The crypto industry is celebrating a long-awaited milestone today as the first exchange-traded fund linked to Bitcoin (BTC-USD) launches on the New York Stock Exchange. The ProShares Bitcoin Strategy ETF (BITO) does not invest directly in Bitcoin, but will rather hold futures contracts of the digital currency – meaning it will have a very high correlation with Bitcoin, but won’t mirror the token’s exact value. It will also cost more to own the fund, but some may be willing to pay up for institutional level custody, execution and security.

The new approval could bring more investors into the crypto market as it comes with a more regulated structure. That means 401(k)s and IRAs could now have an allocation of the sector, while the ETFs will also be available through brokerage accounts. Until now, Bitcoin has been a favorite among tech-savvy or younger traders, who are more comfortable with its technology, as well as the risks or price swings involved with their investments. At the time of writing, Bitcoin is up 1.7% to $62,324.

While the SEC has recently taken a tougher stance on crypto, the ETF green light highlights what structure the agency is currently able to tolerate. Bitcoin futures trade on the Chicago Mercantile Exchange and are regulated by the Commodity Futures Trading Commission, while Bitcoin-related ETFs have already launched in other countries like Canada. There are also concerns about purchasing Bitcoin through digital currency exchanges, given worries about hackers or losing so-called private keys.

The ProShares Bitcoin Strategy ETF might be the first to list in the U.S., but it sure won’t be the last. Grayscale Investments is jumping on the train with plans to convert the Grayscale Bitcoin Trust (OTC:GBTC) – which has $38.7B assets under management – into a spot ETF. Other issuers that are excited about the recent approval include names like Valkyrie, Galaxy Digital, VanEck, ETF Series Solutions and ARK Invest.

The total cryptocurrency market cap reached an all-time high near $2.5 trillion.

 

 

 

The ProShares Bitcoin Strategy ETF (BITO) made its trading debut on Tuesday.

 

 

Valkyrie Investments’ bitcoin futures ETF will debut on Friday under the ticker BTF (not BTFD as originally planned).

 

US Economy

 

  • September retail sales surprised to the upside. US consumers complain about high prices but keep spending.
  • Excluding autos and gas, the dollar amount of retail sales hit another record high.
  • Spending on automobiles increased in September after months of declines from the peak
  • Global inflationary trends (combined with robust US consumption) are causing the market to reevaluate the Fed’s actions over the next few years.
  • The market is increasingly convinced that the Fed will be forced to hike twice next year.
  • Moreover, the market sees the central bank becoming more aggressive over the next few years as inflation becomes tougher to tame. The front end of the Treasury curve is steepening.
  • On the other hand, the longer end of the Treasury curve is flattening.
  • The market sees a more hawkish Fed slowing the economy as it fights inflation.
  • Economists are downgrading next year’s US GDP growth forecasts.
  • The October U Michigan consumer sentiment report was softer than the market was expecting.
  • Analysts expected an improvement as the COVID situation eases.
  • But rising prices, especially on gasoline, have been a drag on consumer confidence.
  • Import price inflation has peaked for now as the dollar rebounded.
  • The Empire Manufacturing report from the NY Fed (the first regional report of the month) showed some moderation in factory activity.
  • But manufacturers remain upbeat about the future.
  • Industrial production surprised to the downside, with supply shortages and the impact of Hurricane Ida weighing on output.
  • Homebuilder sentiment jumped this month as buyers returned.
  • Year-over-year gains in Zillow’s home price index hit a record high last month.
  • Job openings on Indeed continue to climb.
  • US women see much faster wage growth this year.
  • Weak labor force growth will limit US economic expansion.

 

 

  • Just as we saw in the U. Michigan report, other indicators point to a deterioration in consumer sentiment.
  • COVID lockdowns are easing globally.
  • Residential construction eased in September, with single-family housing starts and construction permits dipping below last year’s levels as supply constraints mount.
  • Mortgage rates are grinding higher. The housing market is now more sensitive to rising rates than before the pandemic (due to rapid price gains).
  • Consumers are incredibly frustrated with rising prices and the limited availability of vehicles.

 

 

  • But demand remains robust, sending wholesale used car prices to new highs.

 

 

 

 

  • The GDPNow model estimate for the Q3 GDP growth has collapsed.

 

 

  • The amount of “excess” liquidity in the economy is staggering, which will continue to be a tailwind for inflation. Here is the M2 money supply vs. the pre-COVID trend.
    h/t Jim Reid, Deutsche Bank Research

 

 

  • Retail gasoline prices have been rising quickly, which will remain a drag on consumer sentiment.
  • The average mortgage size is up 20% since the start of the pandemic. With much larger loans, affordability quickly becomes an issue when rates increase.
  • Manufacturers expect a slowdown ahead.

 

 

  • They see unfilled orders disappearing quickly.

 

 

China

 

  • China’s economy slowed last quarter, with the GDP report coming in below forecasts.
  • We had another double-digit gain in thermal coal prices today as the energy crisis worsens.
  • Beijing’s intervention in the coal market sent futures plummeting.

 

 

 

  • And with it, other industrial commodities came under pressure.

 

 

 

  • China’s industrial sector consumes a much larger share of electricity than in the US.

 

 

  • The PBoC says that the property developers’ credit risk is manageable. After a couple of developers paid their coupon, risk aversion eased somewhat, and yields on some leveraged firms’ debt declined.
  • China’s new-home price index saw its first monthly decline since 2015.
  • Domestic aluminum production is declining, mainly due to power shortages.

 

 

  • While it was on the brink of default heading into the weekend, China Evergrande Group (OTCPK:EGRNF) seems to have pulled off an $83.5M bond coupon payment before Saturday. A 30-day grace period would have expired tomorrow after the original missed payment date, but the drama is still far from over. Evergrande still needs to pay $573M on another four dollar notes this year and faces $7.7B in bond maturities in 2022.

 

Debt

 

Government debt is causing our problems, not solving them.

  • Debt has moved well beyond the productive phase in the US, Euro area and Japan, causing lower GDP growth and declining money velocity.
  • The unprecedented debt-financed stimulus measures since 2020 produced only transitory spurts in economic growth.
  • Excess debt acts as a tax on future growth unless it generates sufficient cash flow to repay principal and interest.
  • Velocity of money has been declining since 1997, meaning each dollar of new money produces less GDP. This makes monetary policy less effective.
  • While the Fed can increase money supply growth, declining velocity keeps it trapped in the financial markets.
  • The government spending multiplier is sharply negative in highly indebted countries, making fiscal policy also ineffective.
  • This causes real GDP to drop, leading to demand destruction that eventually reverses rising inflation.

Unlike now, velocity of money was stable in the 1970s, allowing supply disruptions to spark major inflation. Declining velocity this time should limit that pressure. Treasury yields may go temporarily higher but these sporadic moves won’t last.

 

The Fed

 

The Fed’s October Beige Book report showed an increased emphasis on supply-chain issues, high costs, and labor shortages. Pandemic-related concerns continue to recede.

Inflation:

Most Districts reported significantly elevated prices, fueled by rising demand for goods and raw materials. Reports of input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Price pressures also arose from increased transportation and labor constraints as well as commodity shortages. Prices of steel, electronic components, and freight costs rose markedly this period.  Many firms raised selling prices indicating a greater ability to pass along cost increases to customers amid strong demand.

Wage growth:

The majority of Districts reported robust wage growth. Firms reported increasing starting wages to attract talent
and increasing wages for existing workers to retain them. Many also offered signing and retention bonuses, flexible
work schedules, or increased vacation time to incentivize workers to remain in their positions.

Here is the Beige Book tracker from Oxford Economics.

 

 

  • Federal Reserve officials say they are stimulating because the labor market is weak, but “quits” data says it is actually quite strong.
  • Equities are becoming sensitive to the rising possibility of persistent, not transitory inflationary pressures.
  • History shows stock valuations are highest when CPI runs above 1% and below 4%.
  • If earnings decline due to margin pressure and valuations fall to levels seen in prior inflationary periods, stock prices could easily drop 40-50%.
  • Investors should beware of stocks trading at high valuations with limited ability to pass on higher costs to consumers.

The Fed is running policy as if the economy were in a depression when it is booming. More inflation is probable, at least in the short run, and we best appreciate how inflation can wreak havoc on stock prices.

The markets are now expecting a much more hawkish Federal Reserve than most analysts have been forecasting.

Two rate hikes next year are now fully priced in. And the probability of three hikes is over 70%.

Has the market overshot on its Fed tightening expectations? If not, the trends above don’t bode well for risk assets such as stocks.

 

 

This just in..

Federal Reserve officials will no longer be able to buy individual securities following the recent controversy over portfolios that resulted in the departure of two regional bank presidents. That means no more stock picking and active trading of derivatives, leaving officials to only purchase diversified investment vehicles, like mutual funds. The new restrictions will apply to both Reserve Bank and Board policymakers, as well as senior staff.

Quote: “These tough new rules raise the bar high in order to assure the public we serve that all of our senior officials maintain a single-minded focus on the public mission of the Federal Reserve,” Fed Chair Jay Powell said in a statement.

Earlier this week, The American Prospect reported that Powell also sold up to $5M in a broad index fund as the economy was recovering from the pandemic last year.

 

Market Data

 

  • The simultaneous rally in commodities and the US dollar is not sustainable.

 

 

  • Crude oil continues to climb, with traders expecting $100 per barrel.

 

 

  • This year’s flows into US equities hit a record high.

 

 

  • Will rising bond yields stall the stock market rally?
  • The Russell 2000 earnings revisions have reversed while those of the Russell 1000 (large-cap) are relatively stable.

 

 

  • Proposals to raise taxes could push equity flows out of the US.

 

 

  • The S&P 500 is entering a seasonally strong period.

 

 

  • Fund managers are less sure about inflation being “transitory.”

 

Source: BofA Global Research; @SamRo

 

  • Investors’ stagflationary concerns increased this month.

Source: BofA Global Research; @SamRo

 

  • VIX closed at the lowest level since March 2020.
  • Despite the S&P 500 hitting a record high, only 60% of its members are above their 50-day moving average.
  • Speculative activity is back, as non-profitable tech shares outperform.
  • What do fund managers see as the most crowded trade?

 

 

Thought of the Week

 

“Risk is what you don’t see.”

– Morgan Housel

 

Pictures of the Week

 

 

 

 

 

All content is the opinion of Brian J. Decker