolio for 2022, but rather to look at a combined FinTech theme, such as via an ETF that tracks the Indxx Global Fintech Thematic Index. More, perhaps, on that next week.
