Edition #79
Industrial Production Accelerates, ARK Innovation Ties S&P 500 (or does it?), Bitcoin vs. S&P 500
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Economy:
One of the aspects I’ve highlighted in this newsletter has been the lackluster expansion & activity in the industrial & manufacturing sectors. Industrial production has been steady, but doesn’t seem to be as healthy as we’d normally expect in an economic recovery & expansion. With that said, the industrial production data for July 2021 was released yesterday & showed some signs of encouragement.
Consensus estimates was for industrial production to increase by +0.3% relative to the prior month, but the result came in at a growth rate of +0.9%. This was a very strong result, especially considering that the June 2021 growth rate was +0.2%. Not only did the July data beat estimates, but it also reflected an acceleration in the growth rate relative to the prior month.
From a fundamental standpoint, this is exactly what we want to see over a sustained period. The question is now whether or not this growth, or similar levels, can be achieved on a consistent basis. If we look at the graph at the lower-bound of the chart above, we can see that the data is a bit of a mixed bag so far in 2021. With the index hitting 101.1 in July 2021, that represents a +6.5% increase relative to 94.88 reading in July 2020. A +6.5% growth rate isn’t much to write home about. Additionally, if we compare July 2021 vs. the pre-pandemic level in February 2020, the index has declined by -0.2%
At the very least, we’re making progress & trending in the right direction.
Stock Market:
While it has seemingly been a great year for the broader stock market, it’s been a surprisingly tough market for active managers & individual stock pickers. This actually shouldn’t come as much of a surprise considering that most markets are extremely difficult for active managers, in which the majority of active managers underperform the S&P 500 over a 3, 5 & 10-year basis.
To illustrate this point a bit deeper & to particularly focus on why the simplest approach to investing is often the most advantageous, here’s a chart comparing the 12-month returns of Ark’s Innovation fund vs. two broad-market ETF’s. Cathie Wood’s $ARKK is an active, tech-focused, high-growth oriented fund, with the top 5 positions being Tesla, Teladoc, Roku, Coinbase, and Unity Software. These 5 positions represent 31.1% of the allocation within the fund. Invesco’s $QQQ is often synonymous with the Nasdaq-100 & is concentrated on mega-cap tech stocks such as Apple, Microsoft, Amazon, Facebook, and Google. These stocks alone represent 40.5% of the allocation within the entire fund. Finally, the $SPY is a near-perfect match of the S&P 500. The top 5 holdings are identical to $QQQ, but the remaining holdings are much more diversified outside of technology, and these top 5 holdings represent only 21.8% of the fund.
As we might reasonably suspect, $ARKK has significant moments of outperformance while the broader-market ETF’s continue to chug along & provide more consistent returns with less volatility. It’s extremely cliche and I hate that I’m using this term, but the best metaphor to describe this chart is a comparison between the tortoise & the hare. As we can see with $ARKK, an investor who started a position in August 2020 would have achieved a +80% return in mid-February 2021, but had to watch those monster gains dissipate to a return of less than +20%. While the investor would have still had a positive return, their investment in $ARKK suffered more than a -33% drawdown.
Meanwhile, $SPY and $QQQ just continued to chug along. These funds weren’t immune from experiencing a minor drawdown at the same time of $ARKK’s -33% decline, but the drawdowns were extremely muted. During the same period when $ARKK fell more than -33%, $QQQ had a maximum decline of -12% and $SPY had a drawdown of -5.6%.
If we imagine that three individuals chose to invest solely in one of these funds in August 2020, they’d be at essentially the exact same place today at around a +35% return over the last 12 months. Considering that investing is a game of risk vs. return, the investor who chose to invest in $SPY and the other investor who chose $QQQ had much less stress & mental turmoil. These two investors had significantly less volatility than the $ARKK investor, who went through a literal roller-coaster ride over the last 12 months just to end up in the same place as each other. $ARKK can certainly play a key role in an investor’s portfolio, but this exercise simply points to the importance of measuring risk vs. return over the long run. For younger investors and/or those with a high tolerance for risk, $ARKK could make sense as a core holding within a diversified portfolio. For older investors closer to retirement, it’s likely best to avoid $ARKK and prevent headaches & investment turmoil.
Cryptocurrency:
We’ve seen great price action develop in the Bitcoin market over the last several weeks. Objectively, the price has increased by +53% since the lows on 7/19/2021 & now stands at a YTD performance of +54%. Another way we can measure Bitcoin’s price action is through its relative performance vs. the S&P 500, as shown in the chart below.
In the world of technical analysis & evaluating price structure, this is a classic “breakout, retest, and continuation” setup. In this setup, we can clearly identify a peak at the start of 2018 that was followed by a massive decline. After more than two years of consolidating at these lower levels, the ratio of BTC/S&P500 extends beyond that prior peak level from 2018. Then, once the ratio consolidates once again, we retest the prior peak and extend back to new highs.
Here’s a live example of this setup that I shared with premium subscribers in my watch list report on July 18th, 2021. The stock is Evoqua Water Technologies ($AQUA). At the time I published the watch list report (Edition #51), the chart looked like this:
We can see that the structure follows the outline I provided above: price reaches new highs (grey zone), experiences a deep consolidation, rises back & breaks above the prior ATH’s (grey zone), then comes back to retest the breakout level at the prior ATH’s. What does the stock look like today?
Since I shared this setup with premium SubStack subscribers on 7/18 (dotted white line), shares have gained more than +21%. Breakout, retest, and continuation setups are one of my favorite structures to trade because they provide clear risk/reward. I’ll be releasing my newest watch list this upcoming weekend for premium members, which will likely contain 15-20 stocks that I think are poised for similar extensions similar to the one above for $AQUA. In these reports, I provide a full analysis of what I’m seeing in terms of price structure & how I plan to get involved which each of the individual stocks. If you’re interested in receiving that update, be sure to click the button below to upgrade your subscription plan. I’m offering a 20% discount to anyone who signs up using this link, so get it while it’s hot.
In closing, the relationship between BTC/S&P500 is currently in the “continuation” phase of the breakout, retest, continuation setup. Based on this technical analysis setup, my expectation is that Bitcoin will outperform the S&P 500 over the short-term.
Until tomorrow,
Caleb