Markets going through disruption tend to be a bit manic depressive, with headlines alternating between:
“Its a bubble, the big crash is coming, sell sell sell
“Its going to the moon, load up today, buy your Lamborghini tomorrow, buy buy buy”
The Fintech bubble question has become a staple as the media chases page views with sensationalist clickbait headlines.
I want to bring some data, rather than add to the landfill of opinions. That data is lurking in the markets (both stock and cybercurrency). Investors have skin in the game. They back their opinion with cash. Investors can be wrong for a while, but in aggregate their actions usually signal something more interesting than an opinion.
In this post we seek data from the markets to answer the question whether Fintech is a disruptive force or a bubble waiting to pop.
What does the KBW Index tell us?
For example, if Fintech disruption is real, it might be reflected in Bank stocks declining in price. You can see the logic from past disruptions such as e-commerce disruption hitting retailers or social media disruption hitting publishers. In that scenario, bank stocks would be declining.
KBW created a leading index of Bank stocks with symbols BKX. There is another one with a more regional bank focus called KRX. A quick glance tells us that investors still like bank stocks.
The price action to date has nothing to do with Fintech. It is more likely simply that monetary policy in America is on a path to rising rates which benefits banks and there is an expectation that the regulatory load will be lightened under the Trump Administration. The big moves can be easily tracked to the Trump election and statements by Janet Yellen.
So, the takeaway is “Fintech is a bubble, it is having no impact on bank stocks”. Not so quick, read on.
Lets look at publicly traded Fintech stocks.
Fintech ETFs – FINX and FINQ
Daily Fintech created the first Fintech Index back in March 2015. More recently a couple of companies created tradable ETFs from the simple idea of an index – FINX and FINQ. Zacks offers a comparison
These are not as cheap as buying a Vanguard S&P fund. Both charge 68 bps.
There are some differences between weighting by big, medium and small cap and by geographic region, but they share one thing in common. The holdings are almost all “traditional Fintech”; this is Wave 1. Some are Wave 2 which is Emergent Fintech based on SMAC (Social Mobile Analytics Cloud). This is natural. To get to scale big enough to be a public stock you need to play within the current system.
(See this post for a description of the three waves of Fintech). TL:DR: Traditional Fintech Wave 1 is “we bring you lunch” (aka vendor), Emergent Fintech Wave 2 is “lets split the bill and partner” (aka B2B2C revenue share partnership) and Disruptive Fintech Wave 3 is “we eat your lunch”.
So it is natural to see these Fintech ETFs going up in tandem with KBW and the overall bank market. When the banks prosper, the vendors and partners to those banks prosper. Many of these companies are moving from a pure vendor model (here is my technology and here is the price) to a revenue sharing model (either white label or co-branding). In short, Traditional Fintech is morphing into Emergent Fintech as quick as they can; but in both models Fintech and Bank interests are aligned.
There are some great companies in these ETFs, however don’t trade it as a hedge against bank stocks. The correlation is surprisingly strong.
First we show the two Fintech ETFs together (taking a 1 year view):
They track pretty closely. FINQ seems to stop this summer and as they track closely enough I only use FINX for further analysis.
So, lets look at Bank stocks and Fintech stocks together. In a 3 month view we see some outperformance by Fintech, but on a longer term horizon we see mostly correlation:
Stop yelling, its Yellen that matters
Looking at all these ETFs, there is high correlation. Its The Macro Stupid.
So lets look at some individual stocks on opposite sides of the Fintech Bank divide and how they reacted to similar crises.
Comparing Lending Club and Wells Fargo crises
When the Lending Club CEO did something stupid, the board fired him immediately and the stock tanked. In my view, the market overreacted and LC was a bargain and I was fortunate to buy in at the all time low of 3.51 (see this post for my analysis at the time) and sold a few months later.
When Wells Fargo did something stupid my analysis was a) that this was worse than what Lending Club had done and b) the underlying cause was probably related to Fintech disruption (a thesis I outlined in this post).
So you would think that Wells Fargo stock would have crashed like Lending Club did. A quick look at the two charts (on a two year view to get the LC crash) shows this is not true:
The takeaway, scandals are rougher on Fintech upstarts than Banks. How long this will remain true is a matter of opinion. Wells Fargo and Equifax will be stocks to watch, but also assume we will see many more blow-ups like this in the months ahead – it is Act 3: Denial in the 7 Act Creative Destruction Play.
Searching for negative correlation via Disruptive Fintech
Smart money is waiting for the OmniBubble to burst. This is bigger than all previous bubbles, whether Housing or DotCom, driven by money printing all over the world. If you see this OmniBubble, none of the normal strategies work. All the sensible assets are also over valued. You want to buy something that is anti fragile that will benefit from a crash.
There are not many tradable stocks in Disruptive Fintech category of Crypto Finance. There are lots of private companies but then you buy into the public/private valuation inversion which was the subject of no 7 of our Top 10 Fintech Predictions for 2017:
“7. Uber will not do an IPO and may do a private down round.This will signal the dramatic end of the public private valuation inversion (private higher than public valuations). This started in 2016 and will have its dramatic end in 2017.”
Uber is still making brave noises about an IPO, but it is likely that an IPO will be a massive down round. Some other overvalued private companies are “taking their lumps” now and getting the pain over. One example is the 70% valuation drop for Prosper. Their problem was that Lending Club was such an obvious comparable.
The only public stock I can see where any Josephine Q Public (aka unaccredited investor) can buy without permission into the Crypto Finance Third Wave is Overstock ($OSTK) where TZero and other Crypto Finance ventures are lurking within an e-commerce company. That is not a pure play.
That explains the hunger for ICOs. Those ICO issues are all you can buy if you think Blockchain, Bitcoin and Crypto will change the world and you don’t have access to private deals. However there is a much, much simpler investing strategy hiding in plain sight:
You could not buy The Internet in the 1990s, but you can buy Bitcoin today.
There are obvious parallels between the Dot Com bubble and today’s ICO craziness.
In the 1990s, you could not buy “The Internet” if you saw The Internet changing the world. All you could buy was lousy stocks like Pets.com. Today’s equivalent is a lousy ICO. If you see Crypto Finance changing the world and you are an unaccredited investor, all you can do is buy an ICO. Not quite true. Today you can also buy Bitcoin. If you see Crypto Finance changing the world, your actionable trade can be as simple as buying some Bitcoin. Any “dumb” retail unnaccredited investor can do that without anybody’s permission. Meanwhile the smart money buys into overvalued private deals. Err, who is the sucker at this table?
Getting back to the bubble question, one way to look at this is that we are witnessing the end of the Financialization Bubble. This has been going on for so long that it is harder to see it as a bubble. For years, the smart money has seen this and while pumping the securities bubble as much as possible, they buy gold and land as better stores of value than paper assets. More of them are now also buying Bitcoin as an alternative store of value, which explains the rise in price. Some on Wall Street trash talk Bitcoin and some buy it and some do both. All understand that Bitcoin, weird as it may sound, is the anti fragile portfolio response to decades of loose money policy.
Bernard Lunn is a Fintech deal-maker, author, adviser and thought-leader.
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