Edition #81
Fed's Balance Sheet Climbs Higher, S&P 500 Under the Hood, Crypto Adoption Won't Stop
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Economy:
Yesterday, the Federal Reserve released their weekly update on their balance sheet. On a week over week basis, the Fed’s assets increased by $85.4Bn to reach all-time highs of $8,342,598,000,000. As we should expect based on the transparency the Fed has provided about their intentions, the Fed’s assets continue to rise at a consistent pace. Since 2006, the Fed’s balance sheet has grown at an unfathomable rate.
As we’ve covered extensively throughout this newsletter, the Fed has remained committed to purchasing at least $80Bn/month in Treasury securities and at least $40Bn/month in agency-MBS. In the course of the last week, the Fed’s Treasury holdings increased by $24Bn and agency-MBS rose by $74Bn. In total, there was a net increase of $93Bn of factors supplying reserve funds over the prior week. Clearly the Fed won’t sustain the rates of these increases on a monthly basis, so I’d be prepared to see a decline or stabilization in the Fed’s balance sheet for next week’s release.
As the Fed’s balance sheet continues to climb higher, economic data is developing in such a way that the market is becoming more anticipatory of the Fed’s tapering process. The most recent update for weekly unemployment claims was released yesterday morning, in which consensus estimates were expecting for 364k initial claims vs. the prior week of 375k. The result was 348k initial jobless claims, well below expectations, while the prior week’s data was revised slightly higher to 377k.
Overall, this is an encouraging sign in terms of the fundamental direction of the labor market. This was the lowest level of initial claims since the start of the pandemic, illustrating that the job market is recovering at a steady, albeit slow, rate. For context, here’s the data since the start of the pandemic:
As I’ve been continuing to say since the start of this newsletter, the most likely case is for a downward trend in unemployment claims, however we should be prepared for sudden & quick spikes in claims. In my opinion, it won’t be until the end of Q4 2021 that the claims will really begin to decelerate.
Stock Market:
I saw this excellent chart yesterday from Andrew Thrasher (@AndrewThrasher on Twitter), which highlights how the S&P 500 is at/near all-time highs, but the average stock within the S&P 500 is currently -9.4% below their respective 52 week highs.
While this may come as somewhat of a shocking dynamic, it also makes sense at the same time. First of all, it’s a tough pill to swallow that, on average, stocks within the S&P 500 are down -9.4% but the overall index is only down -2.1% from the recent highs. We must consider the fact that the S&P 500 is market-cap weighted, such that the heavy hitters (Apple, Microsoft, Amazon, Google, & Facebook) represent 21.8% of the fund. These five companies alone account for more than one-fifth of the S&P 500’s performance & direction. Let’s quickly evaluate where each of these companies stand based on this metric:
$AAPL: -3.3% below 52-week highs from three days ago.
$MSFT: Currently making new ATH’s as of market close on 8/19.
$AMZN: -15.5% below 52-week highs from one month ago.
$GOOGL: -1.9% below 52-week highs from four days ago.
$FB: -5.9% below 52-week highs from three weeks ago.
Aside from Amazon, each of these stocks are in great shape! Nothing to fret over in my opinion, but it’s always great to see some under-the-hood metrics that make you pause to question the logic.
Cryptocurrency:
Two updates about crypto adoption that came out during yesterday’s session. The first is that the first overall draft pick in the NBA, Cade Cunningham, has signed a sponsorship deal with crypto firm BlockFi. The details of the sponsorship have yet to be released, but it was announced that 100% of his signing bonus will be paid via Bitcoin. Cade’s involvement with Bitcoin, and crypto in general, is another highlight of how athletes are turning towards the digital currency space as an investment vehicle.
At first, I thought this was massive news & I was planning to have this be the sole update for the crypto section of this report. Then, around 7pm ET, Brian Armstrong (co-founder & CEO of Coinbase) dropped a bombshell of an announcement on Twitter.
This is a double-whammy: the company will be front-loading $500M in purchases of various cryptocurrencies to hold on their balance sheet, and will funnel 10% of their profits into crypto going forward. But what scale are we really talking about when we say 10%?
We can take a few different perspectives to determine a range of expectations. First, we can simply take their fiscal year 2020 figures as a baseline. The company is significantly larger than it is today, but let’s just use this as a thought experiment or somewhat of a lower-bound. In 2020, the company generated $1.277Bn in revenues and captured $322M in net income. At 10%, that would imply $32.2M in crypto purchases to hold on their balance sheet.
Second, we can use their Q1 2021 figures, and then multiply them by 4 to get an annualized estimate of their fiscal year 2021 results. In Q1’21, the company generated $1.597Bn in revenues (more than the entire fiscal year 2020) and retained $771M in net income (more than double the entire net income of 2020). On an annualized basis, if Coinbase maintained the same level of performance & had no growth, we can estimate that they will generate $3.084Bn in net income by multiplying their quarterly results by 4x. At 10%, that would imply $308M in crypto purchases to hold on their balance sheet.
Finally, we can use their results for the first half of 2021 by combining Q1 & Q2 data. In Q2, they had $2.033Bn in revenue and $1.606Bn in net income. Cumulatively, Q1 & Q2 generated $2.377Bn in net income (more than 7x the net income for 2021). If we multiply this by a factor of 2 to get an annualized estimate of their net income, we’d expect to see Coinbase generate $4.754Bn in net income for 2021. At 10%, that would imply $475M in crypto purchases to hold on their balance sheet.
Because of the phenomenal growth the company has been able to achieve, the estimates get larger & larger as we use more recent data. Nonetheless, if we expect the company’s growth to continue (which I do), the expectations for their crypto purchases will also rise assuming they maintain a level of 10% of net income for their crypto budget. Based on these estimates we produced above, we could assume a range of $32M - $475M. We can immediately toss out our lowest estimate of $32M for 2021, considering that the company’s current net income in the first half of the year is already $2.377Bn. Even if the company didn’t earn a single dollar in additional profit for Q3 or Q4 2021, that means we can expect Coinbase to purchase $237M in crypto for 2021.
From my perspectives on where crypto is going & the increased level of demand I’m expecting to see for the rest of the year, I think it’s reasonable to expect the company to achieve net income in excess of $5Bn for the year. If so, that would mean an additional $500M in crypto purchases on top of the existing $500M that was already approved by the board. My goodness.
Talk soon,
Caleb