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1) All things Bitcoin ETF.

The SEC finally approved a Bitcoin ETF. The Winklevoss twins filed for the initial Bitcoin ETF in July of 2013 so it’s been 10 years coming. How much money did those guys lose out on by not having that instrument approved so long ago? Meanwhile, other garbage instruments like the closed end Bitcoin trusts were allowed to trade, charge huge fees and expose investors to insane premiums and discounts from NAV because of the inefficient structure of the trust.

We’re obviously big fans of ETFs here so this is a nice development to see. A spot Bitcoin ETF will trade very close to the actual spot price, reduce fees and give investors many of the protections that they wouldn’t otherwise have. In my view it’s even better than holding the real thing because you don’t have to worry about losing your keys. I know the Bitcoin Maximalists would disagree, but the ETF structure is actually an incredibly secure structure.

As for this changing the landscape much – eh, I don’t think this changes much. We already had a futures Bitcoin ETF so while this might bring marginally more efficiency to the structure I don’t think it’s moving the needle too much. And while an instrument like a spot ETF adds some credibility to the instrument I still don’t think it will be widely adopted by advisors because the problem with Bitcoin is that it’s hyper volatile and most advisors aren’t in the business of trying to expose their clients to hyper volatile instruments that you can’t really manage risk around. I spend half my time trying to explain to people how to think about instruments with a standard deviation of 5-20%. Bitcoin has a standard deviation of 50%+. It’s an insanely volatile instrument which, in my Defined Duration methodology looks a lot more like a super long duration and very volatile form of insurance than anything else. Advisors who are fiduciaries have to be able to justify that kind of volatility in a portfolio and when that’s negative volatility they have to own it. Further, you have the problem of trying to manage the portfolio skew that comes from an instrument like that. Is it worth the headache? For most advisors it’s just not worth it. If you want to buy instruments with super high returns and super high volatility then buy some venture capital or speculative instruments, but most advisors aren’t in the business of extreme insurance hedging and trying to hit home runs for people.

That said, I thought it was pretty strange that many brokerage platforms actually blocked Bitcoin ETFs from their platform. Vanguard made big news yesterday saying they wouldn’t allow the products to be traded at all. I love Vanguard and always hesitate to criticize anything they do, but this one strikes me as a little strange. A broker/dealer isn’t in the business of moralizing an investment philosophy. I 100% agree with the Vanguard press release which said they want to focus on stocks and bonds as the core instruments of a portfolio. I’ve said that a million times. Stocks and bonds are the core assets. Things like alternatives, options, and Bitcoin are more like insurance hedges. But how do you moralize the insurance products and which ones should be offered? After all, how would that even work? Or, where do you draw the line on a morality based investment philosophy? Do you allow cigarette and gun makers in your indexed products? Do you let clients trade them as individual instruments? Are those instruments aligned with your investment philosophy? Why or why not? It’s all very murky in my view as a legal instrument that’s viewed as one person’s vice is another person’s virtue.

It’s ironic because I think that a big part of why Bitcoin is even a thing is because people are getting increasingly tired of centralized entities telling everyone what they can and can’t do based on contradictory philosophical narratives that look more like virtue signaling than anything else. Corporate America and especially financial firms have become the poster child for this as they never hesitate to fund controversial firms, but then turn around and moralize it all with ESG products and the like. In my view one of the very worst things you can do to your portfolio is moralize it or politicize it.

Of course, Vanguard can do whatever it wants, but their clients are adults who can make informed decisions without relying on a centralized gatekeeper to police their every action. Their average user probably doesn’t care about this at all, but the word Vanguard means “leading the way in new developments” and while Bitcoin is definitely a new and controversial topic it doesn’t seem very Vanguardian to be 100% closed minded to new ideas like crypto.

2) Is inflation flaring up again?

Thursday’s CPI came in a little hotter than expected. And this got the usual suspects talking about how we are finally on the verge of a second flare up in inflation. I would ignore most of this chatter. As we’ve noted many times in the last few months the road from 3% inflation to 2% is going to be much more difficult than the road from 6% to 3%. It’s going to be bumpy mainly because the rate of change is compressing, but the big drivers are all still in play. The main ones being autos and shelter, which are clearly in real-time decline despite the BLS measurements which are making them appear more elevated than they really are. The shelter component continues to be the main driver there and it’s in a clear downward trend that will feed thru to CPI shelter all year. In fact, if you take out shelter we’re already at a 1.8% CPI. So it’s being driven largely by the elevated shelter component at this point. That’s going to pick up downward momentum in the coming quarters so it’s going to take a whopper of an inflation shock in commodities or something else to offset this.

I’d further add that the best real-time inflation metric is commodities and commodities as a whole are showing no signs of a big resurgence in inflation. So sit tight and don’t let the short-term scare mongering about inflation unduly influence you into thinking that the 1970s are around the corner.

3) Monetary Policy isn’t working?

One of the stranger narratives in recent years is the heterodox view that raising interest rates doesn’t suppress demand and actually increases it. The basic thinking there is that raising rates forces the Treasury to issue more debt in the form of interest and that this actually bleeds thru to consumer demand. MMT advocates have been especially vocal about this and while I am sympathetic to many heterodox views I think this is one where the MMT people go too far. My general view, which is consistent with decades of literature on this topic, is that rate hikes suppress demand by suppressing asset prices and credit markets. Higher rates make asset prices go down and make credit more expensive which results in less endogenous money creation by banks. So, even if there’s a boost in spending due to interest costs these other factors more than offset that in the short-term. For instance, if we look at credit growth we see a huge slowdown in new loan issuance. We also all know that the stock market has gone nowhere for two years, real estate is marginally negative (including commercial values) and the bond market has been whacked for a $10T global loss. So it’s not surprising to me that inflation has slowed at the same time all of this has been going on. Yes, the government has been paying a few more hundred billion per year in interest, but asset markets by trillions and credit growth has slowed from a rate of $500B per year to just $200B a year. It’s no shock that inflation has come down over the course of all that.

Now, some people will say that raising rates only works by suppressing employment. And they’ll say that the unemployment rate is too low to be consistent with a slowing labor market. Except this doesn’t explain the fact that the rate of employment growth has slowed very materially over the last few years at the same time that hourly earnings have slowed materially. So yes, we haven’t seen a spike in the unemployment rate, but we have seen material slowing in the labor market in the rate of employment growth and wages.

In the end, I think the Fed has done a much better job than expected. It’s too early to declare victory, but raising rates, slowing inflation, and avoiding a spike in unemployment actually shows that rate hikes have been more effective than expected. I would have placed a higher probability on a policy mistake than what we’ve seen and while it’s too early to say they didn’t raise too far too fast, I think the data so far shows that they’ve outperformed expectations.

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