THE DAILY EDGE: 16 MARCH 2021

U.S. Retail Sales Fell 3% in February Shoppers pulled back on retail spending in February, but sales are poised to accelerate as the pandemic eases and more government stimulus is distributed.

The decline followed robust January sales that were propelled by stimulus payments to households and other impact from the December pandemic-relief package. January sales advanced a revised 7.6%, up from the earlier estimate of a 5.3% increase. (…)

Retail sales were up 6% over the last three months compared with the same period a year ago, according to the Commerce Department. (…)

Control sales were up 10.3% YoY in February, the last 2020 non-pandemic month. Nothing close to weak.

The Pandemic Ignited a Housing Boom—but It’s Different From the Last One Residential home sales are hitting peaks last seen in 2006, just before the bubble burst, but this time mortgages are stricter, down payments are higher, and a tight supply is supporting prices.

(…) Millennials, the largest living adult generation, continue to age into their prime homebuying years and plunk down savings for homes. At the same time, the market is critically undersupplied. New-home construction hasn’t kept up with household demand, and homeowners are holding on to their houses longer. Buyers are competing fiercely for a limited number of homes.

Mortgage lenders, meanwhile, are maintaining tight standards—buyers are drawn to the market by historically low interest rates, not by easy access to credit. Rising home values also mean that even if homeowners can’t afford their mortgage payments, they can likely sell their homes for a profit rather than face foreclosure. Financial firms are still packaging mortgages as securities, but the vast majority of those mortgages today have government backing. (…)

Those trying to break into the market for the first time have rarely found it more difficult. U.S. house prices soared 10.8% in the fourth quarter from a year earlier on a seasonally adjusted basis, the biggest annual increase in data going back to 1992, according to the Federal Housing Finance Agency. The median home purchase price climbed above $300,000 last year for the first time. Nearly one in four home buyers between April and June bought houses priced at $500,000 or more.

Less-expensive homes became harder to find. Sales of homes priced at $250,000 and below declined in 2020 from a year earlier, according to NAR.

First-time home buyers are struggling to afford down payments. For many renters who lost jobs in 2020, homeownership is even further out of reach. (…)

The homeownership rate stood at 65.8% in the fourth quarter of 2020, up from 63.7% in the fourth quarter of 2016, according to the U.S. Census Bureau.

The housing market’s biggest near-term concern is rising mortgage interest rates, which recently hit their highest level since July and cooled the market slightly. (…) In the fourth quarter, the typical monthly mortgage payment ticked upward to $1,040, from $1,020 a year earlier, NAR said, even though mortgage rates declined nearly a full percentage point. (…)

Unlike in the building boom of the mid-2000s, a deficit of homes for sale is playing a big role in the current spike in prices. New-home construction hasn’t kept up with demand in recent years, as builders took years to recover from the financial crisis and faced shortages of land and skilled labor. Those shortages and rising material costs continue to hinder builders as they increase production.

While housing starts rose in 2020, new-home construction per U.S. household in December was still more than 20% below its average level in the late 1990s, according to Jordan Rappaport, a senior economist at the Federal Reserve Bank of Kansas City.

Homebuying demand is so high that many builders are limiting the number of homes they sell at a time, to ensure they don’t sell more than they can build. They are also raising prices. The median new-home sales price was $346,400 in January, up 5.3% from a year earlier.

“It’s the hottest market I’ve ever seen,” said Sean Chandler, president of the central Texas division at home builder Chesmar Homes. “The buyers that come in are like, ‘I just want a home. I don’t care at this point what it costs.’ ” (…)

Redfin: Key housing market takeaways for 400+ U.S. metro areas during the 4-week period ending March 7:

(Note from D.O.: numbers in parentheses are for the week ended Feb.28).

• The median home-sale price increased 17% (16%) year over year to $328,350, an all-time high. This is the largest increase on record in this data set, which goes back through 2016.
  

• Asking prices of newly listed homes hit a new all-time high of $349,975, up 10% from the same time a year ago.
  

• Pending home sales were up 19% (18%) year over year and up 3% from the four-week period ending February 7. In the two weeks since pending sales dipped during the winter storms over the 7-day period ending February 21, the weekly number of pending sales is up 17%.
  

• New listings of homes for sale were down 17% (17%) from a year earlier.
  

• Active listings (the number of homes listed for sale at any point during the period) fell 41% (40%) from 2020 to a new all-time low. This is the largest decrease on record in this data, which goes back through 2016.
  

• 56% (55%) of homes that went under contract had an accepted offer within the first two weeks on the market, well above the 45% rate during the same period a year ago. This is another new all-time high for this measure since at least 2012 (as far back as Redfin’s data for this measure goes). During the 7-day period ending March 7, 59% (57%) of homes sold in two weeks or less.
  

• 44% (43%) of homes that went under contract had an accepted offer within one week of hitting the market, up from 32% during the same period a year earlier. This is also an all-time high for this measure. During the 7-day period ending March 7, 48% (44%) sold in one week or less.
  

• The average sale-to-list price ratio, which measures how close homes are selling to their asking prices, increased to 99.8% (99.6%) —1.7 percentage points higher than a year earlier and an all-time high. During the 7-day period ending March 7, the ratio shot up to 100.1% (99.9%), the first time on record since this data series began in 2016 that the average home has sold for above its list price nationwide.
  

• For the 7-day period ending March 7, the seasonally adjusted Redfin Homebuyer Demand Index—a measure of requests for home tours and other services from Redfin agents—was up 55% (49%) from the same period a year ago.
  

• Mortgage purchase applications increased 7% week over week (seasonally adjusted) and were up 2% from a year earlier (unadjusted) during the week ending March 5. For the week ending March 11, 30-year mortgage rates increased to 3.05%, the highest level since July.

Air Travel Is Showing Signs of Renewed Demand While federal health officials still advise against travel, passenger volumes are picking up as U.S. airline executives voice optimism about a rebound.

(…) Airports screened nearly 1.36 million people Friday and more than 1.34 million people on Sunday, two of the busiest days since March 2020. (…) Some states, including New York and Connecticut, are relaxing rules requiring that inbound travelers quarantine. (…)

Southwest Airlines Co. LUV 1.75% and JetBlue Airways Corp. also said Monday that more people are making plans to travel, booking vacations or trips to visit friends and family, helping to pare expected revenue declines this quarter. (…)

JetBlue sold more bundled flight-and-hotel vacation packages last week than ever before, Chief Executive Robin Hayes said at the conference hosted by JPMorgan Chase & Co.

Bookings to destinations such as Florida and Hawaii, while still down from 2019 levels, are holding up better than other areas, according to data from ForwardKeys, a travel-analytics company. Domestic bookings were 42% of 2019 levels in the first week of January but were at 64% of 2019 levels in the first week of March, according to its data. (…)

United CEO Scott Kirby said at the conference Monday that the company expects its cash flow to turn positive, excluding debt payments, this month. Mr. Bastian also said Delta expects to stop burning cash as soon as this month. (…)

“For the first time since this crisis hit a little over a year ago, we at American are not looking to go raise any money.”

From Axios:

“Well over half, 60% of Americans, say they will be traveling for leisure in the next three months, according to a survey done less than a week ago,” Micki Dudas, director of AAA Leisure Travel, told reporters.

• AAA also found that 84% of those surveyed have at least tentative plans to travel in 2021.  
• “The travel industry continues to see a parallel between the vaccine roll out and increased optimism among the traveling public, and a greater comfort level from travelers seeking to book for the summer or fall of this year,” Dudas added.

Yes, but: The number of passengers on Friday was still 20% lower than on the same day last year, and down nearly 38% from 2019, TSA data show.

• The 7-day average of travelers is only about half of what it was at this point in 2019.

Data: TSA; Chart: Axios Visuals

• Stumbling Hotel Industry Starts to Regain Footing After Its Worst Year

Swine Fever Resurgence Damps Hopes for U.S. Soybean Farmers A new outbreak of African swine fever is putting new strain on China’s efforts to rebuild its pig herds—a threat to U.S. farmers’ hopes to sell more soybeans there this year.

SENTIMENT WATCH

Risk-on behavior is nearing record levels

(…) By the end of last week, nearly 100% of the indicators were in risk-on mode. That’s so high that it has preceded weak returns. We should generally expect prices to rise when behavior is showing a risk-on mode. But when it gets above 80%, the S&P’s annualized return was -0.1% and above 90% it was -1.7%. (…) The Backtest Engine shows us that when the 50-day average has been this high, future returns were poor. Out of 162 days that met the criteria, only 50 of them showed a positive return 3 months later. (…)

Higher-beta indexes like the Nasdaq Composite fared even worse. Using that index in the Backtest Engine, the median 3-month return was -3.9% with only a 24% probability of seeing a positive return.

If we only look at the first signal in 3 months, then all of them saw any further short-term gains peter out or turn to an outright negative in the months ahead. (…)

We’re still not seeing some of the divergent internal breadth deterioration that often triggers after true extremes in sentiment. For the most part, other than some odd days here and there, the indexes are still showing internal strength. It would be unusual, though not unprecedented, to see a sharp and prolonged downturn given those conditions.

The biggest problem is simply that things have been so good for so long, and investors have grown so comfortable, that forward returns have consistently been weak and extremely unlikely to be sustained.

Ray Dalio Says It’s Time to Buy Stuff Amid ‘Stupid’ Bond Economics

(…) “The economics of investing in bonds (and most financial assets) has become stupid,” he said Monday in a post on LinkedIn. “Rather than get paid less than inflation why not instead buy stuff — any stuff — that will equal inflation or better?”

Dalio thinks it may even be a good time to borrow cash to buy higher-returning non-debt investment assets in a new paradigm he said could be characterized by “shocking” tax increases and prohibitions against capital movements. With rising amounts of government debt and “classic bubble dynamics” among many different asset classes, Dalio recommends a “well-diversified” portfolio of non-debt and non-dollar assets.

“I also believe that assets in the mature developed reserve currency countries will underperform the Asian (including Chinese) emerging countries’ markets,” he wrote, adding that Chinese bond holdings by international investors are rising fast. (…)

CATHY’S ARK

Cathie Wood Persuades Investors to Stick With ARK’s ETFs The stock picker uses TV interviews and YouTube videos to put investors at ease amid a volatile period for her investment funds.

(…) Ms. Wood has leaned on television interviews and YouTube videos, which racked up more than 1.5 million views, to put investors at ease throughout the volatility. (…)

“It’s exciting to be alive. We’re as excited as ever about everything we’re doing,” Ms. Wood said in a video posted March 5.

(…) during the recent tumult, investors put more money into most of the funds than they took out, adding a net $1.6 billion to ARK’s coffers over the past month. That is nearly $300 million more than JPMorgan Chase & Co., the eighth-largest ETF issuer in the U.S. As of Friday, ARK managed a total of about $50.6 billion. (…)

“She still has conviction. It makes me feel better about it,” said Mr. Sanders (…).

“There’s nothing wishy-washy about her opinions,” said Mr. Carroll. “Those come through loud and clear and are part of her success.” (…)

Morningstar:

ARKK’s since-inception performance puts it in rarefied air. Only 64 of the 8,637 (0.74%) U.S.-domiciled stock mutual funds in Morningstar’s U.S funds database have ever gained as much or more over a similar time frame. The common thread among most of these highfliers is the fact that they rode booming markets to great gains. Of the 64 funds in this exclusive group, 26 (40%) trace their success to the inflating of the dot-com bubble, which took some of them with it when it burst. Included in that group of 26 is a fund that today goes by the name AB Sustainable Global Thematic ALTFX, which ARK founder Cathie Wood ran from 2009-2013. Many of these funds ultimately folded.

Of the 64 on this list, 14 (21%) have since been liquidated. Some merged into other offerings. And others have seen regular changes in management—most notably Fidelity Magellan FMAGX, which gained nearly 43% annually from March 1977 through June 1983 with Peter Lynch at the helm. In all cases, searing returns cooled off after a hot streak. A majority of these funds’ subsequent returns were negative over the ensuing three- and five-year periods. (…)

There is no denying ARK’s impressive trajectory. But is it sustainable? Historical precedents suggest it isn’t. And after a period of stellar returns and a flood of inflows, capacity concerns loom large.

In the context of funds, capacity is the amount of money an investment strategy can take in without compromising its performance. Every investment strategy has a finite amount of capacity, the amount of which depends on a variety of factors. These include the breadth and depth of the investment opportunity set, liquidity, valuations, and more. A market-cap-weighted total U.S. stock market index fund has immense capacity. The U.S. stock market is broad, deep, and generally liquid. (…)

Too often, asset managers dismiss as a “wouldn’t that be nice to have” problem. This is because accepting more money from investors has an immediate, positive impact on their bottom line. But failing to manage capacity prudently can be detrimental to their investors. Asset bloat can lead managers to stray from their mandates. New money they receive from investors may be added to existing positions in their portfolios that are no longer trading at attractive valuations or to new positions that represent managers’ next-best ideas. Too much money chasing too few good ideas at unattractive valuations is not a formula for successful investing. (…)

There are increasing signs that ARK’s funds are facing capacity challenges. This is evidenced by the changing contours of its flagship fund’s portfolio and the market impact of its trading activity.

The complexion of ARKK’s portfolio has changed. Over the five years from July 2015 through July 2020, the average market cap of companies within ARKK’s portfolio never topped $10.5 billion, consistent with the team’s goal of finding under-the-radar companies that the market doesn’t fully appreciate. Since then, the fund’s average market cap has spiked, topping $20 billion in November 2020 and reaching over $35 billion in January 2021.

Much of the increase in ARKK’s average market cap has owed to rapid price appreciation among many of the smaller companies in its portfolio. But as assets have swelled, ARK has also begun deploying cash in more-established large-cap companies, a shift that is further changing the makeup of the portfolio. From Oct. 31, 2020, through Jan. 31, 2021, the fund initiated new positions in 10 companies. All but three of these companies had market caps greater than $30 billion at the time of purchase, and three–Novartis NVS, PayPal PYPL, and Baidu BIDU–are mega-caps with market caps of more than $100 billion. It appears the fund’s heft is at least partly responsible for pushing it toward owning larger names.

As its picks have posted big gains and it has added bigger names at the margin, small caps’ representation in ARKK’s portfolio has fallen. At the end of October 2020, 33% of ARKK assets were in stocks with a market cap under $5 billion; by the end of February 2021, those stocks made up just 14% of the fund. None of those stocks rose as a percentage of fund assets over that time period.

Even as ARK has shifted to established, larger-cap companies, it still maintains a sizable ownership stake in many of its smaller holdings. Looking across the portfolios of its five actively managed ETFs, we find that ARK owns more than 10% of 26 companies, up from 24 in October 2020. This data ignores the firm’s two passive ETFs, as well as the funds they subadvise for Japanese asset manager Nikko, which would push its stakes even higher. (…)

These large stakes raise concerns around capacity and liquidity management. The more of a company the firm owns, the more difficult it will be to add to or reduce its position without pushing prices against fund shareholders. For example, ARK holds approximately 25.8 million shares of Cerus CERS–a biotech company with a $1 billion market capitalization. Cerus’ shares represent 0.48% of ARKK’s portfolio and 0.44% of Ark Genomic Revolution ARKG. In a liquidation scenario, assuming the firm accounted for 25% of the past month’s average trading volume of 1.9 million shares a day (a generous amount that assumes near-perfect trading conditions), it would take more than 52 trading days for it to completely exit the position.

These ownership stakes tie ARK’s hands. If it changes its thesis on a company and wants to scale down quickly, it won’t be able to do so without materially impacting stock prices. It also increases the exogenous risks it faces related to the behavior of its investors. If the firm faces outflows that outpace its ability to sell these stocks, these illiquid positions could rise as a percentage of the funds’ assets, especially as the team has typically reduced its stake in “cashlike” stocks and added to its favorite names during sell-offs. (…)

ARK is also beginning to have difficulty initiating positions in new names. Take Paccar PCAR, a manufacturer of heavy-duty trucks, which ARK first added to ARKK on Jan. 20, 2021. On Jan. 19, Paccar announced a partnership with autonomous vehicle platform Aurora. The announcement likely piqued ARK’s interest but went little noticed by the market. That day, Paccar’s stock closed at $89.21, up 1.19% from its $88.17 open. ARK purchased around 175,000 shares of Paccar on Jan. 20, about 16% of the stock’s average daily trading volume of 1.1 million shares over the previous 20 trading sessions.

ARKK’s new stake amounted to roughly 0.07% of its portfolio. ARK broadcast its new stake after markets closed on Jan. 20. The next day, Paccar’s share price jumped 7% at the open, on no news other than ARK’s disclosure from the night before. After its initial purchase, ARK added to the position on 10 of the next 11 trading days, building it up to about a 1% position in the fund. (…)

Since the beginning of 2021, ARK has made 20 first-time buys across its five actively managed ETFs. Among those 20 new names, 14 saw their stock prices rise more than 3.5% the day after ARK revealed its first purchase.

This has been a tailwind for the funds. It is a form of reflexivity. ARK buys a stock. The buying boosts the share price, which in turn boosts fund returns. A spike in the funds’ returns drives flows into the funds, which then spurs the fund to buy more shares and drive prices higher. However, this can just as easily work in reverse in a scenario where redemptions increase and/or returns disappoint. (…)

ARK is facing a novel challenge in managing capacity. Of the $53.2 billion that the firm manages in regulated funds, 96% is invested in its ETFs. The ETF wrapper has many investor-friendly features. ETFs tend to offer lower costs and greater tax efficiency than mutual funds. By virtue of being traded on stock exchanges, ETFs are also more widely available at lower investment minimums (typically as low as the price of a single share). But when it comes to plying an active strategy with significant capacity constraints in an ETF, the drawbacks may outweigh the benefits.

As it pertains to capacity, the most significant drawback of the ETF wrapper is that managers cannot say “no” to new money. An ETF’s manager cannot suspend the creation of new shares at its discretion. Thus, the simplest and most effective means of addressing capacity concerns is not at their disposal. Instead, the firm must either:
1. Allocate new money to existing positions that have experienced significant price appreciation.
2. Invest in its next-best ideas.
3. Some combination of number one and number two—which is what has happened to date.

Since the ETF can’t close to new investors, new assets will inevitably diminish the team’s ability to buy its best ideas at compelling valuations.

Another shortcoming of the ETF wrapper is that ARK’s U.S. ETFs must disclose their portfolios to the market each day. As the firm’s assets under management have mushroomed, so have the number of eyeballs watching its every move. In fact, there is a website (cathiesark.com) and an app (ARK Tracker) that monitor the firm’s trades daily. Investors can also sign up for intraday trade alerts on the company’s website (ark-funds.com/trade-notifications). While transparency is generally laudable, this degree of transparency has never been tested at ARK’s current scale. Based on the market’s response to many of its new positions in smaller names, it appears that this degree of visibility is impeding the team’s ability to build positions in new holdings without sometimes significantly impacting their prices. The daily transparency provided by the fully transparent active ETF format may be detrimental to shareholders.

Forfeiting the ability to turn down new investors and tipping its hand to the market each day are serious structural impediments to ARK’s ability to manage capacity in its ETF lineup. Similarly, because of the equitylike characteristics of ETFs, the firm can’t control where new investors are coming from or readily discern what their motives might be. (…)

But demand for ETF shares isn’t driven exclusively by traditional long-only, buy-and-hold investors, be they individuals, intermediaries, or institutions. As equity instruments, ETFs can also be sold short. Also, many ETFs have derivative contracts, such as call or put options, linked to them. Demand for shares of ARK’s ETFs can be driven by investors looking to bet against the ARK team or to hedge options dealers’ exposure. Indeed, in recent weeks, we’ve seen short interest in ARKK’s shares and open interest in options tied to the fund reach new highs. Demand from these atypical sources can put more capital on the ARK team’s plate.

While there are some precedents of the kind of performance that the ARK team has generated, its explosive growth and the fact that the majority of its assets are invested in fully transparent actively managed ETFs make it unique. While the ETF wrapper has many investor-friendly characteristics, in this instance, it might be investors’ enemy. (…)

Here’s what ARK funds traded yesterday:

BTW:

The S&P will be getting riskier, as the index’s owners announced on Friday they would add Penn National Gaming and Caesars Entertainment to the benchmark equity gauge along with NXP Semiconductors and Generac Holdings.

• Those companies will replace Xerox, Flowserve, SL Green Realty and Vontier, which will move to the S&P MidCap 400, with changes scheduled to happen before the start of trading on March 22.

Of note: Penn’s stock has risen nearly 800% over the past year, joining Tesla as another new S&P entrant that skeptical market watchers have cautioned is displaying the tenants of a highly speculative asset. (Axios)

Meanwhile in China:

• Xi Jinping Warns Against Tech Excess in Sign Crackdown Will Widen The months-long crackdown on China’s internet sector may only just be beginning.
• China Appears to Block One of Last Popular Encrypted Messaging Apps Signal became unusable without a virtual private network for many in the country, intensifying the government’s hold on public and private discourse.
• Beijing Asks Alibaba to Shed Its Media Assets China’s government has asked Alibaba Group to dispose of its media assets, as officials grow more concerned about the technology giant’s sway over public opinion in the country.
• Huawei records biggest jump in patent ownership in 2020 Chinese group at centre of row with US increases R&D as Beijing pushes for tech self-reliance