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Strategic Insights

Volume 13, Edition 2 | January 22 - January 26, 2024

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Cautionary Tales from the Cryptocurrency ETFs

Doug_Walters Doug Walters | Articles

Read Time: 2:00 min

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Cryptocurrencies have entered the world of exchange traded funds, but investors should approach these “investments” with caution.

Contributed by Doug Walters , David Lemire , Max Berkovich , Eh Ka Paw

After many fits and starts, cryptocurrency exchange-traded funds (ETFs) launched in the US to much fanfare. Finally, an easy way to own bitcoin in your investment portfolio. Fund issuers rushed to be first to market and tripped over each other, trying to be the low-cost provider. But should investors be tripping over themselves to purchase these new products?

Let’s take a step back. What is this all about? Fund providers have been lobbying for approval to offer cryptocurrencies like Bitcoin in an ETF wrapper for years. No longer would crypto purchasers have to worry about setting up wallets and remembering passcodes – instead, they could own them through a fund in their investment account. It is not that dissimilar to Gold ETFs. However, regulators viewed cryptocurrencies as different from gold. Not the least because it is a largely unregulated market rife with criminal activity. Somehow, these hurdles were cleared with regulators (we will not comment on how since none of these concerns were remedied).

So ETFs are a safer way to own cryptocurrency, right? Not so fast. There are many reasons why these are as bad or worse than direct ownership. Just look at the 40 pages of risks listed in the prospectus of one of these funds, and you will see why. Here is a stark admission we found in one of them:

“As the Sponsor and its management have limited history of operating investment vehicles like the Trust, their experience may be inadequate or unsuitable to manage the Trust.”

That says it all. These ETFs are unproven products built on cryptocurrencies, which are highly volatile and legally complex. Not mentioned in the prospectus is that these funds still rely on exchanges like Coinbase to operate. As we saw with FTX, the fortunes of these crypto exchanges can change overnight. Should Coinbase go under, it is not clear if the crypto assets owned through the ETF would be protected or subject to loss in bankruptcy.

We wrote about cryptocurrencies last year in this white paper. We made it clear then that they are not investments. Packaging them in an ETF form does not change that thesis. If you really want to own cryptocurrency, you are probably better off sticking with the direct purchase method. If you want to actively trade cryptocurrency, maybe there is a role for the ETFs, but we would not recommend either.

So far, those that have steered clear are feeling pretty good, with some major Bitcoin ETFs falling as much as 20% in the first few weeks. Will that trend continue? I have no idea. They may double from here or halve. Either way, we do not think the time is right for investors to start considering these vehicles as investments.

Headline of the Week

“2”

That’s the first number on the Fed’s preferred inflation measure, the Personal-Consumption Expenditures, and it’s the first time it has been there in years. Technically, the core measure, which excludes food and energy, clocked in at 2.9% annualized for 2023. While the Fed’s target is 2%, and this last stretch towards that number could still prove challenging, the symbolism of seeing something in the “2” range is important. Economists and analysts have also been focusing on the annualized rates for the three- and six-month periods, which came in at 1.5% and 1.9%, respectively. Again, things seem to be moving in the right direction. How this changes the timing and number of rate cuts this year remains to be seen. Markets have dialed back expectations for the first cut coming in March, so we shall see if this report shifts any perceptions.

The Week Ahead

While gross domestic product (GDP) for the European Union, rate decisions from the Federal Reserve and Bank of England, along with a jobs report, would on their own be enough to direct market action, when the dust settles on Friday, earnings will likely be this week’s driver.

Not this time

Both the Federal Reserve (Fed) and Bank of England (BOE) will meet for the first time in 2024.

  • Neither central bank is expected to make any changes at this meeting. However, every syllable, word, letter, and character will be under the microscope for clues as to when the rate cuts will finally arrive.
  • Without new dot plots and a few days before a jobs report, some of the usual sizzle of the Fed confab is missing.
  • The United Kingdom’s central bank has been a little more rigid in its commitment to keeping rates higher for longer than peers, but a dovish turn is still a possibility.

The “R” word

The Eurozone, when it reports its preliminary GDP, is widely expected to have another negative quarter, making it two in a row.

  • Two in a row is technically a recession, which would be scarier if it wasn’t widely expected.
  • What is painfully clear is that the fight against inflation is slowing the economy.
  • Despite the European Central Bank’s insistence on not cutting rates until much later in the year, the dreaded “R” word may force their hand a little earlier.

Payrolling

The First Friday of February brings the highly anticipated US nonfarm payroll report.

  • After 216,000 new jobs were surprisingly created in December, the January number is expected to be much lighter at 162,000.
  • There will most likely be revisions to previous numbers, which can distort things.
  • Unemployment is expected to stay put at 3.7%, and hourly earnings are expected to tick higher.

High Five

Earnings from Qualcomm (QCOM), Pfizer (PFE), Merck (MRK), Boeing (BA), Exxon (XOM), and Chevron (CVX) would be a big week on its own, but five of the “magnificent seven” are also out this week.

  • Investors will feast on big tech this week with Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOG, GOOGL), Meta (META), and Apple (AAPL) all out mid-week.
  • With the S&P 500 hitting new record highs, these five will undoubtedly have an oversized impact on that momentum.
  • It is early in the reporting season, but so far, the S&P 500 is on track to having grown earnings by 4.5% from the same quarter last year.
  • Earnings for the full year 2024 are expected to expand by 10% based on current estimates.

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