2023-03-23 17:26:58 ET
Summary
- The Fed’s decision to boost liquidity could give a shot in the arm to the holdings of ESPO which look oversold relative to the Nasdaq.
- The long-term potential of this market is huge.
- ESPO could face some challenges when risk-off conditions return later on.
Video games are bad for you? That's what they said about rock and roll. - Shigeru Miyamoto
Introduction
Subscribers of The Lead-Lag Report would note that my proprietary Lumber to Gold signal recently switched to risk-on mode, reiterating the shift in risk sentiment across the markets. Much of this is being driven by the notion of additional liquidity into the system (there's a school of thought that believes the Fed could add $2 trillion back into the banking system over time), even as there are suggestions that the rate hiking spree may be easing off.
If the Fed keeps overcompensating on the liquidity front and making financing conditions more palatable, that could serve as the perfect ammunition for the likes of the tech and the communication services sectors to flourish.
If you're looking for an ETF option that is well exposed to both these sectors (~89%) and could benefit from the melt-up momentum that has taken over recently, you may consider looking at the VanEck Video Gaming and eSports ETF ( ESPO ).
Also, note that ESPO offers good value relative to its peers from the Nasdaq. According to YCharts, ESPO's P/E multiple of 20.6x represents a 10% discount to the corresponding forward P/E of the Nasdaq. Meanwhile, a ratio capturing the strength of video gaming stocks as a function of the Nasdaq too has now dropped to more acceptable levels, relative to the highs seen in early 2021.
The Gaming Industry
ESPO essentially focuses on stocks that generate at least half their revenue from areas such as video game development, esports, and related hardware and software. Long-standing followers of the Twitter account of The Lead-Lag Report would note that I've previously touched upon the gargantuan scope of this market.
Twitter
When you ascertain various entertainment avenues, those from Generation X, and the Baby Boomer cohort may typically gravitate to the movies, but as those segments age and other segments take on a more dominant presence, it's hard not to be swayed by the potential of the gaming market.
Note that Roblox ( RBLX ) (a part of ESPO's top 10 stocks) a flagbearer of metaverse-related gaming, which currently specializes in marketplace offerings across an immersive platform, has a loyal pool of customers that continues to grow. According to Matthew Ball , the bonafide authority of the metaverse, 75% of American children already game on the Roblox platform, and he estimates that 140 million new gamers are born globally every year! If the metaverse is to gain traction and envelop our modern world, the linkages with gaming could result in a scenario where every second person from the developed world is a potential gamer.
One can get a sense of gaming's growing omnipresence through the content that gets churned out online, with gaming-related live streams and commentary topping the charts. For instance, if one looks at YouTube, gaming alone is believed to account for one-third of the total video content that gets uploaded on that platform.
A couple of years back, gaming across mobile, consoles, and PC stood at a whopping $180bn, infinitely greater than the business done by the film industry. Going forward, while global growth is expected to come in at 3% for the foreseeable future, the gaming sector (which already has to deal with a high base effect), will likely grow at 8% , at least till 2027!
Investors also need to consider that this isn't just a volume game that we're talking about here. These video game developers are also profiting from an innate level of pricing strength ( $70 games are becoming the norm), while also ensuring a degree of cross-sell (such as signing up for memberships and subscription services) that will likely continue to drive up the average revenue per user (ARPU) metric closer to the $400 levels through 2027.
Risks
Short-term melt-up conditions should continue to abet ESPO's holdings, many of which belong to the growth universe. However, I've also noted in a Lead-Lag Live conversation with Sam Stovall, the Chief Investment Strategist of CFRA Research that bear markets typically end with a bang, and we're yet to see that play out. That's why I feel the recent melt-up is more about near-term path conditions rather than a secular shift in the market outlook.
Twitter
In fact, if you've followed my commentary on The Lead-Lag Report in recent months, you'd note that I've been flagging the risk of a credit event with a potential spike in credit spreads. This may well serve as the trigger for a lower leg down in the market, and some of ESPO's holdings could remain vulnerable during a potential sell-off.
For further details see:
ESPO ETF: This Oversold ETF May Benefit From Melt-Up Conditions