What has been moving the price of bitcoin since 2019?

Summary

- In this post we conduct a structural equation modeling analysis, as a general case of a multiple regression analysis, to understand what has been moving the price of bitcoin since early 2019.

- To make our discussion more practical, it is based on financial instruments that can be easily traded with a typical brokerage account.

- Our results are consistent with the expectation that the price of bitcoin will continue going up as long as we are in a “nervous” bull market, where things seem to be improving but investors are still looking for ways to protect themselves against a possible economic collapse.

- That is, at least until the collapse happens, when bitcoin may simply go down like almost everything else.

The funds that we use in our analyses

In this post we conduct a structural equation modeling analysis, as a general case of a multiple regression analysis, to understand what has been moving the price of bitcoin since early 2019. To make our discussion more practical, it is based on financial instruments that can be easily traded with a typical brokerage account.

The financial instruments, for which daily prices from January 2019 to April 2020 were used, are: Grayscale Bitcoin Trust (GBTC), SPDR Gold Shares (GLD), iShares U.S. Regional Banks ETF (IAT), Invesco QQQ Trust (QQQ), iShares Silver Trust (SLV), SPDR S&P 500 ETF Trust (SPY), iShares 20+ Year Treasury Bond ETF (TLT), and Financial Select Sector SPDR Fund (XLF).

Bitcoin since 2019

The figure below shows the variation of the GBTC over time. Note the spike in price in late 2017. That was due to a number of factors, not the least of which being a general optimism about the use of bitcoin for payments. At that point some held the perception that bitcoin would make banks and other financial companies obsolete. That turned out to be an incorrect perception, and bitcoin's price dropped steadily until early 2019.

That situation changed around early 2019, when arguably the prevailing perception of bitcoin was that of a store of wealth. Something akin to digital gold, with the advantage of not having to be physically stored or transported. As such, individuals could also use bitcoin to easily move money around the world without paying any fees.

Digital gold, like gold, could presumably be used as a hedge against losses in equities. That is an appeal of bitcoin, which is shared by other instruments, notably silver and treasuries. Silver also has industrial applications. Treasures are essentially US government debt instruments with various maturities.

The results of our analyses

The model in the figure below was created with WarpPLS () as a basis for our analyses. This would be a simple multiple regression model if it were not for the aggregation of funds into three predictor “latent” variables.

The predictor latent variables can be seen as indices: FIN, for financials; HDG, for instruments that can be used for hedging; and MKT, for equities whose price is a general reflection of the stock market in the US.

WarpPLS creates the indices based on the component instruments by linearly matching weights with loadings. Weights are obtained by regressing the index on its components, and loadings by regressing the components on their index.

The figure below shows, among other things, the regressions of GBTC on the tree predictor indices. These are not the weights and loadings mentioned above; they are higher-level coefficients, or “structural” coefficients (in the technical jargon of this area of statistics). Also, they are standardized, which means that they can be directly compared against one another.

These results suggest that GBTC (standing in for the price of bitcoin) is significantly and positively associated with FIN, HDG and MKT. The statistical significance here is indicated by the P values lower than 0.01, meaning that the probability that those effects are not “real” is less than 1 percent.

So, if we assume that the hypothesized directions of causality are correct, then the price of bitcoin goes up when financials go up, and when the market goes up; but much more so when instruments that can be used for hedging (HDG) go up in value. The standardized regression coefficient for the latter association is a much higher 0.41 than those for the other predictors (both approximately 0.15).

There are intercorrelations among the variables, as we can see from the correlations table below. Even though some correlations are high, there is no multicollinearity in our model. We tested this via full-collinearity variance inflation factors.

Also, since the diagonal shows the square roots of the average variances extracted for each variable, one would normally see correlations higher than values on the diagonal if there was multicollinearity. Given that this is not the case, the table also suggests that the model has acceptable discriminant validity.

Conclusion

The fact that the price of bitcoin is positively associated with financials goes against the idea that there is a general perception among investors that bitcoin may make some of the functions performed by banks and financial organizations obsolete. Also, the price of bitcoin being positively associated with the broader market does not provide support for the idea of it being very effective when used as a hedge against market downturns.

Our results do seem consistent with the expectation that the price of bitcoin will continue going up as long as we are in a “nervous” bull market, where things seem to be improving but investors are still looking for ways to protect themselves against a possible economic collapse. That is, at least until the collapse happens, when bitcoin may simply go down like almost everything else.

Data from China suggests that economic activity could resume after initial containment and not trigger new COVID-19 cases

Summary

- A study was published in early 2020 by Ainslie and colleagues (), suggesting that, after initial containment is achieved, within-city movement (measured through a “Movement Index”) seems to be uncorrelated with new COVID-19 cases.

- Within-city movement is used in the study as a proxy for economic activity.

- Economic activity seems to have successfully resumed within approximately 2 weeks from containment, and approximately 4 weeks from the peak of new cases.

Within-city movement vs. new COVID-19 cases

The graphs below summarize key results from a study published in early 2020 by Ainslie and colleagues (). Dr. Ainslie is in the Faculty of Medicine, School of Public Health, Imperial College London. The study looked at within-city movement, as a proxy for economic activity, and how that movement has influenced the numbers of new cases of COVID-19 in various areas, after initial containment.

As you can see, after initial containment is achieved, within-city movement (measured through a “Movement Index”) seems to be uncorrelated with new COVID-19 cases; or somewhat negatively correlated, as the authors note. This rather surprising and counterintuitive outcome may be due to people becoming much more cautious about social interactions.

Time to resumption of economic activity

Note from the graphs that economic activity seems to resume within approximately 2 weeks from containment, and approximately 4 weeks from the peak of new cases.

Also note that containment has been fairly effective in China. The Chinese government has enforced it through strict lockdowns. Perhaps this is what makes people so cautious about social interactions afterwards, which we speculate might be at the source of the success of their strategy.

From an economic revival perspective, these are good news – particularly if the same approach can be replicated in other countries and regions.

A simulation-based valuation of DXC Technology (DXC): March 2020

Summary

- DXC Technology (DXC) is a technology consulting and services company headquartered in Tysons Corner, Virginia ().

- Launched in April of 2017, DXC was created from the merger of Computer Sciences Corporation (CSC) and the Enterprise Services division of Hewlett Packard Enterprise (HPE).

- In this post we provide a simulation-based (sim-based) valuation () of DXC.

- Our results suggest the following fair values – stock price: $64.12, and price-to-earnings ratio: 9.96.

- DXC currently trades at $15.14, so it appears to be undervalued, with a potential upside of 323.51%.

DXC Technology (DXC)

DXC Technology (DXC) is a technology consulting and services company headquartered in Tysons Corner, Virginia. Launched on April 3, 2017, DXC was created from the merger of Computer Sciences Corporation (CSC) and the Enterprise Services division of Hewlett Packard Enterprise (HPE).

The company operates in more than 70 countries, and counts among its customers several federal and regional government agencies. In many ways DXC is similar to Accenture (ACN). In fact, DXC has a new CEO, Mike Salvino, who previously served as group CEO for Accenture Operations.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of DXC.

At the time of this writing the company had a negative net profit margin of -8% and a price-to-sales ratio of 0.26. The company has great growth potential, as long as it transitions from legacy technology services to more modern offerings (e.g., cloud applications). This transition seems to be a major focus of the new CEO.

To be somewhat conservative, we will use recent numbers from Accenture to set our sim-based estimated earnings growth rate for the next 5 years (6.47%) and net profit margin (11.06%). We believe this to be a conservative approach because DXC is much smaller than Accenture; e.g., DXC’s revenues are about half of Accenture’s.

Another reason why we believe the above is a conservative approach is that it is quite possible that we currently are in a recession (yes, already), in which case earnings growth should be much higher than it is now in the near future. Sales are likely to go up, and so should earnings – the latter at a faster pace, leading to higher margins for many of DXC’s services (the same goes for Accenture).

The table below summarize our sim-based results.

Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $64.12, and price-to-earnings ratio: 9.96. DXC currently trades at $15.14, so it appears to be undervalued, with a potential upside of 323.51%. Yes, you read it right. The company seems to be more than simply cheap; it appears to be dramatically undervalued at the moment.

Note that we assumed a positive net profit margin of 11.06% for a company that actually has a net profit margin of -8%. This type of assumption is useful in valuing companies that have a negative profit margin, which is often the case with companies that have been experiencing problems; as well as high-growth companies that have been publicly-traded for only a few years.

Other pluses and minuses

DXC pays an attractive dividend of 5.11%, significantly higher than the average S&P 500 dividend. With DXC’s market capitalization of $5 billion, this translates to roughly $255 million per year given out in dividends. DXC has $2.56 billion in cash, so we think that the dividend currently is relatively safe, and will continue being so for several years to come.

While certainly leveraged, DXC has a reasonably attractive balance sheet, with EBITDA in the neighborhood of $3.26 billion. This, added to its cash position of $2.56 billion mentioned above, is actually lower than half of its $10.49 billion dollar debt. So, DXC is leveraged, but much less so than many other companies with much higher valuations.

Is DXC a value trap?

Why does DXC look so undervalued? The reason is a combination of what appears to have been a period of disorganized growth, bad management decisions, somewhat disappointing guidance, the resignation of the former CEO in late 2019; and now, to cap all of this, we have the coronavirus pandemic.

Given the new CEO’s caliber, it is reasonable to expect better stewardship of resources. The coronavirus pandemic is prompting major actions from the US government, including interest rate cuts that should make it easier for DXC to service its debt.

The US government is also promising “as much liquidity as needed”, to avoid layoffs. This means essentially unlimited credit to companies, so that unemployment remains low; this promised by the entity that can print unlimited amounts of it is own currency, the US dollar.

The mighty Office of the US President is fully committed. And we are in an election year. Note that it is not a recession that creates re-election problems for an incumbent US President. Those problems are actually caused by the significant rise in unemployment that usually accompanies a recession. And there can be a recession without unemployment, at least in theory, as long as the country is willing to get into debt up to its ears.

It does not seem like DXC is a value trap; at least not at the current levels. DXC is currently trading at prices not seen since 2012. It has reached a high in the mid-$90s quite recently, in late 2018. If anything, it looks like a big opportunity for investors, as long as the US government keeps its promises of liquidity to address coronavirus-induced sales losses.

Disclosure

The author owns DXC shares at the time of this writing.

A simulation-based valuation of Conn's, Inc. (CONN): February 2020

Summary

- CONN is an American furniture, mattress, electronics and appliance store chain headquartered in The Woodlands, Texas ().

- In this post we provide a simulation-based (sim-based) valuation () of CONN.

- At the time of this writing, the company had a rather low trailing twelve months price-to-earnings ratio of 3.62.

- According to our sim-based analysis, the fair price-to-earnings ratio should be 5.46, leading to a current fair value of $13.81.

- CONN currently trades at $9.16, so it appears to be undervalued, with a potential upside of 50.76%.

- The above conservatively assumes a negative earnings growth rate. Let us say that the company manages to simply have no growth (i.e., 0% growth) in earnings for the next 5 years, instead of negative growth. In this case, our sim-based analysis suggests that the fair price-to-earnings ratio should be 7.19, leading to a current fair value of $18.20. This would mean a potential upside of 98.69%.

Conn's, Inc. (CONN)

CONN is an American furniture, mattress, electronics and appliance store chain headquartered in The Woodlands, Texas (). The company caters to credit-challenged customers, and also operates in the lease-to-own space. It has been around for a long time. It was founded in 1890 as Eastham Plumbing and Heating Company, having been renamed as Conn's in 1934.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation of CONN. The foundation of this approach is explained in a previous post ().

At the time of this writing, the company had a rather low trailing twelve months price-to-earnings ratio of 3.62. The expected growth in earnings for the next 5 years is uncertain. Based on the most recent earnings report, when the company beat estimates, the expectation is that earnings will drop by approximately 5.55% in the near future. To be conservative, we will consider this value, of -5.55%, to be the sim-based earnings growth rate for the next 5 years.

Is the low price-to-earnings ratio of 3.62 suggestive of actual undervaluation? As you can see in the table below, the answer to this question seems to be “yes”. Since our sim-based analysis uses a S&P 500 return as a basis, the fair price-to-earnings ratio should be 5.46, leading to a current fair value of $13.81. CONN currently trades at $9.16, so it appears to be undervalued, with a potential upside of 50.76%.

Keep in mind that the above assumes a negative growth rate. Let us say that the company manages to simply have no growth (i.e., 0% growth) in earnings for the next 5 years, instead of negative growth. In this case, our sim-based analysis suggests that the fair price-to-earnings ratio should be 7.19, leading to a current fair value of $18.20. This would mean a potential upside of 98.69%.

Other pluses and minuses

The business in which CONN operates is less likely to be affected by what has been called the Amazon-driven “retail apocalypse”. Moreover, CONN can be seen as a somewhat defensive stock in the case of an economic downturn, since it primarily caters to credit-challenged customers. When the economy slows down, the number of credit-challenged individuals usually goes up.

Having said that, an economic downturn could lead to an increase in defaults, potentially hurting CONN’s ability to collect from its customers. One way to address this challenge would be to increase CONN’s participation in the lease-to-own space, but in a way that would allow it to operate more as a renter of its products. This seems to be a direction that CONN’s management is looking at carefully in recent quarters.

In the last two quarters, the company bought almost $100 million of its own stock, which makes sense given that the stock price has gone down so much. It has also been retiring debt at a very healthy pace, although it is still very leveraged. Last quarter, however, it issued about $8 million in debt, in part to buy its own shares – about $58 million worth of shares were purchased.

Short sellers may be interpreting the above share purchases as an attempt to prop up the stock price. The current short interest as a percentage of float is a frightening 65.96%. Still, it is hard to question the logic of buying your own shares when they are so cheap, especially given that interest rates are at their lowest point in years. If the company were to re-issue its shares at the more conservative fair value we estimated in this post, it could make a significant profit, which it could use to reduce its debt further.

There is no evidence that the company is anything but conservative in its future earnings growth  projections. It has beaten earnings expectations in at least the last 10 quarters, often by a large margin.

Disclosure

The author owns CONN shares at the time of this writing.

A simulation-based valuation of Aaron's, Inc. (AAN): January 2020

Summary

- AAN is a lease-to-own retailer headquartered in Atlanta, Georgia ().

- At the time of this writing the company had a trailing twelve months price-to-earnings ratio of 21.

- Our simulation-based valuation suggests a fair price-to-earnings ratio of 23.93, leading to a current fair value of $70.18.

- AAN currently trades at $61.58, so it appears to be undervalued, with a potential upside of 13.97%.

- If the growth in earnings is what analysts are currently expecting, namely around 30%, our potential upside may be significantly underestimated. In that case, the fair value of the stock would be $94.96.

Aaron's, Inc. (AAN)

AAN is a lease-to-own retailer headquartered in Atlanta, Georgia (). It focuses on leases and retail sales of furniture, electronics, appliances, and computers. Its acquisition of Progressive Finance in 2014 positioned AAN as the leader in the rent-to-own (RTO) industry, which helps credit-challenged customers gain access to goods they would have otherwise been unable to afford.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of AAN.

At the time of this writing the company had a trailing twelve months price-to-earnings ratio of 21. The expected growth in earnings for the next 5 years is a high 21.50%. Even though it is high, this growth number may be an underestimation given the current spread in estimates for trailing and forward price-to-earnings ratios: 21 and 14.3. To be more consistent with this spread, we will consider the value of 23.89% to be the sim-based earnings growth rate for the next 5 years.

Is the price-to-earnings ratio of 21 suggestive of undervaluation? As you can see in the table below, the answer to this question seems to be “yes”. Since our sim-based analysis uses a S&P 500 return as a basis, the fair price-to-earnings ratio should be 23.93, leading to a current fair value of $70.18. AAN currently trades at $61.58, so it appears to be undervalued, with a potential upside of 13.97%.

Is the fair price-to-earnings ratio of 23.93 too high?

Could the fair price-to-earnings ratio estimated above, of 23.93, be too high? Arguably the answer is “no”, because of the expected growth in AAN’s earnings (see: ). In fact, if the growth in earnings is what analysts are currently expecting, namely around 30%, our potential upside may be significantly underestimated. In that case, the fair value of the stock would be $94.96.

Other pluses and minuses

AAN is not leveraged. The sum of its cash (and equivalents) and its EBITDA (earnings before interest, taxes, depreciation, and amortization) is higher than the company’s debt. Its dividend is not very attractive at the moment, at 0.26%, but the current payout ratio is a low 4.81%. This means that the dividend could be easily raised. In the meantime, the company seems to be using its available cash for other purposes that have a positive impact on earnings, including share buybacks – justified base on AAN’s current relatively low valuation.

The business in which AAN operates is less likely to be affected by what has been called the Amazon-driven “retail apocalypse”. Moreover, AAN can be seen as a somewhat defensive stock in the case of an economic downturn, since it primarily caters to credit-challenged customers. When the economy slows down, the number of credit-challenged individuals usually goes up.

Disclosure

The author owns AAN shares at the time of this writing.

A simulation-based valuation of American Eagle Outfitters (AEO): December 2019

Summary

- AEO is a clothing and accessories retailer based in Pittsburgh, Pennsylvania ().

- At the time of this writing the company had a trailing twelve months price-to-earnings ratio of 9.95.

- A simulation-based (sim-based) valuation () suggests that the fair price-to-earnings ratio is 16.73, leading to a fair share value of $23.62.

- AEO currently trades at $14.05, so it appears to be undervalued, with a potential upside of 68.11%.

American Eagle Outfitters (AEO)

AEO is a clothing and accessories retailer based in Pittsburgh, Pennsylvania (). It focuses on casual apparel, accessories, and footwear for men and women aged 15–25 years. Notably, it sells intimates, apparel, and personal care products for women under the Aerie brand; this is a major growth engine for the company.

AEO does not own or operate any manufacturing facility. As such, it depends on third-party manufacturers for all of its merchandise. The company’s operations may be negatively affected by import disruptions. Trade-related unpredictability is not good for this company. On the other hand,  such unpredictability also regularly offers attractive entry points for investors.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of AEO.

At the time of this writing the company had a trailing twelve months price-to-earnings ratio of 9.95. The growth in earnings for the past 5 years has been on average 27.87%, but has recently (trailing twelve months) gone down to 5.56%. To be conservative, we will consider the mid-point between these two numbers, or 16.76%, to be the sim-based earnings growth rate for the next 5 years.

Is the price-to-earnings ratio of 9.95 suggestive of undervaluation? As you can see in the table below, the answer to this question seems to be “yes”. Since our sim-based analysis uses a S&P 500 return as a basis, the fair price-to-earnings ratio should be 16.73, leading to a current fair value of $23.62. AEO currently trades at $14.05, so it appears to be undervalued, with a potential upside of 68.11%.

Is the fair price-to-earnings ratio of 16.73 too high?

Could the fair price-to-earnings ratio estimated above, of 16.73, be too high? Arguably the answer is “no”, because AEO’s price-to-earnings ratio for the past 5 years has been on average 19.80. In fact, given this, our potential upside may be underestimated.

Other pluses and minuses

AEO pays an attractive dividend of 3.64%, significantly higher than the average S&P 500 dividend, and with a comfortable payout ratio of 36.47%. It has an attractive balance sheet, with $317 million in cash, and no debt – unlike other retailers being affected by what has been called the Amazon-driven “retail apocalypse”.

Also, AEO has been steadily buying back its shares, and it has not been issuing any new debt to finance this.

Recently the stock has lost about 7% of its value in one single day, after it provided “soft” Q4 guidance in an earnings report. The forward guidance was below what analysts expected, but consistent with the conservative approach to guidance usually adopted by AEO.

Still, even with the soft guidance, AEO reported earnings (bottom line) in line with analyst expectations, and revenues (top line) that beat expectations.

Disclosure

The author owns AEO shares at the time of this writing.

The initial jobless claims data may be very misleading: What really matters is the trend of the “second derivative”

Summary

- Initial jobless claims seems to be going down sequentially as of late.

- But the year-over-year rate of change is clearly going up, and fast.

- Recently the popular business media have been largely reporting the initial jobless claims measure as evidence that the job market is strengthening.

- The reality is that it is weakening, based on this measure, at an alarming rate.

Initial jobless claims

In the US data on initial jobless claims is released by the Department of Labor every week. The measure tracks the number of people who filed initial claims for unemployment benefits in the previous week. This measure is closely followed by the financial markets.

Since the measure is “noisy”, usually the 4-week moving average is followed. As you can see from the graph below, from the FRED (), it seems to go up prior to recessions. The latest data is circled on the right, and it looks like it is going down.

What really matters is the trend of the “second derivative”

The above trend is misleading because, as with most leading indicators of economic slowdowns (including recessions), what really matters is the trend of the change in the rate of change. This trend is frequently referred to as the trend of the “second derivative” of the underlying measure.

Look at the graph below, also from the FRED, which is the percentage change in initial jobless claims compared to the same period in the previous year. It is important to consider the year-over-year rate of change, as we do here, because of the seasonal nature of initial jobless claims.

As you can see on the right, this rate of change (the "second derivative") has been increasing steeply in recent months. This essentially means that the year-over-year rate of change in initial jobless claims has been increasing at a fast rate more recently.

The job market is weakening at an alarming rate

This is an unusual situation because the measure itself, initial jobless claims, seems to be going down sequentially as of late. But its year-over-year rate of change is clearly going up. This tends to precede recessions.

Recently the popular business media have been largely reporting the initial jobless claims measure as evidence that the job market is strengthening. The reality is that it is weakening, based on this measure, at an alarming rate.

A simple analogy

Imagine that you are driving from Houston to Austin. Where you are, at any given time, is the measure. The first derivative is the speed at which you are traveling. The second derivative is the acceleration.

Someone that is following only your location would see any movement toward Austin as progress. Positive speed is also seen as progress. However, if acceleration is negative, at some point you may stop and start going back to Houston ...

A final note

This blog discusses, among other things, simulation-based valuations of companies. Those valuations are based on fundamentals (e.g., earnings and revenues), and assume growth rates that are generally different from those seen in steep economic slowdowns or recessions.

If the stock market “sees” a recession coming, expectations about growth change drastically, usually for the worse. As a result, stock prices (and thus valuations) tend to drop precipitously, often regardless of fundamentals.