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Avoid This Money-Pit Investment

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We’re generally seeing good earnings, though inflation leaves its mark … when the S&P is likely to break out of its trading range … steer clear of the new bitcoin ETF

In yesterday’s Digest, we provided real-world examples of the soaring costs of commodities and consumer items.

As you’d expect, price inflation is leaving its fingerprint on the Q3 earnings reports as well as your wallet. Plus, supply chain bottlenecks are exacerbating this upward price pressure.

In this week’s Strategic Trader update, our technical experts, John Jagerson and Wade Hansen, offered two examples of how this is impacting corporate bottom-lines:

The CEO of Caribou Coffee (part of Panera Brands Co.) said on Tuesday that they are stocking up on cups, lids, straws (which are in especially short supply), and hot sauce packets. It is possible that the company may even pull back on expansion plans as construction costs are up 10%.

The Procter & Gamble Co. (PG) reported on Tuesday and despite stellar revenue growth, the company took a hit because gross margins are down on higher commodity and shipping costs.

So, despite the fact that PG reported topline growth that was double what analysts expected, the stock was down following the release.

In today’s Digest, let’s dig deeper into the Strategic Trader update. John and Wade tackle inflation and forecast where the market goes over the next couple weeks. Plus, there’s more earnings analysis. And they even detail why the new bitcoin ETF, BITO, is going to be a money pit (it has nothing to do with bitcoin itself).

Lots to cover, so let’s jump in.

***The push and pull of earnings and inflation

To date, Q3 earnings have largely come in strong. But inflation is definitely showing up in the numbers and the more we see its fingerprints, the more it makes traders nervous.

Here’s John and Wade’s take:

The current feedback loop has traders on edge, specifically with supply chain disruptions and inflation.

On the bright side, demand is high enough that prices are rising naturally. That can be frustrating for consumers, but it’s common in a growth environment.

However, because supplies are still constrained, inflation is rising faster than it would normally.

So, what do inflation and nervous traders mean for upcoming market direction? After all, earlier this morning, the S&P 500 set a fresh record high – will it prove to be a ceiling or a launch pad?

Back to John and Wade:

In our view, the mix of growth, inflation, and supply chain issues will likely keep the S&P 500 at or below its prior highs through the end of the month.

Our original assessment last month that the head and shoulders pattern would “fail” was justified, but a breakout much beyond the prior high before November seems unlikely.

Chart showing the S&P's trading range since the summer

Source: TradingView

John and Wade explain that this near-term, muted market action is due to traders wanting to see more retail earnings reports. How those numbers come in, and what C-level executives reveal about inflation and supply chain issues will provide far more color on broader economic health.

From the update:

Although the PG report is helpful, most retail companies won’t be reporting for a few weeks, and we think investors will wait for more data about the global supply chain before making any big changes to the outlook.

Our plan is to remain cautiously bullish but with a focus on large-cap value as a hedge against uncertainty.

***Using Netflix as a clue for how to play upcoming big tech earnings

John and Wade switch gears in their update, turning to Tuesday’s earnings announcement from content streaming giant, Netflix.

From their update:

The company surprised on top and bottom line: They added more subscribers than expected, however, the stock dropped at the open on Wednesday.

Although the corollary between NFLX and the rest of the tech sector isn’t perfect, NFLX’s fundamental performance bodes well for tech overall. But the bearish reaction to the report indicates that volatility is likely to continue.

John and Wade find the selloff confusing but point out that stocks frequently drop after earnings when they are at a high. This is usually because of profit-taking and the “sell the news” reflex that overwhelms buyers.

But John and Wade suggest we use this as a clue:

We should watch the reaction over the next few days to see if the stock pops back up on dip-buying, which will help us plan for the reaction to more tech reports later this month.

As I write Friday, Netflix has indeed popped. It’s up 5% since the start of Thursday’s trading session.

Clearly, there’s still strength in big tech.

***Meanwhile, if you’re looking for bitcoin exposure, think twice about investing in BITO

On Tuesday, the ProShares bitcoin-linked exchange-traded fund made its official debut with the ticker BITO.

As we noted in the Digest that day, we love what this ETF signifies in terms of mainstream crypto adoption, but we don’t recommend BITO as a way to play bitcoin.

Below, John and Wade explain why. Keep in mind, the problem they identify is a reality of many futures-based ETFs, so go into such investments with eyes open.

Regardless of how investors feel about Bitcoin, the new ETF is likely to be a money pit. This has nothing to do with Bitcoin itself; it has everything to do with the structure of the ETF.

Like many commodity ETFs, the ProShares Bitcoin Strategy ETF (BITO) buys Bitcoin futures contracts which are the assets of the fund. Those futures expire and have to be rolled over by the fund on a regular basis, which is the source of the issue.

You can buy shares of BITO, which gives you a small percentage ownership of the underlying portfolio of Bitcoin futures. However, very often, the new futures contracts that are purchased to replace the old are more expensive than those that are expiring, which is called “contango.”

In other words, under usual market conditions, this type of futures-based ETF turns into a slow-bleed of value.

John and Wade provide an example using the popular oil ETF, United States Oil Fund LP (USO). From 2016 through the start of the pandemic in 2020, USO underperformed the price of oil by a whopping 72%.

Now, a moment ago, I wrote that this contango dynamic is prevalent in usual market conditions. But occasionally, it works to the advantage of traders.

Back to John and Wade to explain:

It is sometimes possible for the new futures contracts to be less expensive than the old ones, which is called “backwardation.” That situation works in favor of investors in the ETF, but that tends to be the exception rather than the rule.

As of this writing, Bitcoin futures are in contango, which we would not expect to change in the short-term.

If investors are determined to invest in the crypto currency, we recommend avoiding the futures-based ETFs until they re-enter backwardation.

***This is when the market will likely break out of its trading range

Earlier, we noted that John and Wade believe it’s unlikely the market will break out of its trading range before November. The reason for this is the anticipated lack of needle-moving market data.

Yes, earnings next week will offer more insights into inflation, hiring, supply chain issues, and whatnot, but those data points are likely to be mixed – keeping the S&P bouncing around its current range.

Back to John and Wade on when this could change:

Investors will need to wait until the next Fed meeting (November 3) and labor report (November 5) before we expect to see any economic data that could move the market to break out of its trading range.

We’ll keep you up to speed on earnings, inflation, and the Fed here in the Digest.

Have a good evening,

Jeff Remsburg