January 3rd, 2023
“Never make predictions, especially about the future.” – Casey Stengel
There is a lot to be learned from 2022, as painful as it was for most of us. The best thing we can collectively do is to try and learn from the signposts and use them as references as we try and navigate ourselves through this crazy world. And most importantly, keep in mind that even with the pain there are always great opportunities being created.
We all focused on the Fed in December for good measure as they finally slowed their rate-raising campaign to 50bps while reiterating their war on inflation and dependence on data – all of which was generally expected seeing that the parade of Fed governors who hit the media circuit in the weeks prior made sure that we all knew exactly what they were thinking. Why they feel the need to constantly try and either massage or confuse the markets is something we will never understand, but it’s the new normal.
Some still long for the old days when the Fed chairman would emerge from his cave, announce a hike, cut, or do neither, and then retreat back inside sans any commentary. Today’s market participants, placated by a 24-7 news environment, and constant social media push notifications, would be incensed if the Fed stopped pontificating on every thought that went into their heads. The constant handholding is annoying and unnecessary.
There is no logical explanation why we need to hear the practically daily thoughts of voting and non-voting Fed governors, but we apparently do. It’s hard to justify, at least in our opinion, on just how this has any positive effect on the markets, or the economy for that matter. It just seems to create confusion and angry short-term price swings while the algos try and decipher another bout of Fed speak. It’s utter nonsense – but it’s only going to get worse in 2023 when the hikes abate, and the commentary is the only nugget of data we have to trade on.
The bigger point is that on December 20th, one of the biggest central bank news events in years took place. That is, the Bank of Japan finally decided to allow the band to widen for its 10-year JGB notes from +/- 0.25 to 0.50. They are expanding the yield curve and removing the last anchor in the global government bond world. More importantly, it’s an admission that Japan needs to join in on the fight against inflation and start to normalize their zombie-like debt markets that have essentially ceased to trade for months now.
Along with the ECB, who this month raised rates by 50bps and said it was “obvious” to expect 50-point rate hikes for a period of time to come and who will begin their own quantitative tightening program in March. Japan now ambles over to the hard-money side of the ledger, where the US has been all year. Expanding the trading band isn’t technically a rate-hike but does in essence act as one and likely signals hikes are coming.
Haruhiko Kuroda is retiring in March, and it sure seems he wants to leave his legacy as the one who finally ended the driftless Japanese monetary policy which has been prevalent for so long.
The shift in yield curve policy has been a boost for the Yen, which gained 4% against the dollar on the 20th and now finds itself at nearly a 6-month high against the USD. One could surmise that the “new” Japanese policy delivers a death blow for the carry trade that has been so popular amongst macro funds and pension plans. Which likely explains the surge in the Yen recently as shorts readjust their playbooks.
One of the biggest things we need to remind ourselves of when we enter the fray in 2023 is the fact that the Fed, and even more so the ECB and BOJ have barely put a dent in the paring of their balance sheets. In 2019 the Fed’s balance sheet was $3.6 trillion, it peaked this year at $9 trillion and currently stands at $8.6 trillion. So, another $5 trillion needs to be taken down to get back to pre-Covid levels. The Fed’s rate-raising campaign may have peaked in November, and we are likely due for a pause after March, but the tightening program, at least as of now, is nowhere close to being finished. At the current rate of $95B per month runoff it would take 7.8 years for the balance sheet to get to pre-pandemic levels.(chart below)
That also means that those looking for rate cuts in 2023 are likely to be disappointed.
After listening to Mr., Powell on the 14th and reviewing a host of commodity charts, it’s becoming more apparent that the real threat left for our inflation woes lies in the labor markets. Prices of wheat, corn, lumber, natural gas, oats, and even oil are well off their highs and in some cases much closer to recent lows – lumber being a great example. Maybe this all changes with the eventual re-opening of China and their new less restrictive Covid policy in 2023. But for now, it’s clear the Fed is focused on labor. Here is a snippet from the press conference on the 14th:
“So far, we have seen only tentative signs of moderation of labor demand… job gains have stepped down from more than 450,000 per month over the first seven months of the year to about 290,000 per month over the past three months. But this job growth remains far in excess of the pace needed to accommodate population growth over time — about 100,000 per month by many estimates. Job openings have fallen by about 1.5 million this year but remain higher than at any time before the pandemic.”
The December jobs report is out on January 6th. One could make an argument that the 12 job reports in 2023 will be more important than the CPI/PPI reports that had so much impact in 2022.
What it also does do however is something we have touched on for parts of 2022. And that is to enhance the volatility in global bond markets and create a fertile trading environment for an asset class that has seemed left for dead for years – as inexplicable as that seems.
The same can be said for the currency markets, as highlighted this month by sharp upside moves in the yen/usd and euro/usd. The policy shifts this year in central banking have awakened the also once-dormant currency markets and have helped with the rebirth of macro trading, something else that had been left for dead with the easy money/TINA (there is no alternative) world we all inhabited for years.
As we mercifully wave goodbye to 2022 and sharpen our knives and begin to attack 2023 there is one word in which we feel will be essential vocabulary for anyone planning on prospering in 2023. That word is tactical.
Webster’s defines tactical as:
“Relating to or constituting actions carefully planned to gain a specific military end”
2022 delivered a sobering, vicious, body blow to those portfolios engrained in the 60/40 models and satiated by the years of dull volatility and disciples of the TINA mantra. That changed, as we all know, and it’s not a one-year phenomenon. Higher sustained rates, a withdrawing of liquidity, contacting economy, and increased demand for goods with China finally abandoning their draconian Covid policies have all but ensured that we are in a permanent new economic world from years gone by.
Buying and holding stocks and bonds are now being replaced by alternative investments and tactical, sometimes quantitative trading methodologies that embrace volatility rather than disregard it, as so many have been conditioned to do in the past. Even long/short strategies which have had such an uphill fight in years past are coming back to life as markets move in wider trading bands and fundamentals start to differentiate themselves more so than ever.
All of this may sound simplistic and obvious. Fundamentals matter? Are currencies and bonds are now tradeable? Admittedly it seems silly to type and read. But the overriding fact remains that easy money policies of the years past have completely warped our sense of normalcy in the markets. That all changed this year and now we are in store for more “normal” times. Normal as in the cost of capital is relevant again and the spigot of capital pouring into any business with a pitch deck and cool buzz word (web3, blockchain) has not only dried up, but will be the first likely victim of 2023.
For years, alternative investments have been perceived as only for the rich or those “in the know.” Many retirement plans eschewed them and instead harped on the 60/40 allocations that served them as well as it did their clients. But now the times and tides have shifted, and alternatives are becoming the new vehicle for those seeking to prosper in this odd environment. We are in the early innings of this shift, and it looks like a very long game ahead of us all.
It was a little over a year ago when we were all still convinced that electric vehicles were the future and any car manufacturer that wasn’t producing them, planning on producing them, or looking to partner with someone who was producing them was woefully behind the curve. Admittedly, the future for electric cars is still bright and the projections of adaptation are viable. But what a year it has been for the EV producers and their stock prices; highlighted by bellwether Tesla having its worst year ever down 69%
Here are some other statistics:
- Rivian Automotive –83%
- NIO Inc (Chinese) -71%
- Polestar Automotive –59%
- Li Auto (Chinese) –37%
- Fisker –54%
- Lucid –82%
Even in a dreadful year for equities, those declines really stand out. The reckoning for an industry that has low production, high costs, and slow adaption, shouldn’t come as a total surprise. But the swift destruction in equity prices for companies that ultimately will facilitate the way generations ahead will drive have been especially jarring in 2022.
We have had moderate success this year in the metals arena, specifically silver. Silver, in our opinion, is the preferred metal to trade because it is lumped in with the industrial metals, to some extent at least, and almost always exhibits greater volatility characteristics. The case for precious metals is a tired one, and one that if you followed the gold bugs playbook should have played out years ago as the world’s money supply/debt increased to irresponsible heights. But the gold to $5,000 guarantee has come and gone – and may likely never happen. However, that doesn’t mean the bullish tint for metals has disappeared.
It’s not a stretch to think the Fed and other central banks will up their inflation targets from the once quizzical 2% to possibly double, or at the least 3%. Higher inflation, although markedly lower from current levels (hopefully at least) should help keep a bid in the metals, as evidenced as their relative strength to stocks and bonds in the latter weeks of 2022, even as the US dollar pulled back sharply from its highs.
It’s our opinion that the metals are being seen as a hedge against inflation (finally), and a store of value (finally) as the big 3 central banks (Fed, ECB, BOJ) all try and inflate away the real value of the massive liabilities they have on their collective sheets, while sacrificing their currencies in the process. Also, after the horrific year in crypto, one that has questioned the veracity of the entire ecosystem, there has been a shift to the metals for some refuge. Something the crypto community doesn’t want to admit to – but it has happened and is happening. The FTX scandal was the last rug pull of sanity for many.
Let’s not use the words above to convert us into gold bugs. We certainly are not. However, as we have repeatedly emphasized, an open mind, especially during these times, is crucial for prospering. And just because the case for the metals hasn’t materialized as so many had predicted, doesn’t mean it can’t, or won’t, or won’t be spurned on by a new set of catalysts – many of which won’t fit the traditional methodology.
After the destruction that was 2022, many are ready to believe that the worst is behind us and that the devastation in individual names (Roku, for example) has marked some sort of bottom, let’s all hope that is indeed the case. But here are a couple of theories that may actually signal when the bottom is here.
The Cathie Woods flagship ARK fund was down 67% in 2022. The fund is stacked with a number of disruptor-type companies that are ready to allegedly change the world. Her top holdings is Tesla – and they were active buyers during the December 40%+ sell off. Other top holdings include Roku, Teladoc, and Zoom. The end of the easy money days from the Fed has thrown a giant-sized wrench in her investing philosophy and generated pain for her investors. But despite the pain, her fund saw net inflows in 2022, and she has never wavered on her investing philosophy in spite of the losses.
Michael Saylor of MicroStrategy, which is essentially a Bitcoin ETF masquerading as a software company, has been evangelic-like in his steadfast belief that Bitcoin is the future of well..everything. He has been public in his belief in Bitcoin, accumulating more and more for his “company” all through the year. Not once has he acknowledged the destruction of faith in this industry or lamented that widespread fraud has laid waste to the credibility of so many. All that is fine if he keeps it private. But he doesn’t. Mr. Saylor is constantly granting interviews to whoever will allow him to recite his standard lines of why Bitcoin is a must own asset at apparently any price level.
As of December 27, MicroStrategy held roughly 132.5K Bitcoin, purchased at an average price of $30.4K., meaning that at the last sale, MicroStrategy is down 45% on its investment in Bitcoin
The point to all this? As much as we all want to declare a bottom in the equity and cryptocurrency misery that was 2022, we are in the growing camp that to see a final “flush” and really rinse out the longs we would need to see the ARK Fund undergo massive redemptions and possibly even close, and also see MicroStrategy succumb to margin calls on its Bitcoin position and capitulate near the recent lows.
Until then we fear that there is still too much hope out there, as incredulous as that may sound. We need a final real ugly, stomach wrenching, 1-800-get-me-out! submission to the market gods before a true sustainable bottom is in place.
Is the above scenario likely? Probably not. But it’s not unfeasible either.
A few tech tidbits as we prepare for 2023:
- Roku now has a market cap of just $5.5 billion and net cash of $1.9 billion. That seems like a juicy takeover candidate for some content-rich company.
- Amazon is now trading at 12x EBITDA, which is its lowest level since the financial crisis of 2008.
- Twilio now trades at 0.79 of book value and is down to 2.2x sales from 22.8x a year ago.
- Ciena now has a market cap of $7.3B and trades 2.7/book with a 19.3 forward PE.
This doesn’t imply that these names will soar this year. We are simply pointing out that the destruction in 2022 is creating some metrics in tech we haven’t seen in some time.
Bitcoin Update: Well, what is there really left to say? It was hard to imagine a worse year for news in the crypto space – and then FTX blew up.
The only question left as we enter 2023 whether crypto can recover from all this? And, if yes, what will it look like? Any hope left has been dashed; a recent poll showed that just 9% of respondents were now interested in crypto. Some auditing firms are now refusing to take on new clients that need crypto services. Coinbase is off a stunning 90% from its all-time highs and closed 2022 right off its all-time lows, as did the crypto-themed bank Silvergate (which we wrote a bullish blurb on in the June update – bad take) and the previously mentioned MicroStrategy.
Binance continues to be the only exchange aside from Coinbase that has any credibility, and that credibility is precarious at best. It feels like another shoe is ready to drop on the industry and we can only begin to imagine what that will look like. It’s also very hard to see 90% of the altcoins surviving another year like this, which may actually be a positive.
If 2022 was the massive hangover from the previous parties, then 2023 is likely to be a long year of sobriety. It’s hard to imagine VC funding piling back into crypto after all the pain endured in 2022 and the likely pushback it would induce from their LPs. Bitcoin miners are going bankrupt at a small clip thus far but that is likely to accelerate if conditions remain static. One item we would draw everyone’s attention to is Tether and the ability for it to “hold the buck” as is said. If Tether were to fail, and there are plenty betting that it will, the ramifications from that could be unrevivable for the industry. Additionally, (and obviously), the ability for the Binance Coin (BNB) to stay afloat and emerge from its $250ish base would potentially be a positive shot in the now almost dead arm of crypto.
One encouraging signal we see and have touched on briefly lately is the surprising resilience of the price of Bitcoin in the face of the crushing flow of negative news. The fact that it can hold the $16k(ish) level and end 2022 still well above $12k is a good sign of relative strength – all things considered of course.
The other bit of “good” news is that the sentiment and subsequent disgust surrounding crypto make the contrarian side of the ledger look at least somewhat attractive. That should not be construed as a bottom call; and it’s hard to envision a surge higher anywhere in 2023. This feels like more of a year in which the dust settles, and everyone looks around in bewilderment waiting for someone else to act first. We could see 2023 being the quintessential “dead money” year.
Casey Stengel’s quote above summarizes our sense of the need to make beginning of the year predictions. Predictions are often wrong and worthless. But we do believe in trying to identify potential themes. Not specific predictions, mind you, but more macro areas of interest.
We’ve touched on silver, and sticking with that theme, we think that STUFF will be a good place to focus on in 2023. Stuff is not a scientific term, but it is relatable. And the simple fact is the world needs more stuff be it oil, steel, food, base metals (cobalt/lithium), lumber, or cement.
The need for materials for the construction of projects will be a big theme for 2023. That may fly in the face of contracting economies, but we would counter with China finally re-opening and the fact that most countries, especially the US, are still woefully behind on their infrastructure plans; the demand will be there. As for supply, it’s generally thought that supply chains and production facilities loosened up as 2022 aged, but it’s still wonky out there and, unfortunately it wouldn’t take much for a supply disruption to occur.
*China’s National Offshore Oil Corporation (CNOOC) sees energy demand rebounding next year: expecting total energy consumption to grow 2.4% and gas demand to grow 5.6%.
Also, it sure feels like 2023 is setting up to be the year Tik Tok either stays or goes in American culture. We are already hearing rumblings out of congress to get it banned and there are currently 18 states that have at least a partial block on all government devices. There is also increased pushback from privacy advocate groups that also want the app banned as well.
On the flip side, it is hugely popular here and has become ingrained in our society, especially amongst the younger set, for better or worse. It’s hard to imagine it just going away in an instant, but the espionage component attached to the app makes it a potential threat to the US. Something we can’t stand for given the already tense relations with China.
Looking Forward and other Market Commentary: It’s a new year but we have the same data inputs to track. Job report on the 6th, CPI on the 12th, and PPI on the 18th will be the highlights. That schedule won’t change as we grind through 2023. In the first month of the new year, we will get a respite from the Fed and ECB but will have the now suddenly interesting Bank of Japan to listen to on the 18th. In December, we saw repeated interventions from the BOJ in their bond markets and a sharp rise in the yen/dollar cross, which has laid waste to some shorts that overstayed their welcome and disrupted the carry trade.
It’s not a stretch to say that in 2023 the most important bank in the world will be the BOJ. They have been longtime proponents of an easy money policy and were the least resistant to change. Their bond markets have been left for dead for years now, even having days where they literally didn’t trade.
But now we have an awakening, and it has, and will, continue to reset prices across the globe, likely aiding the continued growth of the macro trade that came back in vogue in 2022.
Away from the macro, we kick off another round of earnings season on the 13th when JP Morgan reports. Everyone is expecting a sharp earnings contraction in 2023 and equities began to price that in late 2022. The good news for corporate America is that the bar and expectations are low. The bad news is that there is a wide range of estimates for S&P earnings in 2023 – from $190/share that would place the p/e at 15 or up to $230/share that would bring it up to a 19 p/e. That would suggest a range of $2,850-$4,370.
It wouldn’t shock us to see earnings coming in better than all the dour expectations. The optimism is based on the many CFOs already lowering their collective bars late last year (not a coincidence) and the continued strength of the consumer as evidenced by tight labor markets and bullish data out of Mastercard, post-Christmas.
Finally, it’s time for a mea culpa on our part. In the November Update we were critical of the White House for draining the SPR and “waiting” for prices to drop to the low $70s to fill it back up – essentially being short oil.
Well, they got what they asked for. In December, crude traded to a low of $70.30 but has rebounded to the $77 level currently. The White House did issue a statement that they were ready buyers – in February. But we will assume (hope) they have done some buying around the levels they projected it would drop to.
Draining the SPR to fight inflation is still a very poor concept in our opinion and not the purpose of the SPR. Inflation is not an emergency and with supply and supply chains tight this is no time to be hoping for lower prices for a resource we must have ample supply of to function.
Nevertheless, they nailed it and deserve kudos. Energy trading is a complex game that can go south quickly.
Maybe it’s time they set up a strategic stock fund and let us all in on their wizardry.
Occasio Partners, LLC 465 California Street, San Francisco, CA