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EU's energy policy unravels a potential advantage for US energyThe clock is ticking for Europe to shield its economy amidst the current energy crisis. The cost of electricity across the European bloc is nearly 10 times the 10-year average in response to Russia cutting back natural gas supplies in retaliation to sanctions1. There has been a substantial increase in the share of supply of Liquidifies Natural Gas (LNG) and alternative suppliers as a direct replacement of waning Russian gas supply. European leaders are racing to come up with a plan on energy intervention in the power markets. One of the measures being touted is imposing an energy windfall tax on oil and gas profits to help households and businesses survive this upcoming winter season. The plan is to re-channel these unexpected profits from the energy sector to help domestic consumers and companies pay these high bills. The windfall tax on the oil and gas companies should be treated as a “solidarity contribution,” according to European Commission (EC) President, Ursula von der Leyen. Imposing a windfall tax on those profiting from the war A windfall tax would impose a levy on the revenues generated by non-gas producing companies when market prices exceed €200 per megawatt hour (Mwh) and redistribute excess revenues to vulnerable companies and households. There has been greater consensus among other European Union (EU) countries on the windfall tax compared to other parts of the European Commission’s 5-point plan. This includes – setting a price cap on Russian gas, a mandatory reduction in peak electricity demand, funding for ailing utility companies, a windfall tax on fossil fuel companies and changes to collateral requirements for electricity companies. The EC’s plan will need to meet the approval of the bloc before being enforced. The most controversial issue remains the Russian price cap – aimed at penalising Russia for weaponising energy. Coordinated energy policy needed despite different energy mix across EU bloc There are major differences between member states based on those that rely on coal, nuclear or renewable power owing to which imposing a one energy policy will be challenging. Austria, Hungary, and Slovakia, known to import large amounts of Russian gas are against the price cap on Russian gas. On the other hand, a number of EU countries including France, Italy, and Poland, support a cap, but argue it should apply to all imported forms of the fuel, including LNG. Germany is undecided but fears the disagreements on the price caps risk spoiling EU unity. Spain, a big generator of wind and solar power was quick to draw criticism of the proposed €200/Mwh as it does not correspond to the real costs and fails to support electrification and the deployment of renewables. In the US, various Senators including Senate Finance Chair Ron Wyden, have proposed legislation that would double the tax rate of large oil and gas companies excess profits. However, given the current political climate it seems increasingly unlikely that these proposals would gain any traction in Congress. Europe’s energy policy likely to put a strain on capex in the near term Since the oil price plunge from 2014 to 2016 alongside climate change awareness and Environmental Social and Governance (ESG) mandates, the energy sector saw a sharp decline in capital expenditure (capex). Since then, capex in the global energy sector has failed to attain the levels last seen at the peak in 2014. While capex trends in Europe’s energy sector had begun to outpace that of the US, driven mainly by a rise in the share of spending on clean energy, we believe the impending energy crisis and energy policy including the national windfall levies in Europe are likely to disincentivise capex in Europe compared to the US over the medium term. High prices are encouraging several countries to step up fossil fuel investment, as they seek to secure and diversify their sources of supply. The divergent energy policies and prevalent supply situations in the US and Europe opens up a potential opportunity in the energy sector. The energy sector has been the unique bright spot in global equity markets in 2022 posting the strongest earnings results in H1 2022. Despite its strong price performance, the US energy sector2 trades at a price to earnings (P/E) ratio of 8x and has a dividend yield of 3%. In September 2008, the energy sector had a 12.5% weight in the S&P 500 and was the fourth largest sector by market capitalisation in the world’s largest economy and equity market. Fast forward to today, the energy sector accounts for only 4% of the S&P 500 Index. While the future trajectory is greener, the world has come to terms with the fact that we will require oil and gas in the interim in order to fulfil our energy requirements. Investment is increasing in all parts of the energy sector, but the main boost in recent years has come from the power sector – mainly in renewables and grids – and from increased spending on end-use efficiency3. As Europe plans to reduce its reliance on Russian energy supply, it will become more reliant on US LNG imports. This should fuel further investment in the US energy sector in the interim. As one example of a relevant US Equity Income Index, the WisdomTree US Equity Income UCITS Index offers a much higher allocation to the energy sector 19.8% compared to the S&P 500 Index as highlighted in the table below. This enabled its outperformance versus the benchmark S&P 500 Index. Sources 1 Financial Times as of 29 August 2022 2 Source: Bloomberg, MSCI US Energy Sector Index – Ticker MXUSOEN Index 3 International Energy Agency – World Energy Investment 2022 This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
NASDAQ:CRSPEN1
by aneekaguptaWTE
Industrial metal cyclicality is only skin-deepIndustrial metals prices are traditionally cyclical Industrial metals have historically been cyclical. In this current downturn, we are finding that metal prices are suffering, as they have done in the past. However, the importance of base metals in delivering the energy transition has never been greater. We are currently living in an energy crisis exacerbated by the war in Ukraine. Europe wants to accelerate the energy transition to reduce reliance on Russian energy sources. That will place a higher onus on renewable energy sources coupled with battery storage to meet our energy needs. In short, that will require a lot more metals. However, the production of many base metals is declining. That’s partly due to falling prices, making it more difficult to justify the capital expenditure. Also, high energy prices are making the smelting of metals uneconomical1. We believe there is a risk of supply destruction of base metals due to the energy crisis being greater than the demand destruction coming from a decelerating economy. So, while sentiment may be weighing on metal prices right now, the fundamentals may be tighter than the market assumes. That could pave the way for a substantial rebound in metal prices when the market refocuses on supply imbalance and sentiment turns. Inventories are low It is clear from the table below that industrial metal inventory is especially low. We do not believe the year-to-date price performance reflects that degree of tightness. And there is ample room for an upward correction. Most base metals are in backwardation With the exception of aluminium and nickel, all base metals are in backwardation. Backwardation is when spot or front-month futures contracts are priced higher than the price of contracts for delivery in later months. The fact that someone is willing to pay for immediate delivery rather than entering a contract for delivery in a few months’ time indicates that they need the material urgently. Thus, the backwardation structure of futures markets is another indication of market tightness. Production is hampered Surprisingly, aluminium and nickel are not in backwardation like the other base metals. The inventory table seems to indicate that metal availability is the worst for these two metals. Looking at European aluminium production data this year (to July 2022, the latest data point available) relative to production in 2021 over the same period, production is down 11%. A surge in China’s summer temperatures in August 2022 has led to a power crisis, resulting in curtailed power supply to the industrial sector in Sichuan province. Aluminium is very energy-intense to produce. Inflation Reduction Act and European policy on energy transition European policymakers are currently debating the path to secure energy independence from Russia. In her State of the Union speech on 14th September 2022, Ursula von der Leyen, President of the European Commission, emphasised investing further in renewable energy and hydrogen in particular. These investments will be metal demand positive. In the US, the Inflation Reduction Act, which was signed into law in mid-August, sets out several initiatives to reduce inflation. The US also recognises that energy reform is part of the puzzle. The bill includes circa $390Bn of spending/credits over the next ten years related to energy and climate change, with the goal of putting the US on the path towards 40% emissions reductions by 2030. The bill takes steps to enhance energy security and provides credits to help tackle climate change. There are incentives for cleaner fuels (e.g. hydrogen), for consumers to electrify appliances/upgrade home energy efficiency, and tax credits for buying electric vehicles. We expect the bill will be metal demand positive. Conclusions We believe supply destruction is occurring at an equal or faster pace than demand destruction in the base metals space. However, metal prices are currently falling, mirroring historical cyclical patterns for industrial metals. When markets refocus on the fundamentals, we may find prices correct to the upside. Our long-term projections for industrial metal demand – underpinned by an infrastructure rebound and energy transition – remain firm. Sources 1 See Zinc and aluminium supply tightening amid energy price shock This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
All roads lead to a very exciting future of mobilityIn the classic 1980s film, ‘Back to the Future’, the protagonists, Dr. Emmett Brown and Marty McFly, travel 30 years into the future. In the year 2015, their DeLorean time machine, which now runs on waste matter, is airborne in what appears to be heavy car traffic in the skies. Although our skies don’t quite look like what was envisioned in the movie, ‘Back to the Future’ did get two things right. First, cars have found alternative fuels to run on. And second, the technology at our fingertips today bears no resemblance to what was there back in the 80s. We know that as technology advances, the rate of change increases too. But we don’t need another dose of science fiction to imagine the future of automobility. All we must do is observe the megatrends already in motion. At WisdomTree, we see the future of automobility as connected, autonomous, shared and electrified. This is exciting not just for car and technology enthusiasts, but investors as well. Connectivity Imagine you are driving on the motorway. You feel hungry. You verbally ask the car to search for good restaurants along the route, pick the one which optimises between the highest rating and your cuisine preferences, and add a stop on the navigation. This isn’t science fiction; some cars with high-tech infotainment systems can do precisely this. The Mercedes Benz User Experience (MBUX) responds to “Hey Mercedes” and uses artificial intelligence to predict your personal habits. The more you drive it, the more likely it will find you a route you will enjoy most. It will also remind you when your next service is due. It knows, after all, how forgetful you can be… In 2021, there were 236 million connected cars worldwide. A connected car is one that uses the internet to download, as well as upload, data. By 2035, this number could reach 863 million1. The connected car brings additional benefits as well. It can update its software automatically, like your mobile phone. This means fewer trips to the workshop. It can also help you monitor critical safety information about the car remotely. This is especially useful for managers who need to maintain entire fleets of cars. Digital dashboards can enable them to monitor their fleet quickly and remotely, instead of checking each car manually. Autonomous driving Now, imagine being on the motorway again. Perhaps you don’t have enough time to sit at a restaurant, but you could pick something up and eat in your car while driving. Not very safe? Why not let the car drive itself while you enjoy your meal in the backseat and maybe even respond to some urgent emails. Autonomous driving isn’t just for the hungry driver in a hurry, it will have a huge impact on all forms of mobility. Logistics is one example. The global drone package delivery market is expected to grow from $824 million in 2021 to $11,519 million in 2030, expanding at a compound annual growth rate of over 55%2. Autonomous mobility has many tangible benefits, including improving safety. Currently, approximately 1.3 million people die each year because of road traffic accidents3. Although there are regulatory and psychological barriers to overcome before full automation becomes the norm, assisted and partially automated driving is already making cars safer. As we progress along the continuum of automation, this dreadful statistic might hopefully be reduced. Moreover, not always requiring humans to do the job will make logistics more efficient and cost effective. The UK, with its recent lorry driver shortage, could certainly have benefitted from automated driving. Shared mobility Back to the motorway scenario again. This time, imagine you reach your desired restaurant in a town nearby only to find there is no parking. But what if you don’t need to park. You don’t own the car anyway. The car drops you off and goes to pick up another passenger. Once you’re ready to go, you call another car. These days when we think of ride-hailing, we think of Uber as the alternative to calling a traditional taxi. But in many crowded cities, shared ownership can reduce the need for people to own cars. This could not only reduce the financial burden on individuals and city planners, but also help the environment. vironment Vehicle on demand (carsharing) and mobility on demand (ride-hailing) create a marketplace for transportation. This marketplace creates ‘positive feedback’ through network effects. Source : Hackermoon, Berylls, 2022. Electrification Let’s return to the motorway scenario one last time. This time you hear on the radio how terrible the weather is going to be the following week. As you ponder the state of the planet amid climate change, you feel assured that at least you have ditched your internal combustion engine car in favour of an electric one. Road transportation accounts for almost 12% of all greenhouse gas emissions4. Electrification can, therefore, make a huge difference. A few years ago, electric vehicles were limited to the likes of Tesla and a handful of other car manufacturers. Today, most car makers have rapidly growing ranges of electric models. Electric vehicle sales doubled in 2021 compared to 2020 and reached 6.6 million worldwide. All of this in a year when the automobile industry was faced with semiconductor chip shortages. By 2040, electric vehicles will dominate sales worldwide (see Figure 3 below). Source: BloombergNEF, as of 01 June 2022. Drivetrains: BEV (battery electric vehicles), PHEV (plug-in hybrid electric vehicles), FCV (fuel cell vehicles), ICE (internal combustion engine vehicles). ICE includes self-charging hybrids. Types: Shared (digital-hailing, taxis, car-sharing and autonomous vehicles operated in a shared fleet), private (privately owned vehicles). Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties. Electrification (that is, making cars that run on lithium-ion batteries) isn’t the only innovation car makers are pursuing. Manufacturers are actively exploring alternative fuels like hydrogen. Daimler already has hydrogen fuel cell trucks under testing. Car makers are also innovating with cutting edge technologies like wireless charging. BMW is an example in this space. After all, it will be easier for autonomous cars to park themselves over bays where they can charge wirelessly, rather than finding a way for cables to be connected somehow. How can investors capture these megatrends? The automotive ecosystem can be split into five key segments. Original equipment manufacturers – companies developing, manufacturing and selling vehicles. Suppliers – companies developing, manufacturing and selling software, hardware or engineering services for vehicle development. Dealers and aftermarkets – companies buying and selling vehicles or providing platforms for doing so. Likewise, servicing, optimising and repairing vehicles after they have been put into operation. Infrastructure – companies developing, operating, and maintaining the infrastructure required for industry transformation (for example, charging, hydrogen refuelling). Mobility service providers – companies providing mobility services (B2B / B2C)5 or providing the platform for a third party to provide mobility services. An exposure across the five segments can help investors capture the megatrend of future mobility. Expect change. Expect innovation. Expect excitement. The mobility ecosystem is evolving rapidly to meet the changing needs of consumers and cities, and to tackle climate change. And, it is starting to get a lot of attention from investors. Sources 1 As per September 2021 forecasts from Statista. 2 According to Research and Markets ‘Drone Package Delivery Markets’ July 2022 report. 3 According to the World Health Organisation June 2022. 4 Our World in Data 2020. 5 B2B is business-to-business and B2C is business-to-consumer. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
Zinc and aluminium supply tightening amid energy price shockMore and more metal smelters are falling victim to the European energy crisis. Last week, Nyrstar, a large European zinc smelter, announced it would shutter production at its Dutch Budel facility from 1 September 2022 and Norsk Hydro, a significant aluminium producer in Norway, said it will close its Slovakian smelter around the same time. Aluminium is one of the most energy intense metals to produce, leaving the metal very sensitive to soaring energy prices. Drought in parts of China is also reducing the availability of hydropower. Energy rationing in China resulting from this is likely to see a decline in aluminium production from the largest producing country. In July, the European Union agreed that it would ration natural gas by 15% until spring 2023. That will mean the Union will have to depend on other forms of energy or cut back on economic production. The production halts are likely to deepen recession risks in Europe. However, if demand for these metals does not fall as quickly as the supply is contracting, we may find base metals markets significantly tighten. Inventory in decline Supply of both zinc and aluminium is already looking tight. London Metal Exchange (LME) inventory of zinc has pared back to pre-covid levels and sits at only 6% of the level seen at the peak in 2012. You would have to go back to the 1990s to see LME inventory of aluminium as low as it is today. Underappreciated story While zinc prices popped higher on the day Nyrstar announced its closure, the metal's tightness appears to be an underappreciated story. Net speculative positioning in zinc futures is at the lowest it has been since 2018 and more than 1.5 standard deviations below the 4-year average. Positioning in aluminium is also below average but not as extreme. Energy transition to boost demand for both metals Both metals are essential for the energy transition that is required to meet global climate goals. Aluminium is needed to lighten vehicles to reduce their energy needs and is a key element in electrical infrastructure, solar panels and wind turbines. Zinc coatings protect solar panels and wind turbines and prevent rust. A 10MWh offshore wind turbine requires 4 tonnes of zinc, while a 100MWh solar panel park—enough to supply 110,000 homes—requires 240 tonnes of zinc1. The EU is focused on energy security today as it tries to wean off Russian energy dependency. It will be pushing the energy transition harder as a result. Zinc backwardation underscores tightness Zinc is also one of the most backwardated base metals2. Backwardation is when front-month delivery futures prices are higher than the second or third-month delivery prices. That is also an indication of market tightness, i.e. that people are willing to pay more for immediate delivery rather than wait a couple of months, indicating they need the metal soon and it is in high demand. Investors in rolling futures strategies tend to benefit from markets in backwardation: as the futures approach spot prices as time passes, the price should rise (assuming the curve shape remains the same). Conclusion The energy crisis in Europe and elsewhere is driving supply challenges in the base metals market. There have been notable smelters shuttered in zinc and aluminium. Zinc stands out as a metal with low speculative length, indicating an underappreciated story. Sources 1 Word Economic Forum 2 See Commodity Monthly Monitor, July 2022 This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
The secret tool that institutional investors use Recent news of potential attacks on wallet applications built on the Solana ecosystem, resulting in lost funds, has once again highlighted the long-running problems around the difficulties in securing hot wallets1. As a reminder, "hot wallets" involve storing private keys used to sign digital assets transactions, on a computer or phone connected to the internet. This provides users with a convenient way to send, store and receive digital assets. However, they can also be hacked… and the digital assets lost. The emergence of institutional demand for digital assets has brought with it all kinds of questions around access, security, liquidity, and transparency. Equity, bonds, or commodity futures contracts are all traded on similar exchanges or through the same market makers and brokers. Digital assets, by definition, live in their own, newly created corner of the world and, therefore, accessing them can be difficult. The institutional world is asking for an all-in-one bridge that would facilitate access to digital assets while also managing cybersecurity risk, custody risk, liquidity and all the relevant operational risks on their behalf. In the last two years, the institutional solution that strikes this fine balance has finally arrived in Europe under the name of physically-backed digital assets exchange-traded products ("ETPs"). Investing in digital assets – the access points There are many ways to invest in digital assets. Each one comes with its pros and cons, these include: direct holdings - personal wallets - account on centralised crypto exchanges - hot or cold wallet with custodians synthetic exposure - futures or swaps - futures backed ETPs - structured products physically-backed wrapped solutions - close-ended funds - physically-backed digital assets ETPs This is a long list, right? The choice can be a bit overwhelming. This is why we have recently released our latest WisdomTree Insights, ‘A New Asset Class: Investing in the Digital Asset Ecosystem’. In this report, we discuss, in detail, the pros and cons of these many different access points for an institutional investor. The results of the analysis show that: - Direct holdings are mostly kept in hot wallets, which are always connected to the internet and, therefore, open to cyber-attacks and hacking. Furthermore, they do not plug at all into existing trading or portfolio management systems. - Physical exposures through direct investment stored with a custodian in a cold wallet are very tedious to set up correctly and manage daily. - Synthetic exposures can be useful when leverage is needed, but they suffer from a large performance drag due to the negative roll yield of Digital Asset futures. This negative roll yield is very often higher than 10% a year, i.e. create a 10% per year drag on the performance. - Close-ended funds suffer from high fees and extremely large discounts and premiums to net asset value. The tracking error and difference of those products are therefore very poor. This leaves physically-backed ETPs, which appear to be the most robust and easiest to set up for a long-only institutional investor. They combine an easy operational setup and trading with security and efficient tracking. This is one reason why institutional flows in such products have significantly picked up as the product range has become more numerous and available via more venues. Selecting the right digital asset ETP for your needs Physically backed digital assets ETPs are new, though if you know how a gold exchange-traded commodity (ETC) works, then you understand the core concepts. When selecting between various ETPs, investors must consider the unique characteristics of each potential product. Investors could use the below holistic framework to approach their selection: 1. Security & custody The number one concern when it comes to digital assets is cybersecurity. Crypto hacks make the news regularly, and so it is often front of mind for investors. However, in almost every single case of digital assets being stolen, the asset was stored in a hot wallet. The gold standard is storage in a cold wallet (i.e. where the private keys are stored somewhere that is not connected to the internet), managed by recognised custodians for institutional investors. Having a safe custody solution and a robust process for approving any transfers is critical. Investors should pay attention to the custody provider, the storage solutions, their relationship with the crypto ETP issuer and the security practices for transferring coins in or out of the wallet. 2. Issuer & product structure Choosing an issuer with recognised expertise in creating and running physically-backed listed financial products and a track record in managing their trading and liquidity, particularly in a crisis, can deliver important peace of mind to investors. To mitigate the risk, it is also important to see if the issuer has a diversified business and range of products (not only digital assets) that can support periods where digital assets are down and out of favour. 3. Cost of holding For physically-backed digital asset ETPs, all the direct costs should sit in the total expense ratio (TER) of the ETP. There should not be any other hidden costs. The lower the TER, the fewer coins the issuer takes and the more coins per share are left for the investor. Trading costs are also part of the cost of holding. Secondary market bid/ask spreads are impacted by many factors: the liquidity of the ETP on the exchanges, the depth of the order book, volatility profile of the coins, inventory level, authorised participants' (APs) ability to source liquidity, and the number of market makers etc. For most efficient trading, it is always best to discuss with the Capital Markets team of the issuer to request an analysis when planning for large trades. 4. Lending & staking For equity ETFs, investors have become familiar with security lending. This feature can also apply to digital assets ETPs – but not all. Essentially how this works is that the coins that should be held as backing to the product are lent out to counterparties in exchange for additional yield. This additional yield could subsidise the issuer, enhance the product's performance, or both. This activity can, however, be very risky with additional credit/counterparty risk vis-à-vis "unknown" entities the coins are lent to – not to mention the additional process risk with lent coins moving out of cold storage and into hot wallets. In some cases, this lent amount can be collateralised. Certain physically-backed crypto ETP prospectus' allow for crypto lending, while others do not. Therefore, investors should check the details accordingly with the issuer. Staking, on the other hand, is very different to lending. It is a unique feature of certain Digital Asset networks and, therefore, of certain digital asset ETPs. Staking needs to be enabled on blockchain networks that use a Proof of Stake consensus mechanism2. Overall, staking is less risky than lending, even if the reward for staking can be as high or higher. However, the operational setup of the issuer to deal with staking is an important criterion when selecting an ETP tracking a Proof of Stake asset. 5. Primary and secondary trading ecosystem How the APs trade the underlying coins to facilitate the creation and redemption of the shares within a crypto ETP is critical for a due diligence process. When completing due diligence for the AP process, it's key for the issuer to be able to present the subscription/redemption process in detail and make sure the workflow is understandable to the investors. 6. Operational considerations for digital asset basket products Digital assets are the most at risk when they are on the move since they have to come out of cold storage and move to a hot wallet. In the case of ETPs that are tracking not just one digital asset but a basket of digital assets, rebalancings are necessary to ensure that weight remain in line with the investment objectives. A robust and detailed process around those basket rebalancings is therefore a must. Sources 1 www.washingtonpost.com 2 For a brief explainer on staking, see: www.wisdomtree.eu This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
Many Megatrends Depend on Semiconductors. Governments are competing with each other to ensure stable future supplies The phrase ‘chip shortage’ has made quite an impression1. - The US has earmarked an enormous one-time sum, $77 billion, in subsidies and tax credits to boost chip production within the US - China is prepared to spend more than $150 billion through 2030 - South Korea is poised to offer an array of incentives over the coming five years, valued at roughly $260 billion - The European Union (EU) is seeking to spend $40 billion - Japan is seeking to spend $6 billion In 2021, revenues in semiconductors were $553 billion, and are expected to grow to $1.35 trillion by 2030. Roughly three-quarters of chip-making capacity is in China, Taiwan, South Korea and Japan. The US only sits at about 13%, whereas the EU sits at roughly 9%2. All chips are not the same The Covid-19 Pandemic has shown different economies the importance of securing the supply of semiconductors. One thing to note is that there is a wide variety of semiconductors, and some countries are seeking to secure one type of supply over another. China’s push is aimed less at the cutting edge and more at being a higher volume player in the essential part of the market for lower priced but still important chips3. Some necessary chips that inhibit the production of automobiles, for example, could be valued at $1 dollar or less on a per-unit basis4, far from the most cutting edge in the space. Company results are showcasing both successes and failures Intel reported that Q2 earnings that received a bleak reception, with revenue falling 17% relative to Q1 of 2022. This was the worst sequential quarter-to-quarter revenue performance going back to the year 2000. Intel also noted a delay to its next generation server chip, Sapphire Rapids, and that its data centre chip business would grow slower than the overall data centre market for two years5. This compares to Taiwan Semiconductor Manufacturing Company (TSMC) growing revenue 37% and profit by 76% year-over-year6. Earlier in 2022, Samsung reportedly lost its two biggest foundry customers, Qualcomm and Nvidia, to TSMC. Reports indicate that they were not satisfied with Samsung’s capability in the 4 and 5-nanometre space, which represents the current cutting-edge in semiconductor manufacturing. TSMC captures greater than 50% of foundry market share, operating at a market share level roughly three times that of Samsung. Still, Samsung did hold a recent ceremony to celebrate its first shipment of 3-nanometre chips, hitting this milestone faster than TSMC7. In contrast, it is estimated that roughly 25% of TSMC’s business is from Apple, and then Nvidia, Qualcomm and Advanced Micro Devices (AMD) are estimated to provide about another 5% each8. Capital expenditures set companies up for future growth TSMC is also investing at an incredible clip, aiming to spend up to $44 billion in 2022 compared to Samsung’s $12 billion, even if Samsung has announced a spending plan to total $151 billion between now and 20309. Intel has announced in its most recent, admittedly tough, quarterly results a plan to cut planned capital expenditures in 2022 by 15% to a level of $23 billion10. Samsung is also facing competition in the dynamic random access memory (DRAM) business, as Micron and SK Hynix have introduced some of the most advanced chips for these purposes. Still, even amidst the competitive onslaught, Samsung’s DRAM market shares sit at about 40%. In the smartphone application processor market, Samsung’s market share was 6.6%, compared with Qualcomm at 37.7%, MediaTek at 26.3% and Apple at 26%11. Time to invest? Semiconductor companies tend to follow a particular rhythm, seeing strong demand, making investments, increasing supply, hitting levels of oversupply in certain types of chips, then waiting for the market to re-attain something closer to equilibrium. Today, we may be at the tail-end of the ‘chip shortage’ and it may not, at least in the short run, be the time to expect an immediate performance pop in the share prices of most semiconductor companies. However, any megatrend that touches technology in any way requires semiconductors to function—in a sense if any of them grow, the demand for necessary semiconductors will also grow. Having a multi-year time horizon could be of greater interest, in our view. Since not all semiconductors are the same, it is also worth recognising that different companies may be more associated with different megatrends—for instance, certain companies are doing more in Artificial Intelligence (AI) model training space, whereas others are doing more in the industrial and automobile space. The supply/demand balance within different types of semiconductors will not necessarily be the same. Sources 1 Source: Sohn, Jiyoung. “The U.S. Is Investing Big in Chips. So Is the Rest of the World.” Wall Street Journal. 31 July 2022. 2 Source: Sohn, 31 July 2022. 3 Source: Strumpf, Dan & Liza Lin. “China Bets Big on Basic Chips in Self-Sufficiency Push.” Wall Street Journal. 24 July 2022. 4 Source: Gallagher, Dan. “No Quick Fix for Auto Chip Shortage.” Wall Street Journal. 9 February 2021. 5 Source: Kim, Tae. “Intel Stock Will Plunge Further, Analyst Says, after ‘Worst’ Quarter He Has Ever Seen.” Barron’s. 29 July 2022. 6 Mellow, Craig. “Taiwan Semi’s Spending Spree Will Pay Off Big in the Long Term.” Barron’s. 29 July 2022. 7 Source: Jung-a, Song & Christian Davies. “Samsung seeks to reassure markets over semiconductor competitiveness.” Financial Times. 30 July 2022. 8 Source: Craig, 29 July 2022. 9 Source: Jung-a, 30 July 2022. 10 Source: Gallagher, Dan. “Intel Shows Limits of Chips Act.” Wall Street Journal. 29 July 2022. 11 Source: Jung-a, 30 July 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
NASDAQ:NXPI
by aneekaguptaWTE
1
Will we see batteries powering large containerships?When it comes to batteries, automobiles have stolen the lion’s share of our attention. From there, people may naturally think about our smaller devices that also use batteries. The idea of large ships or planes being powered by batteries—many of us would have a natural intuition that there could be obstacles to widescale usage. Maritime shipping: lots of pollution and regulations are on the horizon Maritime shipping is responsible for the transport of roughly 11 billion tonnes annually, which, put another way, accounts for 90% of global trade by mass. This is done through the consumption of about 3.5 million barrels of low-grade heavy fuel each year1. This fuel contributes significantly to pollution. How much pollution? - One estimate placed the contribution of ships to human-generated carbon dioxide in the 2018 year at 2.5%. It is possible that by 2050, ships could be responsible for as much as 17% of total carbon dioxide emissions2. - Another estimate indicated that one large ship emits as much carbon dioxide as 70,000 cars, as much nitrogen oxide as 2 million cars and as much fine dust and other carcinogenic particles as 2.5 million cars3. The International Maritime Organisation (IMO) has indicated action to reduce maritime emissions consistent with the Paris agreement. One component: A reduction of 50% of carbon dioxide emissions by 20504. What do ships do today? Ships are already seeking to optimise their routes or travel across the water more slowly, which can use less fuel. There is even work being done on hybrid systems. However, whether it is traveling more slowly or using methods of being ‘hybrid’, meaning mixing an electric motor with an internal combustion motor, it is currently thought that the reduction in emissions would be in the range of 10-15%--better than nothing, but not close to 50%5. Ships vs. planes—the story of energy density Whether one is flying through the air, taking off from the ground, or pushing a ship through the water, it is fairly simple to know how much energy is needed to do each of these things. Here, we are considering the source of that energy, and it’s important to note that any source could theoretically be used, but that there are certain trade-offs that occur with each choice. The simplest of these trade-offs comes down to ‘energy density’, meaning how much energy can be extracted per unit of weight. Hydrocarbon fuels have significantly higher energy density than current batteries, and this is why people will tend to cite the weight of the battery in an electric vehicle or the fact that adding batteries to planes has a big increase in weight that is difficult to compensate for. Depending on the specific type of fuel under discussion as well as the specific battery chemistry, statistics indicate that hydrocarbon fuels are in the range of 50-100 times as energy dense as current batteries6. The bottom line—with hydrocarbon fuels you can get the same energy for a lot less weight. Now, in a giant containership, weight is a lot less of a concern than it is for a vehicle that needs to take to the skies. There could even be benefits from distributing the weight across the ship such that it sits more evenly in the water. If one is looking at a current setup that causes a lot of pollution and where adding incremental weight may not be the biggest concern, maritime shipping could offer a lot of ‘bang for the buck’ so to speak. Fleetzero—a start-up bringing battery power to maritime shipping It’s notable to see the founders of Fleetzero flipping the key question on its head—instead of trying to use batteries on the largest current ships to replace the dirty, pollution-generating fuel for power, they recognised that the reason that ships operate the way they do, with the capacity to go around the globe on a single tank, is due to the historical path of innovation that has led us to this point. Smaller ships that stop more frequently in different ports could much more easily use battery technology for power7. Instead of changing ships that were optimised for fossil fuels, why not rethink how ships are built and operated around battery technology? Fleetzero’s innovation would include batteries that were the size of shipping containers that could be swapped on and off the ship and charged at times of the day when the price of electricity was lower. They are in the process of building these prototype batteries, and over time they would seek to be building entire ships. Customers are already indicating the demand for ‘zero carbon shipping’—firms like Ikea, Patagonia and Amazon are already discussing this with a timeline of getting it done by 20408. It's notable that this approach would allow for further innovations in battery technology to be reflected in the batteries being swapped in and out, so as new energy storage systems gain primacy, Fleetzero’s systems could reflect it and take advantage. Energy storage represents one of the most exciting focus areas of the coming decades With the world’s focus on climate change, a catalyst is therefore created for a continual focus on different ways to effectively store energy for ‘on-demand’ use. Energy supplies are nearly unlimited—just think - if we could effectively corral and capture all of the sun’s energy hitting earth on a given day, but the challenge is in converting it into a form that can be stored and used as and where needed. So many different technologies are being explored that we are certain the coming decades are going to be quite interesting in terms of unpredictable breakthroughs. Sources 1 Source: Kersey et al. “Rapid battery cost declines accelerate the prospects of all-electric interregional container shipping.” Nature Energy. Volume 7. July 2022. 2 Source: Kersey et al. July 2022. 3 Source: www.infineon.com 4 Source: Kersey et al. July 2022. 5 Source: Kersey et al. July 2022. 6 To cite an exact figure, one would need to specify a precise type of fuel and a precise type of battery chemistry. That was not our focus here, but there are many potential sources available to drill down further. 7 Source: Peters, Adele. “This start-up designed an electric cargo ship to cross the ocean.” Fast Company. 6 April 2022. 8 Source: Peters, 6 April 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
AMEX:LIT
by aneekaguptaWTE
Supply bull vs. demand bear clouds cotton's outlookCotton prices have been very volatile in 2022. The three-month implied volatility on cotton is currently at 43.7% fast approaching the levels last seen in 2011. A pickup in volatility has historically been an important indicator of a change in trend. Back in 2011, Texas (the biggest growing cotton state in the US) witnessed the driest year on record. The reason for the drought was the weather anomaly La Nina. The La Nina results in an abnormal cooling of waters in the equatorial Pacific Ocean that is linked to severe droughts in the southwestern parts of the US. In the wake of the drought, the US Department of Agriculture (USDA) cut its estimate of 2011/12 cotton production by 1mn bales to 17mn bales. Cotton prices reached a record 215.151 USD/lbs in response. Drought plaguing US’s biggest cotton growing state We are seeing history repeat itself with a persistent drought in Texas this year. The National Oceanic and Atmospheric Administration sees a 72% chance of La Nina between November and January raising the odds for a rare third-straight La Nina to form across the Pacific. USDA has slashed its supply projections for global cotton ending stocks by 1.5mn bales in 2022/23. Production is lowered nearly 3.1mn bales whilst consumption is reduced by 800,000 bales. US producers increased their cotton acreage by 11% this season to 5.05m hectares. But, with the drought becoming more severe over the last couple of months, the USDA expects that the harvested area won’t exceed 2.89m ha. The abandonment of 43%, if confirmed, will be by far the highest since USDA records began in 1960. Owing to historically high abandonment in the US Southwest region, US production estimates are forecast to reach their lowest level since 2009/10. The US is the world’s largest exporter of cotton, having more than 27% share of the world export market. That implies that the fall in US production will dampen the world trade surplus, putting pressure on declining inventories. Harsh climate conditions amongst key cotton producers threaten supply Unpredictable weather patterns have been challenging the cotton crop outlook in other key producer countries as well. Drought is hitting China’s cotton crop in the Xinjiang province, which grows majority of the country’s crop. In China, ending stocks are estimated at 36.2 million bales in 2022/23, the lowest in 4 years2. Australia, Brazil, and Pakistan experienced untimely rains that have reduced a large share of their grades. The World’s stocks to use ratio at 68.25% is at its lowest in five years highlighting the constraints on supply with respect to demand. Cotton’s demand outlook set to weaken amidst slowing global economy Cotton consumption is likely to weaken amidst a challenging macroeconomic backdrop. Europe is on the brink of a recession and the European consumer will be exposed to soaring energy costs. Meanwhile the US consumer’s spending pattern is shifting away from goods to services. In China, the economic headwinds are multifaceted – from a weaking property market, intermittent covid lockdowns alongside supply shortages to strategically imported goods. The outlook for apparel and textile consumption looks tricky. Consumption in 2022/23 is projected lower than a month ago in the US, Pakistan, Vietnam, Turkey, and Bangladesh3. Conclusion Supporting prices higher has been the 25.8%4 rise in speculative positioning over the past month. A 12% unwind in short positioning alongside a 10% build up in long positioning underscores the improvement in sentiment towards the cotton markets. The front end of the cotton futures curve remains in backwardation with a positive roll yield of 3.2% versus 8.5% a month back. Evidently the supply situation remains tight however amidst a tougher macroeconomic environment cotton prices are likely to walk a tight rope. In order for cotton prices to stage a sustained move higher we will need to see an improvement in demand. Sources 1 Source: Bloomberg as of 4 March 2011 2 Cotton Outlook August 2022, Economic Research Service 3 United States Department of Agriculture 4 Source: CFTC, from 19 July 2022 to 16 August 2022 This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
ICEUS:CT1!
by aneekaguptaWTE
Suspension of EU ETS unlikelySharply rising energy prices are pressuring politicians to react. Last week the European Commission called for an overhaul of the electricity market following price increases in excess of 20% in a single day in France. The European Commission is talking tough but is offering very little in terms of detail on its proposals1. Poland is looking for a suspension of ETS... Poland’s Prime Minister called for a suspension of the EU’s Emission Trading System (ETS)2 to deal with the stress of rising prices. Poland’s state-owned electricity company has launched an advertising campaign blaming the ETS for the country’s high energy prices. With EUA prices reaching a new all-time high of EUR98.42/MT CO2e last week, it's easy to see how their rhetoric could gain momentum. …which appears unlikely to happen However, there appears to be no legal basis for a suspension of the ETS. A suspension would need to be decided through a joint decision by EU member states and lawmakers as an amendment to the ETS Directive. The process will need to involve the European Commission, European Parliament and Council. Changes would first need to be decided at an EU level and then implemented by each member state. Even if the political will was strong across-the-board that would take over a year to pass and thus do very little to lessen the immediate stress on households. The political will is lacking to suspend ETS. REpowerEU – the policy proposal to wean off Russian energy dependency – also focuses on speeding up the energy transition away from hydrocarbons in general. In short, the energy shock is unlikely to derail EU ETS from being the cornerstone of EU’s climate policy. Article 29a reform, however, could gain some momentum However, there has been much talk about reforming Article 29a of the Directive – the mechanism designed to reduce instability caused by price spikes. Despite the high price volatility of EUAs and the sharp price increases in the past two years, the clauses under Article 29a have never been invoked. Under Article 29, if for more than six consecutive months, the allowance price is more than three times the average price of allowances during the two preceding years, the Commission shall convene a meeting of the Climate Change Committee. As a second condition, the EC Climate Change Committee has to determine that the excessive price fluctuations do not correspond to market fundamentals, while the legislator does not define market fundamentals. Only if both conditions are met, Article 29a is triggered. The Directive is ambiguous and makes calculating the thresholds difficult. For example, it is unclear if the past years include the 6-month look-back window. Whether it’s based on monthly or daily prices. Our calculations show that the trigger would not have been met on this “3 times” threshold (spot prices have been below the ‘x3 factor’ line in the chart below). But reform to a “2 times” threshold would have triggered the first stage (spot prices have been above the ‘x2 factor’ line for a period greater than six months). Several Members of the European Parliament (“MEPs”) have been pushing for this lower threshold, including Peter Liese, environment and climate policy spokesman for the EPP Group and rapporteur on emissions trading for the European Parliament3. Summer recess is over; Fit for 55 legislative progress to resume With summer recess in the European Parliament over, Trialogue discussions on the Fit for 55 package the Commission, Parliament and Council agreed on separately in June4 will now commence. As we have argued before, the package is highly supportive for the EUA market. At the same time, with other discussions around the energy crisis brewing, there is a risk some aspects of the ETS get watered-down while other aspects are strengthened. Sources 1 ec.europa.eu 2 www.euractiv.com 3 www.euractiv.com 4 What's hot: European Parliament supports strengthening the EU Emissions Trading System This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
F
by aneekaguptaWTE
Cloud Computing continues to exhibit strong growth in 2022When you think about cloud computing companies this year, the most likely starting point will be performance1: - The BVP Nasdaq Emerging Cloud Index, from its high last November to its near-term low in June, fell 60.20%. - This compares to the S&P 500 and Nasdaq 100 Indices, down 21.21% and 31.17% respectively, over the same period2. However, from June 16th to August 22nd this year3: - The BVP Nasdaq Emerging Cloud Index returned 17.56%. - The S&P 500 and Nasdaq 100 Indices returned 13.07% and 15.97% respectively, over the same period4. The bottom line: The dominant force explaining the performance of cloud computing companies has been macroeconomic, meaning that as the US Federal Reserve (Fed) and other central banks pursue more restrictive monetary policies to fight inflation, the valuations of cloud companies have fallen. Similarly, if investors ‘feel’ that inflation is easing in any way—and subsequently central banks may slow the pace of tightening—there has tended to be a strong positive share price response. The BVP Nasdaq Emerging Cloud Index: August 2022 rebalance We mention the BVP Nasdaq Emerging Cloud Index as a measure of the performance of cloud companies because it is designed to offer a precise exposure to their growing revenues by serving enterprise customers. What we see in Figure 15: - The blue line, sloping upward from left to right represents the weight (vertical axis) and the six-month performance (horizonal axis) of initial constituent companies before the August 2022 rebalance. Companies like RingCentral, Asana and Blend Labs faced performance challenges over this period, whereas companies like Paylocity Holding Corp, Box and Qualys tended to see stronger performance. - The grey line shows that the rebalance resets the Index to equal weight. Companies that outperformed see their weights decrease, and companies that underperformed see their weights increased. This leads to a valuation sensibility and risk mitigation every 6-months. - Red dots and company labels indicate companies that will no longer be constituents after the August 2022 rebalance. The primary reason, historically, why companies are deleted is that there is an announced deal, such as an acquisition by a private equity firm. - Green dots and company labels indicate companies that are new constituents and will be added to the index after the August 2022 rebalance. The primary reason companies are added is that they have become accessible in public equity markets. The fundamentals will matter again It would be difficult for us to argue that the main catalyst for the share price performance of cloud companies has to do with fundamentals like revenue growth. As we noted earlier, the main catalyst has been the macroeconomic backdrop. However, company fundamentals are always an important force and will always come back to prominence once macro pressures fade. What we see in Figure 26: - Along the horizontal axis, almost every blue dot is to the right of the 0% boundary, indicating positive year-over-year revenue growth, as per the most recently announced quarterly results. It may be a tough economic environment, but by and large these companies continue to grow revenues. - Along the vertical axis, higher on the chart means higher valuation. Some companies, like Gitlab, Snowflake and SentinelOne are still trading in the range of 25-30.0x Enterprise Value to Sales ratio (EV/Sales). While this may not be ‘inexpensive’, these companies have been growing revenues in the range of 50-100%, year-over-year. If that can be kept up, maybe that premium multiple is warranted. We would note that the majority of the 75 blue dots are below the 10.0x line, however. - The weighted average sales growth for the BVP Nasdaq Emerging Cloud Index is still in the range of 35-40%, where it has been positioned consistency for some time. Is this sustainable? Microsoft Azure, Amazon Web Services and Google Cloud tend to see their, admittedly, very large revenue bases growing year-over-year in this range. The fact that the biggest players seem to, for the moment, be sustaining these rates of growth, tells us that the smaller companies—like those in this index—may be able to sustain growth rates higher than one might see in other sectors. Conclusion: Cloud Companies will continue to deliver exciting results In cloud computing, it’s important to look at all the available signals such that one can gain the most appropriate sense of market conditions. Bessemer Venture Partners has just put out its annual Cloud 100 Benchmarks report for 20227. This report specifically looked at the largest and most dynamic private cloud companies, which provide important signals for the overall health of the business model. In 2022, Bessemer specifically notes that the valuation of private companies may not be the best metric to look at if the goal is to get a sense of the ‘health’ of a given market. For instance, if companies have not raised money recently, they may not have their valuations marked all the way to present market conditions. Bessemer instead focuses on what they call ‘Centaurs.’ While being a ‘Unicorn’ is $1 billion in private market valuation, a Centaur is 100 million in annual recurring revenue. For the 2022 Cloud 100, 70% are already achieving Centaur status and a further 10% more are quite close and could reasonably do it before the year is out. In an environment where the market is focusing much more on results than exciting stories and private funding is harder to come by, proving business success at the Centaur level is indeed important. Sources 1 Source: Bloomberg, with data from 9 November 2021 to 16 June 2022 2 Refers to the S&P 500 and Nasdaq 100 ‘net total return’ indices 3 Source: Bloomberg, with data from 16 June 2022 to 22 August 2022 4 Refers to the S&P 500 and Nasdaq 100 ‘net total return’ indices 5 Source: The 6-month period between rebalances is from 22 February 2022 to 22 August 2022. The performance source is Bloomberg 6 Sources: WisdomTree, Nasdaq and Bloomberg, with data measured as of 22 August 2022. Further details in sourcing are below Figure 2 7 Source: www.bvp.com This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
C
by aneekaguptaWTE
Central bank policy has catalysed a valuation opportunity2020 and 2021 saw investors putting record amounts of investments into thematic funds. Whilst no two thematic funds are the same, two things in particular were noticeable: 1. Strategies focused on software were able to showcase very strong revenue growth metrics, in many cases providing solutions that were more broadly used during the Covid-19 lockdown periods. Investors were attracted to these growth metrics and, in many cases, the assets piled in. 2. As performance accelerated, so did valuations, at least measured on an enterprise value to trailing 12-month sales (EV-Sales) basis. This tells us that, even though sales were growing, investors were pushing up valuations because of their excitement in future potential. Obviously, in 2022 the environment has changed. -The WisdomTree Team8 Cybersecurity Index (WisdomTree Cybersecurity), Nasdaq CTA Artificial Intelligence Index and BVP Nasdaq Emerging Cloud Index represent three distinct indices aiming to capture companies in three megatrends. Each touches the software space, but we recognise that the Nasdaq CTA Artificial Intelligence Index is slightly different as it also incorporates significant exposure to semiconductor companies, which can have very different relevant financial metrics than software companies. -The BVP Nasdaq Emerging Cloud Index has seen three distinct regimes, looking at the EV-Sales metric. October of 2018 to April of 2020 had the valuation moving around but sticking below 10.0x. Then, from April of 2020, the valuation ratio expanded towards a level of 12.0x to 14.0x, until November 2021. In November 2021, the ratio fell off and seems to have stabilised at roughly 4.0x to 5.0x as of July 2022. We can clearly see how these dates correspond to different parts of the Covid-19 pandemic and announcements of shifts in central bank policies. -WisdomTree Cybersecurity, during its shorter live history, has behaved with high correlation to the BVP Nasdaq Emerging Cloud Index. It is notable that ‘cloud security’ is an important part of cybersecurity today, and there is overlap between these indices. Today, one can consider if the fact that cybersecurity is essential to the strategy of any company translates to a higher valuation multiple than what we’d see for the general cloud computing company. -The Nasdaq CTA Artificial Intelligence Index is more diversified in terms of industry—there are software companies, but there are also semiconductor companies. The EV-Sales multiple has dropped from November 2021 to July 2022, but from a level of roughly 4.0x to a level of slightly above 2.0x. Semiconductors also tend to have their own cycle of boom-and-bust where there can be a shortage, massive investment, oversupply or a market correction and the cycle continues in a different way than purely focused software companies. Conclusion—a signal to invest? We wish the matter was as simple as, ‘valuation is down a certain percentage, therefore it has bottomed and it is a great time to enter’. Unfortunately, all three of the indices shown in Figure 1 could drop further from here. We can note the revenue growth of some select cloud companies, recognising that the BVP Nasdaq Emerging Cloud Index saw the largest overall drop in the EV-Sales ratio. -Squarespace, Tenable, ServiceNow, AppFolio, 2U, Shopify and Zendesk reported quarterly results during the week of 25 July 2022, on the early end of the quarterly earnings reporting cycle1. -If we think in terms of ranges: Squarespace and 2U saw revenue growth in the 0-10% range; Shopify was between 10-20%; Zendesk, ServiceNow and Tenable were in the 20-30% range; and AppFolio was the leader at 32% revenue growth, year-over-year2. We are tending to see cloud computing companies guiding in the range of either stable or slightly lower growth for 20223. As yet, we have not seen revenue growth ‘disasters’, but that doesn’t mean it couldn’t happen as companies continue to report. Tobias Lütke, CEO of Shopify, wrote a letter that was posted to Shopify’s public site concerning their strategic decision to let go of around 10% of their workforce4. Included, was the chart in Figure 2 which we think is illustrative of what we are seeing in a lot of the software space. -Shopify is focused on ecommerce, so the ecommerce adoption rate is critical to their business. -Ecommerce is still on a significant growth trend, but it’s clear that the slope is moderating back to the longer-term trend after a very large spike. Many software companies might have been priced as though the ‘covid spike’ in growth was going to continue, and what we are seeing in 2022 is the need to moderate back to a still growing but more sustainable growth figure. We think that ‘growth = opportunity’, but recognise that it will be critical to see central banks transitioning from aggressive tightening to slowing or pausing their tightening. A massive rally in software company share prices would be difficult to see in the face of continued 75 basis point hikes. One way to potentially manage this risk could be a longer investment horizon, where the risks associated with any singular macroeconomic environment can typically be lessened. Sources 1 Source: Bloomberg for the aggregation of quarterly earnings reporting dates 2 Source: Respective company investor relations website for each specified company where they post a press release and presentation reporting the most recent results 3 Source: Company investor relations websites, recognising that not all companies provide guidance or provide it based on the same exact metrics or time periods 4 Source: news.shopify.com This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
C
by aneekaguptaWTE
Currency hedged gold – preserving gains in a Dollar depreciationDespite living in a period of elevated inflation for the past 18 months, gold has failed to reach the highs of summer 2020. In fact, gold has largely been falling since March 2022, when it briefly rose above $2000/oz1. A strong US Dollar and a bond sell-off have put gold under pressure. The US Dollar basket (DXY) reached a 20-year high in July 2022, and we have not witnessed such a sharp appreciation in the US Dollar since 2015. The Euro briefly fell below parity to the US Dollar in July 20222 – a spectacle not witnessed since the early days of the currency3 when the US came under pressure from a ballooning deficit. Gold holding up well, all things considered Factoring in these pressures, gold has not fared that badly. In fact, our internal forecast model4, indicates that gold should have fallen in the order of 10.8% y-o-y in July 2022, whereas we only saw a 2.7% y-o-y fall in the month. Despite subdued investor sentiment toward the metal of late, recession fears are likely to put gold increasingly into focus. Gold has historically been a strong performer in economic downturns. As hawkish central banks clip the wings of global economic growth, we expect interest in gold to be driven higher. US Dollar pressure could ease As we enter August 2022, we have witnessed US Dollar negative pressure on gold ease. Market consensus expects the US Dollar to depreciate going forward. The Dollar basket, currently at 106.2 is expected to depreciate to 101.8 by end Q2 20235. While most central banks have disposed of forward guidance tools and their policy course will be very data dependent, markets expect the Federal Reserve and European Central Bank to deliver most on their policy tightening in a front-loaded manner. Therefore, interest rate differentials may (at least initially) narrow, lessening the upward pressure on the US Dollar. WisdomTree model points to gold price increases Dollar depreciation is usually gold price positive, but for non-US Dollar denominated investors, the gains on gold can be lost when translating back to home currency. If we put consensus economic expectations6 into our gold model (and hold investor sentiment toward gold steady around current levels), gold could rise to $1825/oz by end Q2 2023, a gain of 6.9% relative to end Q2 2022. 2.5% of this gain comes from the Dollar depreciation that the market expects. An example of why an unhedged position fails to benefit from US Dollar depreciation Taking a numerical example, starting from an ounce of gold at US$1700/oz (i.e. €1734/oz with a EURUSD exchange rate at 1.02), if the US Dollar depreciates against the Euro by 5%, everything else being equal, the expectation is that the intrinsic value of gold would not have changed and therefore the price in Euro would remain €1734 per ounce. However, because of the currency move, the price in US$ is now 5% higher, i.e. $1785/oz. In such a scenario, the Euro investor unhedged would not benefit at all, the price of gold in Euro is unchanged after all. However, the hedged investor would benefit from the 5% increase in Dollar terms. Currency hedging Currency hedging is one way of protecting a gold investment for non-US denominated investors. As an illustration, when we have seen gold price gains (in USD) greater than 5% m-o-m (which on average since December 2003 has given rise to gold performance of 7.8%), gold unhedged for Euro based investor has only returned 6.8%. Thus, an entire percentage point has been eroded by the currency translation. However, a currency hedged position would have on average performed 7.7% i.e. only 0.1% less than the US Dollar performance for a US Dollar denominated investor. Even in months when gold price gains were not as strong as 5%, for example between 0 and 5%, currency hedging has protected more of the gains. Conclusion Gold prices in US Dollar terms tend to rise when the US Dollar depreciates (all else being equal). A non-US Dollar denominated investor holding their position unhedged would lose out on the proportion of gold gains that come from Dollar depreciation. A currency-hedged exposure would historically be the best way to attempt to preserve these gains. Sources 1 Gold had reached US$2029/oz on 8 March 2022, dipped to US$1985/oz on 9 March 2022, touched US$2003 on 10 March 2022 before falling below the US$2000/oz thereafter (source: Bloomberg) 2 The Euro fell below 1 to the US Dollar on 14 July 2022 for a day (source: Bloomberg) 3 The Euro began trading on 1 January 1999 around 1.18 to the US Dollar and by 27 January 2000 it fell below 1. It remained below 1 until November 2002 (source: Bloomberg) 4 See Gold: how we value the precious metal for more details on the WisdomTree’s model 5 Using Bloomberg survey of economists from July 2022 6 Using Bloomberg survey of economists from July 2022, covering CPI inflation, 10 year Treasury Bond yields, and the US Dollar basket This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
F
by aneekaguptaWTE
Looking back at Equity Factors in Q2 with WisdomTreeMarkets in Q2 2022 continued to suffer from entrenched inflation and aggressive rate hikes from central banks. They also reacted to the slowdown of the global economy and the increased risk of a recession in developed economies. These changing market conditions impacted equity factors differently. In this instalment of the WisdomTree Quarterly Equity Factor Review1, we aim to shed some light on how equity factors behaved in Q2 2022 and how this may have impacted investors’ portfolios. -High dividend continued to dominate, followed by a revival of min volatility -Value started to show signs of slowing down due to its cyclical nature -Momentum and size continued to suffer -Quality strategies continued to deliver mixed results depending on their portfolio’s overall valuation Over July, central banks aggressive tightening continue to slow down the global economy, raising the probability of a global recession.The impact of this slowdown has been clear with rate hike expectations lowering leading to a factor rotation in favor of quality and size. Looking forward, uncertainty around recession and economic growth will continue to rise. Investors are facing the need to balance their portfolio between building wealth over the long term and protecting their portfolio during economic downturns. This environment could therefore favour high dividend and quality stocks. Performance in focus: high dividend continues to lead, but min vol is catching up In the second quarter of 2022, equity markets suffered from a deep drawdown, leading to the worst first half year in decades. The MSCI World lost -16.2%. Unusually, the US underperformed European markets with -16.9% versus -9%. Emerging markets suffered as well with -11.4%. Q2 2022 factor performance continued to be driven by inflation surprises on the upside and the hawkish stand of developed countries' central banks. However we also saw two new entrants this quarter with heightened volatility and the fear of recession rocking markets further. Faced with such a brutal landscape, some factors continued to do well, and some did not: -High dividend dominated in most regions. This factor finished first in all developed geographies -Pushed by increasing volatility and heightened fears of recession, min volatility followed closely: second in developed markets and first in emerging markets (EMs) -Value is the last factor that managed to outperform consistently this quarter thanks to rate hikes and despite the volatility increase -Momentum, size and growth suffered the most over the quarter, delivering underperformance across regions -Quality sat between those two groups, delivering mild underperformance in European and global equities but outperforming in US equities. However, like in Q1, the definition of quality and the criteria used would have hugely impacted the result. Quality, left unattended, tends to tilt toward growth (investors pay for quality, after all) and would have suffered from that tilt. For example, highly profitable companies and dividend growers have fared better over the period using their value/high dividend tilt to outperform. Looking at the outperformance of factors over the last six months, we notice that: -After a very strong start, value showed signs of slowing down in Q2. Value is a mostly cyclical factor, and an inflationary environment with aggressive rate hikes is very supportive. Fear of recession and increased volatility are not -High dividend is the overall winner for the 2022 first half and went from strength to strength -Min volatility started a bit slower in Q1 but has picked up speed in Q2 on the back of recession fears -Size and momentum suffered across the full six months in an environment that was not supportive of cyclical stocks -Finally, quality suffered the most in the first six weeks of the year and has hovered around the same level since then. With the market turning more defensive toward the end of Q2, quality is showing signs of life. Here again, highly profitable companies and dividend growers, for example, have fared better. It is worth noting that since the end of June, markets expectation of a recession has continued to grow. This has led to a revision downward of the expectation on future rate hikes. Equity factors have reacted to this change pretty strongly, with quality and size taking the lead for that month while value and high dividend released some of their performance. This rotation has been particularly strong in Europe where economic predictions are the most dire. Having said that, the performance difference in the first 6 months were so high that the full year to date picture remains similar. Valuations continue to come down across the board In Q2 2022, valuations continued to decrease across the board for factors. Momentum and quality saw the largest drop in valuations in all geographies. On a relative basis, high dividend stocks and value stocks got more expensive versus the market on the basis of lower drop in their price to earning ratios. The re-opening trade in 2021 has evolved into the ‘recession trade’ in 2022, owing to a tardy start to the hiking cycle by central banks. Their aggressive tightening plan is slowing the global economy, raising the probability of a global recession. Leading economic data (LEI) shows economic momentum is fading quickly. The impact of this slowdown has been clear in July with rate hike expectations lowering leading to a factor rotation in favor of quality and size. However, this risk of recession only adds to the uncertainty for investors. They need to carefully balance the risk in their equity allocation. All-weather assets continue to be best positioned, delivering balance between building wealth over the long term whilst protecting the portfolio during economic downturns. This environment could therefore favour high dividend and quality stocks. World is proxied by MSCI World net TR Index. US is proxied by MSCI USA net TR Index. Europe is proxied by MSCI Europe net TR Index. Emerging Markets is proxied by MSCI Emerging Markets net TR Index. Minimum volatility is proxied by the relevant MSCI Min Volatility net total return index. Quality is proxied by the relevant MSCI Quality net total return index. Momentum is proxied by the relevant MSCI Momentum net total return index. High dividend is proxied by the relevant MSCI High Dividend net total return index. Size is proxied by the relevant MSCI Small Cap net total return index. Value is proxied by the relevant MSCI Enhanced Value net total return index. Sources 1 Definitions of each factor are available below This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
AMEX:HDV
by aneekaguptaWTE
WisdomTree Quarterly Thematic Review: Thematic ETFs holding grouAfter the start of the global value rotation towards the end of 2021, thematic assets in Europe decreased from $371 billion to $276 billion as of 30 June 20221, mainly due to performance. A significant correction in many themes resulted in a slowdown in thematic flows but pointed to the relative resilience of the European thematic exchange traded funds (ETF) market, with thematic ETFs gathering more flows in Q2 than open-ended funds. Open-ended funds experienced a larger percentage drop in their assets under management (AUM), compared to ETFs2, as they lost around $85 billion, or 26.4%, compared to around $10 billion, or 20%, in ETFs. The impact on AUM from performance year-to-date was similar in both open-ended funds and ETFs. However, exchange-traded vehicles gathered $3.5 billion or around 23% of the total flows they gathered last year when open-ended funds gathered just $7 billion, or 7% of last year's flows. In Q2, the correction that started originally in the growth space further expanded to broad equity markets amidst higher prospects of more hawkish monetary policy in the United States and fears over ensuing economic slowdown and a potential recession. Many themes extended their drawdowns even further. Resurgence of China-centred themes in June was one of the bright spots within the thematic landscape. In this quarterly thematic review, we will look at the space and analyse the second quarter as well as the first half of the year through the lens of performance, flows, and new launches. For all of our calculations, we will use the WisdomTree Thematic Classification that we have previously introduced in a series of blogs in which we discussed how to classify and select thematic funds. Winners and losers As noted in our research paper on thematic investments, themes tend to rotate in flows and performance over time due to their individual narratives. For example, compared to a rough Q1, China-centered themes were most resilient in Q2. They posted strong returns relative to the global equity benchmark in June, as lockdown policies eased in China and the government expressed readiness to provide stimulus for propping up the economy. The MSCI ACWI Index lost 15.7% in Q2 and -20.2% year-to-date. Only five themes beat the benchmark year-to-date and seven in the Q2. Overall, most themes posted more negative returns in the Q2 in comparison to the Q1. The major exception were the top 3 themes that benefitted from the rebound of Chinese stocks in June. The performance differential in Q2 vs other themes allowed the China-centered themes to be in the top 5 performing themes year-to-date as well. Notably, the top performing theme, "China Tech", was the only theme that delivered positive returns in Q2. "HealthTech" was another technological theme in the top 5 that held up better in the Q2, but year-to-date, it has shed -25.7%. Apart from the themes focused on the Chinese market, sustainable energy production was another theme that appeared in the top 5 both in the Q2 and year-to-date. "Sustainable Energy Production" and "Agriculture" might have better resisted the global correction in equity markets year-to-date, as the war in Ukraine brought them into the spotlight. The bottom of the performance spectrum continues to be composed of technology themes, as growth stocks continued to suffer from the value rotation. For most of the themes, we can note crypto, e-commerce and digital payments as common denominators. A collapse of UST/LUNA around mid-May, deleveraging in the decentralised finance (DeFi) space, and a general risk-off sentiment in the financial markets contributed to the significant correction in blockchain. Platforms & digital markets and fintech & digitalisation of finance were falling out of favour already earlier in the year amidst the concerns over deceleration in the pandemic-driven growth and broader rotation out of growth stocks. The downward trend continued with new strength into the second quarter as inflation, economic slowdown, and recession fears did not bode well for consumer spending and hence potential revenues for e-commerce and digital payment companies. Semiconductors and cloud computing were the other two tech themes that suffered amidst the global value rotation. The valuations for many cloud computing companies have seen a steep correction from its peak in November last year, offering entry avenues for investors believing in the long-term growth potential offered by the megatrend. As for semiconductors, the global chip shortages over the past two years incentivised companies to work towards ramping up their production. While increasing inflation and economic slowdown are now contributing to uncertainty on the demand side, putting downward pressures on the revenues and margins in the industry. Flows were muted but point to resilience in ETFs Thematic flows significantly slowed down in 2022 as part of the broader risk-off sentiment in the markets, but the slowdown was much more pronounced for the open-ended funds. In the second quarter, flows into ETFs outpaced open-ended funds, $1.8 billion vs $1.7billion, respectively. This greatly contrasts the annual figures in the last five years, where flows into thematic ETFs amounted to 10%-25% of the open-ended funds. Regarding the most popular themes in Europe, climate change and sustainability themes continued to gather the bulk of the flows. Year-to-date, flows into open-ended funds are still far ahead of ETFs, with $7.5 billion vs. $3.5 billion. Open-ended funds have predominantly suffered from outflows in the technological themes, with $3.6 billion outflows year-to-date and $1.2 billion in Q2 alone. In contrast, to open-ended funds, the tech-focused thematic ETFs were more resilient and continued to gather assets with positive inflows of $177 million in Q2 and $503 million year-to-date. Year-to-date, 4 out of the Bottom 5 themes by flows in both ETFs and open-ended funds were from the technological shifts. However, the picture has slightly changed in Q2, as investors might have found entry opportunities within the tech themes created by the global value rotation. In contrast to the outflows in open-ended funds, equality, inclusion & diversity was the top gathering theme within ETFs. At the same time, sustainable energy production and agriculture continued to gather significant flows in both wrappers with $1.7 billion and $1.1 billion, respectively. The former theme continued to feature in the top 5 flows from quarter to quarter in the last year, while the agricultural theme entered the top 5 only last quarter potentially on the back of the rally in agricultural commodities amidst the global supply tensions created by the war in Ukraine. Notably, China tech and the rise of the EM consumer have gathered flows in the second quarter coinciding with the relatively strong performance in both themes. No sign of deceleration in ETF launches Huge slowdown in flows within open-ended funds in Europe might have influenced the pace of fund launches in the space. The number of newly introduced funds amounted to 53 compared to 138 for the full 2021 year3. Despite the outflows this year, most of the launches are happening within the technological shifts cluster and such themes as healthtech and metaverse. In contrast, the thematic ETF providers continue to grow the space with 29 new strategies launched year-to-date and 11 this quarter. Last year the thematic ETF market expanded by 44 products. So, the launches in 2022 are currently on track to overtake that figure. The majority of year-to-date launches in ETFs continue to focus on the "Environmental Pressures" cluster followed by technological shifts. Sustainable energy production andsustainable mobility strategies prevailed in environmental pressures, while technological shifts had a much more diverse mix of launches. We will continue to closely watch the space in Q3 2022 and we will summarise our findings in the next WisdomTree Quarterly Thematic Review. Stay tuned. Footnotes Performance of a theme: For any given theme, we consider each month all the ETFs and open-ended funds classified in that specific theme that have published a monthly return for that month in Morningstar. We then calculate the average of all those monthly returns to compute the average monthly return for that theme. So, the monthly return for January 2020 for the theme may include 19 funds, while the February 2020 return may comprise 21 funds (if two funds classified in that theme have been launched in the meantime). By collating monthly returns for the theme, we get the theme's average historical performance. Therefore, the theme's average historical performance incorporates every ETF, and open-ended fund focused on this theme. The theme's average historical performance is not biased towards surviving funds or successful funds. Every fund alive in a given month is included irrespective of its future survival or success. Investments that try to focus on multiple themes and, therefore, classified either at cluster or sub-cluster level are not included Sources 1 Source: WisdomTree based on its Thematics Universe and the underlying data on AuM for the funds provided by Morningstar, as of 30 June 2022. 2 Source: WisdomTree based on its Thematics Universe and the underlying data on AuM for the funds provided by Morningstar, as of 30 June 2022. 3 Source: WisdomTree based on its classification of new fund launches reported by Morningstar, Bloomberg This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
AMEX:TMAT
by aneekaguptaWTE
2
AI continues to build the foundation for a remarkable future in 28 July 2022 was an historic day in both biology and artificial intelligence (AI). DeepMind, a firm specialising in AI research owned by Alphabet, made freely available the structural data on more than 200 million proteins from its AlphaFold tool. This represents data on roughly 1 million species and covers the vast majority of known proteins on earth1. In proteins, shape can determine function In the late 1990’s into the early 2000’s, the scientific community was awash with news of the race to sequence the human genome. This genome contains the instructions embedded in DNA about how cells should build certain structures, typically through the formation of proteins that are made from different combinations of amino acids. In a sense, DNA is the instruction manual, amino acids are the building blocks, and proteins are the product. Knowing the code, however, is not the full story. Looking at figure 1 is instructive on the point. This is the image of a protein that may protect the organism responsible for malaria from an attack by the human immune system. Even if you knew the list and the order of all the amino acids, it would be difficult to go from that list to something that looks like figure 1 in three dimensions. The importance of the shape of the protein could not be overstated: It can correspond to the way in which it might react in the presence of different molecules, like those associated with different drug therapies Variations on the shape—sometimes termed mutations—could be instructive in determining the causal factors of certain symptoms or diseases Parts of the shape could be used as targets—think of the ‘spike protein’ associated with the virus behind the Covid-19 pandemic, specifically targeted within the mRNA vaccines. AlphaFold Represents a Leap Forward on the Journey Scientific breakthroughs are difficult, in that in many cases one builds on another and another and another…a process that can take decades prior to widespread results that impact the lives of the general public. For instance—we sequenced the human genome, but that did not necessarily lead to immediate cures of all sorts of diseases or conditions. mRNA2 research had been occurring for decades, but the Covid-19 pandemic was somewhat of a catalyst to supercharge the process to use it as a case for vaccines. AlphaFold’s new database is therefore unlikely to lead to immediate cures for difficult conditions. The critical element with regards to how researchers that would have formerly had to undertake a cumbersome process of X-ray crystallography to determine the shape of a given protein could instead go to the database. Experimental techniques would still have their place, but less time would have to be spent on the equivalent of the ‘blank page.’ What’s also incredible is that AlphaFold’s database is, in conjunction with the European Molecular Biology Laboratory’s European Bioinformatics Institute (EMBL-EBI) freely available with a simple interface. It also provides an estimate of the accuracy, recognising that predictions based on AI do not yield perfect results all of the time. Roughly 35% of the 214 million predictions are deemed highly accurate—roughly as good as experimental results. A further 45% are deemed to be accurate enough for many applications3. Drug discovery—Better therapeutics developed more efficiently Even before the onset of inflation at the levels we see in the summer of 2022, it was widely recognised that drug development was time consuming and expensive, and as a result many different medications carried with them exorbitant price tags. Any process that could mitigate this pressure without degrading the quality of the therapies would be valuable. Considering the following could be instructive as the space continues to progress4: Pipeline growth: 20 smaller companies focused on AI drug discovery, typically with a focus on smaller molecules, over a period from 2010 to 2021, had development pipelines that were roughly 50% as robust as those of 20 of the largest ‘big pharma’ companies. We recognise that the reporting of pipelines may not be perfect and that a molecule in a pipeline is not a finished product, but activity is the first step on the path Pipeline composition: This is not always disclosed, but from the information available it does indicate that the AI-focused companies will tend to focus on well established biological targets for their therapies, around which much is known. Data is the fuel for AI, and these companies will also want higher chances of success. Bigger pharma companies will be more likely to venture into more emerging areas of drug discovery Chemical structures and properties: It is too early to be able to draw any robust conclusions regarding AI drug discovery efforts versus big pharma efforts at this point Discovery Timelines: Preliminary data would appear to indicate that, if traditional approaches would tend to take 5 or 6 years in preclinical phases, AI-focused drug discovery might be able to, in certain cases, take this timeline down to 4 years We’d note that currently it’s a story of more ‘progress’ than ‘perfection’, in that we would appear to be some distance away from AI being able to fully create new drugs, but AI is representing an entirely new set of tools that could have beneficial impacts. AlphaFold’s database, for example, may provide drug researchers with important inputs and catalysts for different ideas, even if it doesn’t have the immediate answer or cure right there in its system. Focus on the AI & BioRevolution megatrends At WisdomTree, we focus on both the AI and the BioRevolution megatrends (click to find out more). What we see here with the case of AlphaFold is an important case study in the fact that AI is a tool that can have the potential to supercharge other megatrends, in this case the BioRevolution. It is no accident that the BioRevolution is ramping up at the same time there are massive amounts of data, massive amounts of processing power and other things like cloud computing readily available. It is very exciting to consider what the coming decades can bring within these areas. Sources 1 Source: Callaway, Ewen. “’The Entire Protein Universe’: AI Predicts Shape of Nearly Every Known Protein.” Nature. Volume 608. 4 August 2022. 2 mRNA – Messenger ribonucleic acid 3 Source: Callaway, 4 August 2022. 4 Source: Jayatunga et al. “AI in small-molecule drug discovery: a coming wave?” Nature Review: Drug Discovery. Volume 21. March 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Editors' picks
N
by aneekaguptaWTE
3
What’s hot: Which party will industrial metals attend?While the Federal Reserve, European Central Bank and other developed world central banks are removing the punch bowl from the party, the People’s Bank of China (PBOC) is serving the Baijiu . Industrial metal prices could lift as they move to the afterparty. Developed world central banks removing the punchbowl Increasing fears of an economic recession are weighing on commodity prices as many developed nations’ central banks rev up their fight against inflation. As hawkish central bank headlines dominate the press, commodity prices are increasingly ignoring the underlying tightness in supply of many commodities. The US June 2022 Consumer Price Index inflation print from last week, which surprised once again to the upside, has increased the market’s conviction that the US Federal Reserve will raise Fed fund rates by anywhere between 75 and 100 basis points when the Federal Open Market Committee convenes on July 27th. The European Central Bank is likely to exit negative interest rates by September and commence its first increase in the Refi rate since 2011. PBOC serving the Baiju But while many investor’s eyes are focused on these developed market central banks, the People’s Bank of China has been loosening its monetary policy setting for several months. China has been grappling with slower economic growth for most of this year due to the country’s zero COVID policy. Q2 2022 grew only by 0.4% y-o-y, missing the 1.2% expectations and 4.8% from the prior quarter. Hence the central bank has been easing policy for some time. That effort is starting to show in aggregate financing to the real economy (Figure 1) . Not only was the reading higher in June 2022 than the average since 2017, but it is also close to the reading from March 2020 when extraordinary efforts were made to help avert the Chinese economy falling off a cliff when COVID-19 became a global pandemic. Metal demand to rise Historically, a boost in aggregate financing to the real economy in China has been accompanied by a boost in demand for metals. Figure 2 illustrates the case for China’s copper demand. Given that China accounts for more than 50% of demand for copper, nickel, zinc and aluminium , this is meaningful for the supply-demand balance of all metals used in infrastructure. China’s government encouraging more infrastructure spending In addition to central bank policy loosening, the government has been also providing stimulus. In April 2022, President Xi called for an “all-out” effort to construct infrastructure. Proposed projects ranged from waterways and railways to facilities for cloud computing. Back in April however, words felt cheap. Today, we are seeing evidence of government financing support. In July 2022 media reports claimed China’s Ministry of Finance is considering allowing local governments to sell 1.5 trillion yuan ($220 billion) of special bonds in the second half of this year. These special bonds are traditionally used to raise money for infrastructure spending. In aggregate, according to Bloomberg calculations, China is making 7.2 trillion yuan (US$1.1 trillion) available for infrastructure spending. That represents a decisive move away from the focus on debt control from last year. Conclusion While China faces several challenges ranging from falling property sales to private market reluctance to invest in infrastructure during uncertain times, we believe the strong lift in aggregate financing to the real economy and government support for financing infrastructure bode well for an infrastructure rebound. Along with that will be a boost for metal demand. China’s outsized presence in metal demand will be felt in prices once the initial shock of developed market central bank hawkishness abates. Sources 1 Baijiu, a traditional alcoholic drink from China is the most-consumed distilled spirit in the world (Source: londonspiritscompetition.com) 2 Total social financing (TSF) refers to the aggregate volume of funds provided by China’s domestic financial system to the private sector of the real economy within a given timeframe. It includes financing from the following 10 sources: RMB loans; Foreign currency loans; Entrusted loans; Trust loans; Undiscounted bank bills of acceptance; Corporate bonds; Non-financial corporate domestic equity financing; Insurance company repayments; Investment property; Financing via other financial instruments. 3 Source: IMF Special Focus Report 2018: Changing of the Guard - Shifts in Industrial Commodity Demand This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
N
by aneekaguptaWTE
Every act of creation is first an act of destructionThe digital asset ecosystem as a whole has retreated from all-time highs of over US$3 trillion in November 2021. Now sitting just below US$1 trillion in mid-July 20221, the drawdown of -73% has been vertiginous for the recently initiated. However, this is not the first time that such drawdowns have occurred in the digital asset ecosystem. In fact, it is fairly common to see boom and bust cycles in the adoption of new technologies. In many instances, new technologies or new industries emerge in a series of booms and busts. Let’s not forget the railway mania, canal manias or the dot-com bubble. Notice that the infrastructure is still left after the boom-bust cycle is complete. This is a part of the entrepreneurial process, Schumpeter’s “creative destruction”, particularly when new technologies are involved. Initially, it is not always obvious what will work or where new markets lie. This only becomes clearer as the technology becomes more available and affordable to different population segments. Below is a depiction of technology adoption S-curves, which show how new technologies spread across societies. Note that the process is rarely linear, with regression occurring at various points of the adoption process. Note also that the time taken for these technologies to reach close to full saturation is speeding up. Historically, they all related to some physical good – even the Internet involves fibre optic and submarine cables – and it took time for them to diffuse across societies. The arrival of Bitcoin in 2009 marked the start of what has now been over a decade of entrepreneurial and technical experimentation with digital assets and distributed ledgers (‘blockchains’). A key point here is that Bitcoin, and other digital asset networks like Ethereum, are at their core open source software. This means that they can spread very quickly over the pre-existing internet infrastructure and, being open-source, can be iterated on quickly by developer communities. This would help to explain how digital assets have grown so quickly globally over the past decade. With cellular phones now ubiquitous, and the internet infrastructure now well established, digital asset and distributed ledger technology have found their way into many sets of hands at a rapid rate. People have found and brought to market new use cases as they use these technologies to solve their problems. As this process has played out, there have been phases of booms and busts. WisdomTree has summarised this history in approximately four phases so far, which are explained in-depth in the new report ‘WisdomTree Insights - A New Asset Class: Investing in the Digital Asset Ecosystem’: - Bitcoin and ‘alt-coin’ cryptocurrencies, ending in the Mt Gox exchange hack - Ethereum and smart contracts, ending with the bust of the Initial Coin Offering (ICO) bubble - Defi and NFTs, built on smart contract networks and having receded from highs in late 2020 and late 2021 respectively - Layer 1 smart contract alternatives, such as Solana and Cardano, which have experienced steep falls in the first half of 2022 broadly speaking. So there have been many such boom-and-busts for the space over the years, a process whereby ‘what works’ is found, which then forms the basis for future development/adoption, and ‘what does not work’ ends in failure. This is characteristic of the space, which: - has enjoyed a backdrop of relatively loose global monetary policy - is ruthless in terms of competition due to the way that open-source software can be copied and altered (‘forked’) - benefits (or suffers) from network effects which can quickly appear and disappear for these networks and decentralised applications It would be unwise to suggest that the entire space will disappear once this latest bust is over and a new phase begins. More venture capital went into the space in 2021 than in the six previous years combined (US$25 billion)2. The ecosystem is more diverse than ever. The more pertinent questions will aim to uncover what new use cases might emerge and form the new opportunities of the next phase in digital asset adoption. Sources 1 www.coingecko.com 2 www.theblock.co This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
by aneekaguptaWTE
What’s Hot: Is it all bears from here for oil prices?How have oil markets evaded the bearish sentiment in equities in the last six months? Have the fundamentals between the two risk markets really diverged or, as the OPEC1 claim, oil markets have simply been panicking? Is the discrepancy now getting corrected? Might the cure for high prices be high prices? Commodity prices are ultimately a function of demand and supply. Energy consumption isn’t inelastic, i.e., when prices rise due to supply constraints, consumption isn’t unaffected. Discretionary spending on energy can be reduced by limiting non-essential car and plane journeys. Painful? Yes. But doable? Also, yes. Even where things stand now, global demand and supply figures do not necessarily support the bull run in oil markets in recent months. According to the International Energy Agency, global oil demand was 99.2 million barrels per day (mb/d) in June while supply stood at 99.5 mb/d. Moreover, global oil supply is expected to average 100.1 mb/d in 2022 before hitting an annual record of 101.1 mb/d in 20232. So, Brent oil prices exceeding $123/barrel in June, up from under $78/barrel at the start of the year3, doesn’t seem like a function of on the ground demand and supply dynamics. Further demand destruction on the cards? China is still pursuing a zero-Covid policy, and forty-one Chinese cities are under full or partial lockdowns or district-based controls, covering 264mn people in regions that account for about 18.7 per cent of the country’s economic activity4. China is the second largest oil consuming country in the world and further lockdowns could dent demand again, as they have in recent months (see figure 02). What does OPEC say? Saudi Arabia and the United Arab Emirates (UAE), the two countries where most of OPEC’s spare capacity sits, have both resisted pressure until now from the West to increase supply in the wake of rising prices. While some have seen this as the group’s inability to increase output, the US Energy Information Administration (EIA) state that OPEC’s spare capacity in the second quarter of this year was 2.85 mb/d and will remain above 2.5 mb/d through 2023. This is much higher than the 2003-2008 period when price rallied sharply, and spare capacity was below 2.5 mb/d5. The OPEC have repeatedly asserted that the case for increasing supply at a faster rate is not strong enough as prices have rallied due to markets panicking over the Russia-Ukraine conflict. Oil bulls can easily argue that OPEC could cut production if demand slows down meaningfully and this could cause prices to rise. Admittedly, this is possible. But it seems like the group is taking a more measured approach in view of the medium term demand outlook rather than making hasty decisions, in raising supply now and cutting later. Is tackling oil prices the solution to inflation? Probably yes. Consumer spending in the US has exceeded pre-pandemic trend levels. This is certainly not the case in Europe. But inflation is equally rampant in both regions. Energy prices are arguably playing a larger role in driving inflation than other components of aggregate demand. Perhaps governments can help their central banks avoid pushing their economies into a recession by rethinking energy policy and sanctions. While Russian oil exports fell slightly by 250 thousand barrels/day (kb/d) in June to 7.4 mb/d, export revenues increased by $700 million month on month to $20.4 billion due to higher prices, 40% above last year’s average6. So, the West’s plan to punish Russia via the oil market doesn’t seem to be working. What’s the bottom line? Oil prices were on the rise at the start of the year on expectations that demand might outpace supply as people start travelling again. But while chaos at airports around the world does confirm that travel activity has picked up, supply has been ample to meet the additional demand. And then there has been the Russia-Ukraine conflict. Some might call it panic, other might call it a geopolitical risk premium. Either way, the perceived risk of supply shortages has helped sustain oil prices higher while equities, and other risk assets, have pulled back on recessionary fears. Markets may now be moving to address this discrepancy. Sources 1 The Organization of the Petroleum Exporting Countries. 2 According to the International Energy Agency’s Oil Market Report July 2022. 3 Source: Bloomberg. 4 Source: Financial Times article from July 18 quoting a report from Nomura. 5 Source: US Energy Information Administration, data as of 12 July 2022. 6 According to the International Energy Agency’s Oil Market Report July 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
ICEEUR:BRN1!
by aneekaguptaWTE
Cloud computing: Beyond the fog of macro2022, so far, has been a year of the value style of investing outperforming the growth style, and few megatrends in recent years have been more growth oriented than cloud computing. Big stories and sales growth went from being in favour during 2020 and 2021 to being completely out of favour in an environment of higher inflation and interest rates. However, do we risk painting an entire megatrend with too broad a brush? If most cloud computing companies are trading more based on macroeconomic factors, opportunities can be created because the companies where positive things are happening are being pulled downwards along with everything else. Anyone interested in cloud computing and software-as-a-service (SaaS) businesses would do well to follow Jason Lemkin’s SaaStr blog. Some of the examples that I point out in the text that follows were inspired by his writing, and it’s excellent food for thought in finding positive financial developments in these companies. Zoom video communications It’s possible that the biggest value of Zoom is the fact that they are a global brand that everyone knows. There is even such a thing as ‘Zoom fatigue’—meaning the product is used so much that there is common language to describe using it too much. But, is this just a ‘pandemic darling’ or is this a business that has a significant future outside of the Covid-19 Pandemic? Customer Cohorts are Changing Customers that generate more than $100,000 plus in recurring revenue are the engine for future growth. This group of customers, roughly 2,900 in number, are growing 46% year-over-year. This could be Zoom’s ultimate future, but it will be a journey. Even in 2021, 63% of Zoom’s revenue was still from 10 seat or smaller customers1. Cost Control I was fascinated and even surprised to see that Zoom’s sales and marketing spending is around 25% of revenue, having grown from 20%. The reason for the expansion of spending is to facilitate Zoom’s transition more towards enterprise customers. The typical Software-as-a-Service company is spending something closer to 50% of revenue on sales and marketing, so Zoom is operating at roughly half the scale of the typical SaaS business, at least on the basis of measuring their expenditure this way. This is a big reason why Zoom is able to generate roughly $2 billion of adjusted free cash flow per year. In the current environment, if these stocks start trading less on macroeconomic factors and more on fundamentals, we believe that the capability to transition from revenues to free cash flows to earnings will be prized, and Zoom is doing this2. Multi-product Expansion Zoom has annual recurring revenues of about $4 billion, and the vast majority of this comes from the core product of video communications. However, Zoom’s phone product does have about 3 million users. We can recognise that Zoom attempted to acquire Five9, which didn’t work out, but they are still seeing growth of their phone product. It will just take time for the phone product to get big enough to materially impact the $4 billion in annual recurring revenues. Sprout Social Sprout Social is a company that helps increase the impact of brands, people and companies on social media. Growth Acceleration Consider these growth rates at different levels of annual recurring revenue3: $100 million: 30% growth. $180 million: 34% growth. $240 million: 41% growth. We can recognise that this past behaviour doesn’t guarantee any future growth rates, but it’s at least worth continuing to watch Sprout’s results. If they can maintain this trajectory for a time, when cloud computing stocks trade more on fundamentals and less on macroeconomic factors, performance could be quite interesting. Cost Control As mentioned with Zoom, the typical SaaS company spends something around 50% of annual recurring revenue on sales and market expenses. Sprout is spending about 39%, which is below a key measure of 40%, which has tended to be associated with better performance on free cash flows. Sprout Social is generating 9% free cash flow at $240 million in annual recurring revenue, which is a level that many SaaS don’t see until $500 million or even $1 billion in annual recurring revenue, speaking to a certain degree of efficiency in the business4. Box Box provides a solution that allows for efficient file sharing and data storage. Operating Margins Again, we note that the market today cares far less about the ‘story’ and more about the discipline and the execution. I’ll admit that I had to read the following a few times to make sure that I had it right and I wasn’t making a mistake5: Box had a 1% operating margin in 2020. Box most recently reported an operating margin of 20%. That is an incredible display of discipline, helped by the fact that sales and marketing expenses has been driven down to a low of 28% of annual recurring revenues. Box is approaching a level of free cash flow that is almost 20% of revenue, which is a significant figure for a SaaS company. Conclusion: Remember the Digital Transformation Cloud computing is certainly a high volatility, high risk megatrend, and we recognise that the first half of 2022 has been tough on the basis of share price performance. However, we were recently asked about how these companies might fare in an environment of rising rates and higher inflation. While there is no guarantee that customers don’t cancel subscriptions—and many cloud companies operate on subscription models—we tend to think about why customers are subscribing in the first place. Even before the Covid-19 pandemic there was a push toward digital transformation. Companies were largely doing this to increase efficiencies, make better use of data, and run their businesses in a more optimal way. The present environment makes us think that there could be an even greater value on businesses saving costs and finding efficiencies. To the extent that cloud subscription services can actually help businesses continue operating and save costs, we think this is a very interesting space for consideration. Sources 1 Source: Lemkin, Jason. “5 Interesting Learnings from Zoom at $4.3B in ARR.” SaaStr. 8 June 2022. 2 Source: Lemkin, 8 June 2022. 3 Source: Lemkin, Jason. “5 Interesting Learnings from Sprout Social at $240,000,000 in ARR.” SaaStr. 15 June 2022. 4 Source: Lemkin, 15 June 2022. 5 Source: Lemkin, Jason. “5 Interesting Learnings from Box at $1 Billion in ARR.” SaaStr. 1 June 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
What's Hot: The stakes are high for the widow maker tradeThe widow maker trade is back. At over 136 yen to the US dollar, the yen is approaching levels of weakness last seen in the summer of 1998. Investors are now betting that the Bank of Japan (BOJ) under growing pressure to stabilise the yen will have to abandon its 0.25% cap on benchmark bond yields and allow them to rise. If this were to happen, it would have widespread ramifications allowing the yen and Japanese rates to rise. BOJ’s unprecedented quantitative easing program is getting harder to defend The BOJ kept its bond purchase plan unchanged for the July-September quarter, even though its actions are weighing on the yen. It insists the Japanese economy still needs support. While this is true, the BOJ needs to take a balanced approach by considering both the merits and side effects of its ultra-easy monetary policy. As it stands, liquidity deteriorated on the JGB market and the weaker yen continues to drive up imported inflation. The BOJ spent more than ¥16Trn (US$118Bn), its largest monthly purchase in June since Governor Haruhiko Kuroda took the helm of the BOJ in 2013, as it sought to suppress yields. The JGB market faces continued pressure with a gauge of liquidity pointing to worst levels since 2013. A rise in the index implies a decline in liquidity. Inflation becoming a concern A gauge of Japan’s inflation expectations has climbed to a seven-year high, as a weak yen compounds the effect of elevated commodity prices. In Tokyo, the core CPI (excluding only fresh food) increased 2.1% YoY in June, picking up from a 1.9% YoY rise in May. The boost from energy prices barely changed owing to government subsidies for oil wholesale companies. The June BOJ tankan (short term economic outlook), showed business confidence Diffusion Index (DI) among large manufacturers decline in June for a second quarter in a row owing to parts shortages, surging raw material costs and lockdowns in China. With raw material prices surging and the yen depreciating, the output price DI continued to show pass-through of higher costs to sales prices, and corporate inflation expectations increased further. BOJs containment of yields becoming a costly affair By implicitly capping 10-year Japanese government bond yields at 0.25%, the Bank of Japan (BOJ) is struggling against the tide of rising global interest rates. In doing so, the BOJ now owns almost half of all Japanese government bonds (JGB). This could spell trouble for the Japanese government as it relies on the BOJ indirectly underwriting its spending with large debt purchases. According to Mitsubishi UFJ, the BOJ may have been saddled with as much as ¥600Bn (US$4.4Bn) in unrealised losses on its JGB holdings earlier this month, owing to the widening gap between domestic and overseas monetary policy. They estimate if 10-year yields reach 0.65%, paper losses on JGBs could exceed the BOJs capital base, which totalled ¥10.9trn at the end of March. As the BOJ’s own calculations use book value as opposed to market value, it reflects no change in its finances. Yen remains a favourite habitat of FX reserves in Q1 According to the IMF, global FX reserves managers sold euros, US dollars, and pounds in Q1 2022 and bought more yen than any other currency making it a favourite habitat of FX reserves. FX reserves probably had to shore up a decreased share of yen assets owing to the yen’s decline. Persistent demand from reserve managers alongside Japan’s status as the world’s largest net creditor may also help provide a floor for further downside. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
by aneekaguptaWTE
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When holidaymakers become interested in travel and leisureMy hairdresser recently told me how her strategy of buying Apple shares before the end of the year had been serving her well. ‘Everybody wants an iPhone for Christmas, it’s simple”, she exclaimed. It may be that investing is much easier when everything is going up – at least if you are taking long positions. Or maybe one only needs to combine observation with common sense to see how people are spending their money. That’s where the investing opportunity may be. Pretty simple? Given the widespread chaos at airports these days, might the opportunity be in the travel and leisure sector? People are certainly travelling again After two years of lockdowns and staycations, it seems like people are now keen to get on a plane and fly away somewhere. Passenger numbers at airports have bounced back, as expected, but remain below pre-pandemic levels Where are all these passengers off to? In May, around 44% of the total traffic for London Heathrow was made up of passengers to or from Europe1. This is in line with the historic average which means that the destinations haven’t changed, broadly speaking. But as the absolute numbers continue to rise and eventually return to trend levels, European travel numbers will rise further. When people travel, they also stay at hotels So, it appears that people aren’t just taking flights, they are booking hotel rooms as well. Monthly hotel occupancy in Spain based on tourists from abroad has also risen sharply (see figure 02 below). Naturally, with higher bookings come higher revenues, and eventually profits for the hospitality sector. According to forecasts by Statista, Europe’s travel and tourism revenues are expected to return to pre-pandemic levels somewhere between 2023 and 2024, i.e., it is a sector still very much in recovery. Key considerations for investors Europe’s travel and leisure sector comprises of three major categories of businesses. These are 1. Airlines, 2. Hotels, resorts, cruises, and restaurants, and 3. Online gaming and betting companies. Arguably, the sector’s performance has not been stellar this year given the risk-off sentiment in equities more widely. Among the 20 industry groups within the Stoxx Europe 600 Index, energy is the only one with positive performance year-to-date2. The travel and leisure sector is down this year but currently ranks somewhere in the middle in terms of year-to-date performance among the 20 categories. This implies that macroeconomics is currently driving markets and the sector-specific improvement in outlook for travel and leisure is perhaps underappreciated. If the macro clouds dissipate, we may see lift-off in the sector in line with its supportive fundamentals. Nevertheless, there is also a flipside, as there always is. If recessionary risks rise in Europe, travel and leisure numbers may drop again before even returning to trend levels. Travelling is indeed a ‘discretionary’ expense that can be curtailed when money becomes tight for both individuals and businesses. Ultimately, predicting market movements is difficult but it may be easier to track consumer behaviour through airport passenger volumes and hotel occupancy rates. Will prices follow the fundamentals? You can never be sure, although my hairdresser is convinced that they do. Sources 1 Source: Heathrow.com as of 23 June 2022. 2 Source: Bloomberg, as of 23 June 2022. This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE
Digital Assets: don’t confuse rhinos for unicornsIt is important to categorise correctly. Marco Polo, when in Sumatra, thought that he had seen unicorns. “Very nearly as big” as the “wild elephants”, he wrote in ‘The Travels’. Sig. Polo in fact saw rhinoceroses. All month long obituaries for Decentralized Finance (DeFi) have been written1 as exposure to the liquidation of Three Arrows Capital, a hedge fund, has become evident amongst many companies in the relatively new ‘crypto lending’ space (e.g. BlockFi, Celsius, Voyager Digital, etc). Not all horned animals are unicorns however – and not all companies operating on the crypto rails are ‘DeFi’. Introducing the WisdomTree Digital Assets Taxonomy To understand what is happening it is helpful to refer to a reading grid. WisdomTree has developed its WisdomTree Digital Assets Taxonomy for precisely this purpose. Outlined in detail in the recently released WisdomTree Insights - A New Asset Class: Investing in the Digital Asset Ecosystem the taxonomy: - Classifies digital assets into distinct and easily understandable categories - Assists in understanding the investment opportunity of each digital asset through the prism of the category that they belong to (that is the ‘use-case’) - Allows one to build an investment case for each individual asset with its opportunities, risks and relevant metrics to monitor DeFi’ is one of eight segments in the taxonomy. It is joined by other segments such as: smart contract platforms, non-fungible tokens (NFTs), and the somewhat nebulous ‘miscellaneous’. Turning back to DeFi, one can use the following definition: “Decentralized Finance offers financial instruments without relying on financial intermediaries as brokerages, exchanges, or banks by using smart contracts on a blockchain.”2 The most important part of this definition is the reference to: ‘using smart contracts on a blockchain’. Doing so creates a number of implications. First, one can audit the holdings at any point in time owing to the transparent nature of distributed ledgers (blockchains) and open source smart contract code. Second, the rules of the contract are very clear. Those who use these DeFi apps do so in possession of their public/private key pair, which means that they self-custody their assets and decide when and how those assets can and are used. This is very different to the entities, like Three Arrows Capital (3AC), that have caused so much commotion over the past month. DeFi is very different to Centralized Finance (CeFi), which is sometimes termed Traditional Finance (TradFi). The difficulty, at present, is that these two concepts are blurring as traditional financial companies integrate distributed ledger technology into their operations. So what is ‘DeFi’ and what is not? The collapse of Terraform Lab’s UST/LUNA was entirely linked to the digital assets space – though it could arguably be categrorised as ‘DeFi’ or not. Formally categorised as a ‘layer 1 smart contract platform’, according to the WisdomTree Digital Asset Taxonomy, prior to its collapse, the LUNA network was used to issue the UST ‘stablecoin’. In this way it crossed taxonomy segments – LUNA constituting a layer 1 network cryptocurrency and UST, a stablecoin. LUNA went from around US$41 billion in market capitalisation at the beginning of April 2022 then plummeted US$300 million by mid-May3. At its high the amount ofoutstanding UST was over US$18 billion. By 1 July 2022 one UST was trading at 4c on the dollar4. The collapse of UST/LUNA left a number of entities exposed in the relatively new crypto lending industry. It was thought that 3AC had over US$200 million in exposure to LUNA though it is hard to know this definitively5. Entities like Three Arrows Capital do not appear in the taxonomy. That is because they do not issue their own token, nor do they run ‘blockchain’ infrastructure. Three Arrows Capital is (was) a hedge fund that took leveraged, long positions on a highly volatile asset class – and lost. The outcome is unsurprising. A more interesting case study is crypto lender Celsius, which suspended withdrawals in the wake of the 3AC debacle citing, “extreme market conditions”6. The interesting thing about Celsius was that it issued its own CEL token. Lenders could opt to be paid back their interest in the CEL token, which has lost 88.5% of its value since its all time high7. As a consequence, the CEL token was categorised in the WisdomTree Digital Asset Taxonomy as a ‘DeFi’ token used for ‘Lending’. Celsius is (was) an incorporated entity in the United Kingdom8. It straddles the line between a centralised lending company coupled with its own crypto token. Contrast this with crypto lender BlockFi, which began to cut headcount9 before revealing it was one of a number of companies involved in the liquidation of positions belonging 3AC10. BlockFi does not have its own token, nor does it really have much to do with digital asset networks except that it lent out clients’ digital assets to other intermediaries. Another similar example is crypto broker Voyager Digital, which revealed that 3AC was unable to meet payments on a loan of 15,250 BTC, worth about US$305m, and US$350m of USD Coin (USDC).11 Voyager filed for chapter 11 bankruptcy on 6 July12. Market maker and lender, Genesis, may have hundreds of millions of dollars of exposure to 3AC.13 Neither entity has its own token – yet notice that Voyager was dealing in so-called ‘stablecoins’ (i.e. Circle’s US-regulated USDC). Even in the ‘stablecoin’ segment of the WisdomTree Digital Asset Taxonomy there is a lot of nuance.14 DeFi is dead, long live DeFi The turbulent events of June and July have had an upside. The events have demonstrated the strengths of many decentralised finance (DeFi) applications (e.g. Compound, Aave, Maker), which are still running smoothly. Positions have been liquidated, when necessary, using automated computer scripts (‘smart contracts’) to conduct what can be a messy business. These applications have had 24/7 uptime, performed as designed and are globally accessible to anyone with a cell phone and internet connection. These applications provide transparency and auditability that are so often not present in the traditional financial system. It is only by categorising cryptocurrencies, networks and tokens correctly that one can see where the real problems – and opportunities – lie. This is what the WisdomTree Digital Assets Taxonomy does. To brand all the insolvencies of the crypto lending industry as ‘DeFi’ would be akin to mistaking all horned animals for rhinos. Sources 1 www.wsj.com ; podcasts.apple.com 2 en.wikipedia.org 3 www.coingecko.com 4 www.coingecko.com 5 www.wsj.com 6 blog.celsius.network 7 www.coingecko.com 8 celsius.network 9 www.reuters.com 10 www.ft.com 11 www.prnewswire.com 12 cointelegraph.com 13 www.coindesk.com 14 www.wisdomtree.eu This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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by aneekaguptaWTE