2023-04-24 03:21:00 ET
Summary
- BJK has been a big winner in 2023, and over the past year as well.
- This was driven by a re-opening economy in China, peak inflation in the U.S., and an expansion of online gaming in North America.
- While a victory lap is a fun thing to do, what is important now is how the fund (and gaming sector) will perform going forward. In my opinion, recent gains reflect too much optimism.
- Therefore, I see a downgrade to "hold" as appropriate. This suggests new investors be patient and current holders lock in some profits.
Main Thesis & Background
The purpose of this article is to evaluate the VanEck Vectors Gaming ETF (NASDAQ: BJK ) as an investment option at its current market price. This is a broad casino/gaming fund, with an objective to track an index consisting of companies involved in casinos and casino hotels, sports betting, lottery services, gaming services, gaming technology and gaming equipment.
I have been bullish on this sector for roughly a year - reiterating this stance in December. Simply put: It is time for a victory lap! The fund has performed extremely well during since both my buy calls (the first in May 2022 and more recently in December 2022). Since December, BJK is up almost 17% and the fund is up more than that year-over-year. This handily beats the S&P 500:
As much fun as it is to gloat, it is more relevant to determine where the fund might head from here. Generally when I see such strong, market-beating returns, that makes me cautious. That is absolutely the case this time around as well - and I will explain why in detail below.
Equities Sharp Rise Signals Too Much Optimism
While BJK is focused exclusively on the gaming sector, the broader (equity) market is still something that should be taken into consideration when evaluating this play. I feel this way because gaming and leisure stocks do well when optimism is high and the stock and labor markets are strong. After all, when people are working and have money to spend, discretionary areas tend to out-perform, and vice-versa. And online and casino gaming are certainly discretionary sectors.
With this in mind, the recent strength in equity markets should be a welcome occurrence. I am not suggesting it hasn't been - and the results speak for themselves. The market is up (as measured by the S&P 500) and BJK is up to an even larger degree. That supports the thesis that Consumer Discretionary can be a leader in a bull market.
So, the natural question here is - what is the problem? Well, the problem, as I see it, is that markets are getting a bit too optimistic. That has been a welcome signal for investors so far, but it signals the time may be ripe for some patience or caution going forward. Irrational exuberance can be fun for a while, but it often ends painfully for those who are not proactive or tactical. That is precisely what I am trying to avoid here.
To understand why I feel this way let us look at corporate earnings. Over the past few quarters we will see that earnings growth for the S&P 500 (less the Energy sector) has been sharply negative on a YOY basis:
I takeaway two key themes from this graphic. One, earnings have been weak at a time when the stock market has risen. That disconnect makes me very weary of further gains. Ironically, while the Energy sector has seen earnings rise, that sector is down over the past two quarters while the S&P 500, which has seen an earnings decline, is up!
From a purely logical standpoint, this doesn't make sense and it suggests a move into Energy at the expense of broad equity funds is advantageous.
The second takeaway for me is that investors are anticipating earnings to rise starting in Q3 and continuing to rise (year-over-year) throughout 2024. This type of optimism is striking because markets are also anticipating a recession to occur during the same time period. Also illogical in my view!
To tie this back to BJK, all these factors make me cautious on discretionary and cyclical sectors. Gaming and resorts/leisure are top of the list here. This means that despite BJK's momentum, I see these macro-headwinds as influencing equity markets in a negative way in the coming months. That tells me the prudent move here is to lock in profits in the funds like BJK that have been performing extremely well of late.
China Recovery Baked In
A key part of my bull thesis for BJK back in December was the China re-opening / economic recovery. I saw the country re-opening to be a boon for travel, consumer spending, and destination spend in Macao. This has all turned to fruition, especially benefiting top holdings in BJK like MGM Resorts International ( MGM ), Wynn Resorts, Limited ( WYNN ), Las Vegas Sands ( LVS ) (and Sands China ( OTCPK:SCHYY )), among others:
This was central to why my bullish call worked out so well. As 2023 got underway, China has seen a sharp economic rebound and GDP growth:
On the backdrop of this re-opening play and upside to the economic activity, the casino/gaming names I highlighted above have soared year-to-date:
To be fair, this is all great news. And I am not suggesting that these trends are suddenly going to reverse and spark widespread losses in these stocks or the underlying sector. But what I am suggesting is readers need to view these strong gains with prudence. We all know stocks do not go up forever, and 30% gains in a stock should give some pause at the very least. Again, these gains are definitely justified given the good news out of China that flows in to Macao. But the question now is, how long can it last?
I think the good times can continue but we have to acknowledge the impending headwinds. It is because of these headwinds that I see merit to taking some profit here - hence the rating downgrade. While the longer term story is still one I view favorably, I want to be much more selective with buy-in points for now.
There are multiple reasons for this, and I'll examine a few below. One is that the Chinese economy is not as stable as what we see in the U.S., or even Europe. So while I view the recent jump in GDP growth as a big positive (and an expected one), we have to take it with a grain of salt.
For perspective, let us look at China's GDP growth over time. It has been a story of big moves, akin to a "boom and bust" cycle, for the past three years:
What this signals is that China's growth going forward is by no means set in stone. Yes, I anticipated a rebound and, yes, it could very well keep going for a few more quarters. But recent history suggests a contraction could be in the cards - which is especially true if we see recessions in the U.S. and/or Europe as these are two primary markets for China's exports. So keep a watchful eye.
Another concerning fact is China's youth unemployment rate. At almost 20%, this risks social instability and unrest. Neither of those attributes bode well for discretionary or travel sectors:
I am not trying to be alarmist here. Rather, I am trying to emphasize why I am happy to take the gains the China re-opening theme has produced. The sustainability of these gains is something I question - so locking in some easy money makes a lot of sense to me at the moment.
Online Betting/Gaming Taking Hold In USA
The next topic for discussion is how online sports wagering and casino gambling has been rapidly expanding in the U.S. over the past couple of years. This is a trend that has picked up steam as neighboring states without legalization are getting increasingly envious of the tax revenue of those that have. It has led to a domino effect, with roughly half of U.S. states now offering some form of online wagering:
This is fundamental to why I want at least some gaming exposure going forward. This is a multi-year, multi-theme play on the growth of online wagering in the U.S. (and Canada, among other nations that have more mature industries). It is something not going away, but rather expanding.
I think BJK is a fine way to play this, but plenty of other options exist. I personally am a big fan of the FanDuel app, which is owned by Flutter Entertainment ( OTCPK:PDYPY ). Personally, that is my preferred way to own this investment theme because FanDuel is the most popular betting app right now in the U.S. (with a 42% market share and growing) - and its Irish/UK counterpart is successful as well. This is part of the reason the company is BJK's top holding, and it is the primary reason I own the iShares MSCI Ireland Capped ETF ( EIRL ), which boosts Flutter Entertainment as its second largest holding.
The conclusion I draw here is there are multiple ways investors can play this space and BJK is one good option, albeit not the only one. It does have the benefit of owning both online plays and brick and mortar casinos. It also has diversity across borders. But the downside is investors pay a rather hefty management fee for the privilege of owning it.
So buying the individual names directly has plenty of merit too.
Bottom-line
BJK has been a big winner and it is possible more gains could be on the way. This is why I am not "bearish" here. The momentum is strong, China remains on the rebound, and online wagering is making strong headway domestically. With real wages ticking up in the U.S., it is easy to surmise that casinos will see a boost in revenue - both in-person and online:
However, we must be mindful that the sector has been on fire and this bakes in a lot of good news. It won't take much to result in a worsening outlook for this sector and there are plenty of headwinds out there. These include a recession in the U.S. and/or Europe, unrest or declining economic activity in China, and a slowdown in sports betting in the summer months with the resolution of the NHL and NBA playoffs.
In summary, I have enjoyed the recent gains for this sector and suggest readers take a more opportunistic and selective approach going forward. This justifies the "hold" rating at this time.
For further details see:
BJK: These Gains Don't Seem Sustainable (Rating Downgrade)