Back Nine Begins

50% of 2022 is now officially in the books and we reckon that the vast majority of investors, particularly those with traditional IRA’s or 401ks, would rather not spend much time reflecting on it. We aren’t going to spill a lot of ink on just how bad 2022 has been thus far.  We are trying to stay optimistic and do still believe there are more positives than negatives on the horizon, as contrary that seems right now, and that all the gloom and doom we are fed on a daily basis from social media and the mainstream media only has only exacerbated the mood.


But…. we do have to acknowledge that the S&P 500 is off to its worst first half of the year since Richard Nixon was president. Over $23 trillion of market capitalization has been lost since last November’s high, which eclipses the 2008 Great Financial Crisis’s now relatively paltry $9 trillion drawdown.  And the much heralded “60/40” model of equities and bonds is currently mired in its worst year ever.  We are not trying to throw any salt in wounds or dismiss the loss of capital.  No one likes to lose money.  No one.  But these are the facts thus far in 2022. 


There is some good news, the last 5 worst first half performances before this year were all met with solid second half returns averaging over +17% in the S&P 500. This is surely not a typical year (for a variety of already-stated reasons, but that doesn’t mean the 17% is off the table either)


Let’s kick off the second half of this crazy year focusing on some positives.  They do exist, and include:


  • There is currently $2 trillion in excess savings from consumers
  • Despite the recent slump, there is a vast majority of homeowners who still have a nice cushion of gains
  • Corporate balance sheets remain strong thanks to a long-low-rate environment and easy access to capital markets that has been going on for years.
  • Labor markets remain robust and tight.  There are plenty of jobs available for those who want to work.
  • The PMI index, which is expansionary when over 50 and signaling contraction under 50, currently stands at 57. Chart below.
  • Since May 1st, there has been a marked downturn in the price of commodities.  Some examples include: Lumber -40%, Tin -37%, aluminum –19%, copper – 15%, soy oil -24%, cotton and wheat both -10%+.  Even oil has fallen from $120/barrel to the current price of $100.
  • The 5-year breakeven rate, a popular inflation gauge, fell to 2.6% late this month from a peak of 3.6% in April.  
  • Rates, while still higher than a year ago, have also come down.  The 10-year yield is back to around 3%.
  • US banks just passed their latest stress tests with flying colors this month.  Not surprising, but a good sign, nonetheless.  This isn’t 2008 by any means.
  • China’s draconian Covid policies have lightened up some, which should free up some ports and help loosen supply chains.
  • The war in Ukraine, as awful as it is, has likely been priced in by the markets and there is some faint hope of a settlement that would lower energy and dampen global food supply concerns.


There are daily debates between economists and strategists on whether we are in, or about to enter a recession.  They love to pull outdated statistics and various inverted yield curve charts to try and prove their cases.


So, maybe some commentary from the real world, in this case the Fed Ex CEO, would serve as more indicative of what is really happening.  A “boots on the ground” type analysis versus a bunch of muddled statistics.  We found this quote from Fed Ex chairman 


“Management does not foresee a recession over the next twelve months as it assumes low single digit volume growth. Management was upbeat on the tailwind of ecommerce given the still relatively low penetration.”


Fed Ex guided 2023 EPS to $22.50-$24.50 vs. The $22.40 current estimate.  The stock rose 6.6% on the news and briefly pierced it’s February highs before pulling back with the indices.


Now, we can’t pretend to be Pollyanna’s and whistle past the proverbial graveyards that certainly exist. There is still a slew of worries to overcome for the market to climb.  Most notably, the world’s central banks battling inflation via their now increasingly tightening monetary policies (ex-Japan).  This point was strongly echoed by Chairman Powell on 6/22 when he said, while testifying in front of the Senate:


“We can’t fail. We really have to get inflation down”


The Fed is set to raise rates again by another .75bps on the 27th of July, and there are some who believe a 100bps raise would be more effective. However, the Fed Fund futures don’t agree and the recent tumble in commodity prices makes that seem highly unlikely.  Also, the ECB is set to raise rates for the first time in 11 years on the 21st of July. This comes on the heels of the Swiss National Bank enacting an emergency rate hike this month, as well as that of the Bank of England.


A BofA fund manager survey taken this month listed the top 6 biggest worries as follows:


  1. Hawkish Central Banks – 30%
  2. Recession – 26%
  3. Inflation – 17%
  4. Russia – 10%
  5. Credit Event – 8% (chart below)
  6. Covid – 3%


Clearly, monetary policy remains the top worry and the recession that may or not be caused by the effects of it.  Good news is Covid seems to become just an afterthought.

What are some of the lessons we’ve learned thus far in 2022?  This may seem like too simple an exercise, but during tough environments it’s often best to simplify as much as possible to keep outsized emotions in check.

  1. Don’t fight the Fed on either side.  The Fed was our friend and now our enemy as they begin the great unwind.  
  2. The Fed, and many others, are poor economic and inflation forecasters.  Forecasting is a tough business, and one we like to abstain from.
  3. Rates matter – a lot.  Obvious now, but for years people forgot how much rates move assets.  They are seeing the linkage in 2022.
  4. We have NEVER been in an environment where the Fed is both raising rates and cutting its balance sheet.  Always keep that in mind when trying to explain away outsized price moves.
  5. When assets deflate, they all deflate.  Bitcoin, gold, art, fine wine, farmland.  Nothing is immune when sellers are in charge and there is cash to be raised.
  6. There is no perfect model or balanced portfolio.  Sure, you can construct something that in theory provides a margin of safety, but as we are seeing this year with the “60/40” model is providing little solace.
  7. The demise of the US dollar has once again been greatly exaggerated.  The DXY Index is currently at around 104 and trading at 19-year highs.  Sure, our fiscal policies are problematic to say the least.  But others around the globe are apparently a lot worse.
  8. Green and clean energy seems perfect and can be a real game changer for the world.  But, you’d better have the proper supplies and capacity in place to placate the current demand before instituting a change.
  9. The world, ex-China, is learning to live with Covid.  Cases are still prevalent, but society is moving on anyway.  Hopefully, vaccinations and climbing levels of herd immunity eventually will make it almost obsolete.  But for now, it’s more an annoyance than a pandemic – at least that’s what the markets are saying.

We want to focus on what we feel are some positives that have been born out of the   turbulent past 6-8 months.  They are in-line with how we run our fund and the lend credence to the environment we envision the next 3-5 years.


For starters, the crypto debacle currently unfolding (more below), is creating both attractive price points and interesting situations that may seem dire now but have the possibility of bearing fruit in the near future.  Specifically, Ethereum and some of the lesser-known miners such as Hut 8 Mining and Riot Blockchain.  All the deleveraging and margin selling, which we don’t feel is over yet, that is decimating the entire asset class (including large crypto hedge funds), is only going to aid those who have the patience and readily available capital to pounce when the timing is right.


When exactly that time is precisely is impossible to predict.  We readily admit that and would never pretend to be astute market timers.  But the point is all the intense negativity now surrounding cryptocurrency is exactly what you’d want for those trying to add exposure to their fund and continually gain more insight into this industry.


Sure, it’s a lot more fun when Bitcoin is at $60,000 and everyone is pumping all the new alt-coins.  But it was unsustainable. And now we get to see what survived and what’s in the bargain bin, and if, or at what price they are even still attractive.


This year has been obviously frustrating for cryptocurrency participants and the tremendous slide in the price of Bitcoin has dampened our performance for sure.  But, again, to stay positive, we have to be excited about what the markets are delivering to us in this area.  As painful as it is now (and, boy, it is!)


Another positive so far in 2022 is the pronounced and sustained levels of volatility across all asset classes. They have emboldened active traders such as ourselves and, more importantly, brought into play some asset classes that felt dormant for years, namely, the interest rate markets, all due to easy Fed policies.  But the energy markets are also proving to be tremendously fertile grounds for traders with a penchant for volatility as are the grain and softs, whose interest and importance have been magnified by the Russian invasion.


And other markets that have sprung back to life are the currency markets.  That may sound odd as it trades $6.6 trillion in volume daily all around the globe.  But again, with the perverse global central bank polices intact for years, and the fact the ECB has been so euro-negative, it has really diminished the trading bands and kept the US dollar at elevated levels versus all other pegs.  That too is starting to unwind some and luring traders back to one of the most historically fascinating markets.


In the same vein as cryptocurrency, but not as extreme – at least industry specific wise, are the opportunities developing amongst certain companies who have seen their share prices fall 70-80% in the past 12 months or so.  


There are numerous examples to cite, but some of the most high-profile names include: Netflix -71%, Roku –82%, Teledoc -90%, ARKK ETF -55%, Block –62%, and even fan favorite Lululemon has fallen -31%.


Lists are being built and monitored.  This bear market in stocks won’t last forever (9.6 months with a 35% drawdown is the average) but it isn’t an average world anymore and there are values being created amongst the wreckage.  Especially in some of the smaller cap companies whose share prices are subjected to brutal algorithmic sell programs that take entire sectors regardless of underlying fundamentals. Lists are also being constructed of companies that, despite their large downdrafts will remain shorts on any significant bounces that are accompanied by bear markets.  A few of which we have already seen this year, particularly in the highly valued software space and some of the specialty retailers like a Lululemon, Chipotle, or Restoration Hardware.


“Everyone has the brain power to make money in stocks. Not everyone has the stomach.” -Peter Lynch


Last, currently the least important in our lists of positives for now, are the shrinking valuations and more favorable financing terms for private companies and debt deals.  This area was simply way overvalued and ridiculously oversubscribed.  The valuations have come in some, but still has more room lower in our opinion.  This is an area we are taking a very slow and deliberate approach to, and, as expressed, is by far the smallest level of our interest (10% of fund).  So, it’s nice to see some lower prices and a dash of sanity finally.

The point of all this is that, despite the negative tone to the markets (and world), if we try to use these vicious drawdowns that have permeated across all asset classes as more of a sign of opportunity than fear, we can possibly prosper from them.  Granted, that will require patience, some luck, and better economic conditions.  But, giving in to the negative refrain here seems like the wrong side of the trade. Especially when you look at the opportunities created in 2008, 2018, and 2020 – not all that long ago.  This doesn’t mean history is destined to repeat itself; maybe this time it will be truly different.  That is a bet we are willing to take – however, with defined risk.

Bitcoin Update: 

Well, the crypto “winter” ok summer is here and it’s as bad as anyone could have imagined and then multiply it by 10.  We have spent months trying to highlight all the positives surrounding the cryptocurrency world, and to be fair, those catalysts are real and still applicable.  But, and there always is a but, the past few months have absolutely eviscerated any confidence in this arena.  It started with the Luna/Terra collapse to zero, as we detailed in the April Update.  Which was part of the stable coin contingent along with Tether.  Tether has seen sizeable withdrawals and intense shorting lately but still has been able to maintain its $1 peg.  We would concede that a significant break of that peg or, God forbid another Luna-like consequence would send a death blow to the crypto community that frankly they may not be able to survive.  We aren’t predicting this by any means but are watching it all very closely.


Another huge problem this month was the freezing of accounts and withdrawals at Celsius.  The crypto lender, which was offering yields as high as 17% (red flag) has now hired a restructuring-based law firm and Citigroup in advisers. That’s not good news if you have any funds with Celsius.  Our guess is that you are about to become an unsecured creditor and will be lucky to get pennies on the dollar.


This reminds us of a great saying we once heard on the trading floor: “If you don’t know where the yield is coming from…you are the yield.”


As if that wasn’t enough bad news to rattle the cages of the crypto world.  Also, this month Three Arrows, a multi-billion-dollar crypto hedge fund began proceedings to liquidate their holdings after a failure to meet margin calls and redemptions.  This in turn led to some forced selling of their assets and only added to the downward pressure felt by all assets this month – but especially those of crypto.  Headlines such as these, only weeks after the Terra/Luna debacle, hardly inspire confidence for an asset class that still needs to prove itself as a legitimate investable entity. Babel Finance, a digital asset lender, also froze withdrawals this month.  Adding more kindling to the raging crypto fire so far in 2022.


FTX, one of the largest crypto firms in the world, agreed to buy BlockFi in late June for a paltry $25 million.  BlockFi was valued as much as $4.8 billion in the last round of financing in July of 2021.  Essentially wiping out all investors who participated in any rounds.


Coinbase, the stalwart of cryptocurrency, announced in June that they would be shedding 18% of their workforce due to over hiring, and unseemly market conditions.  This follows smaller layoffs in both Gemini and Binance.

There are 19,607 virtual currencies in circulation, almost 80 percent of the ecosystem’s total value is in just 5 names:

  • Bitcoin: $564.4 billion (45.8%)
  • Ethereum: $222.5 bn (18%)
  • Tether: $73.2 bn (5.9%)
  • USD Coin: $53.2 bn (4.3%
  • Binance: $51.1 b (4.1%)
  • Total: $964.4 bn (78.1%)

These seem to be the “FANGS” of the crypto world.  Let’s hope they can keep their relevance. 

It seems to us, at least in the interim, that focusing on the price action of the five above will be the real tell for strength for the overall sector.  But those who still have faith in the 19,000 or so “alt-coins” may be in for a harsh lesson in how bubbles pop.  It is hard to envision any of these coins actually surviving. We would put a 10% survival rate as generous on the 19,000 or so coins currently circulating out there. Some that we will continue to monitor (but not own) include: Sol, Wax, Gala, and Stellar Lumens.

It’s 2008 for crypto currencies and the businesses that have been created around them.  The sector over-promised, over-hired, and much more importantly over leveraged itself.  That was passable when liquidity was flowing, and assets were immune to downturns.  But those days, as we all are painfully aware, are over.  And those who thought cryptocurrency would differentiate itself in a difficult environment, are in for the gut check of their lives.  Bitcoin has not proven to be an inflation hedge nor a flight to safety.  We never presumed that it would but do still believe it can serve as the bellwether for the blockchain that is not going away anytime soon, despite the carnage unfolding in front of us thus far in 2022.  

One interesting stat we came across this month: In 2020, we saw seller exhaustion following a 75% drawdown from an all-time high, and last week, bitcoin completed a 76% drawdown

Also, the Greyscale Bitcoin now trades at a discount to Net Asset Value by -28.5% which is near its highest level of -34% set in June. This month the SEC denied Greyscale’s request to become an ETF. Further adding to the woes in crypto land.

It may seem like an opportune time to scale into some of these names after the shellacking that has taken place recently.  And it may very well be, but the fact that exchanges and large crypto funds are both withholding withdrawals and being forced to liquidate positions makes us wary that the selling is over.  It is very, very difficult to gauge when the selling will cease while it’s margin-type selling.  And that is what we are witnessing now.  It would be great to call this spate of recent bad news the bottom.  But, if the cockroach theory holds any water, and it almost always does, there is more collateral damage coming and likely more firms and funds likely going under before any bottom is put in place.  

There is, however, some good news amongst the wreckage.  And that is, if you reflect back to the boom/bust of the late 1990’s the similarities are striking.  We had a new industry that not many understood or had total access to (internet), tons of venture capital piling into start-up companies with little due diligence, desperate attempts to try and explain away the silly valuations and business models (eyeballs, page hits), and a complete saturation of an industry (or an idea) that led to eventual massive layoffs, company shutterings, and complete disgust for anyone attached to that bubble.

We can check a lot of the same boxes currently in crypto land, but we should also remember that from the 2000 bubble bursting we still came away with Amazon, eBay, Cisco, and Google and a slew of other now companies we can barely live without.  Also, it’s rather obvious to state that the internet and all the plumbing involved with it has been complete life-changer for the world and is the most deflationary invention ever.

It would be silly to compare blockchain or Bitcoin to the internet, and we aren’t, but it’s also silly to write the whole thing off and assume it just all disappears like waking up from a nightmare.  There is some middle ground there and some future behemoths are being fortified right now to rule their slice of the world for years to come.  

It happened before amongst tremendous speculation, and we are certain history will once again be repeating itself in the next few years.

Also, the crypto community prides itself on being decentralized and the anti-government movement for a better financial world.  So, if they expect any type of 2008-like bailout from that said government if conditions really worsen, our guess is the government response would be something to the likes of “hard pass.”

Satoshi Nakamoto, the alleged creator of Bitcoin, stated years ago: “The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.”

That all may be well and true. And maybe Bitcoin is the answer.  But it’s time for it to prove itself and see if it can survive this nuclear summer with its reputation still intact.


And finally, for those gold bugs and metals enthusiasts who scoff at cryptocurrencies and continue to pound the table on the benefits of owning metals.  The gold miner index touched its Pandemic 2020 lows this month and gold is now flat on the year, despite inflation at the highest levels since the 1970’s.

Looking Forward and other Market Commentary:

July is going to be a very busy month for active market participants.  Earnings season will kick off on the 14th when JP Morgan releases their Q2 numbers and that will commence three weeks of high-profile releases, followed by approximately two more weeks of smaller-cap companies reporting.  We are expecting that many of the conference calls that accompany the releases will be using inflation as a catalyst to explain away some so-so reports and underwhelming guidance.  But we also think that the negative sentiment around earnings has become too lopsided and actually feel like this quarter’s releases, when all is said and done, will prove to be stronger than many are anticipating. 


However, we are also anticipating management teams using this current unsure environment as a great time to lower guidance and lower the overall bar for future expectations – justified or not.  It’s the classic under promise/over deliver set-up. We will likely hear about more layoffs as well, although for the most part that has been pretty benign so far; it will be interesting to see if the market can sniff out any lowballing attempts and price accordingly, or if suggested guidance will equate to irrational reactions and sharply lower prices. 


 Let’s keep in mind that Wall Street analysts still expect the second half of 2022 S&P 500 earnings to be 9% higher than the first half. ($60/share in each quarter, up from $55/share in the current/recent quarters. These projections certainly fly in the face of the hard landing scenario many are, including the Fed, assuming and warning about.  


The three main central banks all meet again this month.  The ECB and BOJ on the 21st and the Fed on the 27th.  These are obviously huge events given the current tightening environment and the fact that the ECB is set to raise rates for the first time in 11 years and the fact that the BOJ still insists on maintaining an easing policy and yield curve control while the rest of the developed bankers are taking the exact opposite route; this will all make for some interesting commentary out of the BOJ.  Also, we will see if they continue to address the weakening yen and inflation concerns from a nation that imports a significantly high number of products.


As much as we harp and obsess about Fed policy, with good reason right now we might add, it is starting to feel like we need to focus much more on the ECB and the developing crisis we are seeing unfold.  For starters, the energy conundrum that has resulted from the Russian invasion of Ukraine and the fact that Germany is heavily reliant on green energy and Russian natural gas only further complicate the inflation predicament, although German inflation readings just came in at 8.2% versus 8.6%, so maybe they have “peaked” as well?  


Regardless, the ECB is where the Fed was in late December.  Meaning, they are now coming to grips with the fact that inflation is a persistent problem, and we are in the first inning of likely aggressive rate hikes and deleveraging of their massive balance sheets.  It’s a bit more complicated across the pond seeing that the EU is made up of different countries with different economies and varying rates of inflation.  

Which may explain the increased level of interest in credit default swaps for the PIIGS (Portugal, Italy, Ireland, Greece, and Spain).  The markets are pricing in a .50bps hike on the 21st.


“I don’t think that we’re going to go back to that environment of low inflation. There are forces that have been unleashed as a result of the pandemic, as a result of this massive geopolitical shock that are going to change the picture and the landscape within which we operate.”  – ECB President Christine Lagarde


The latest job data will be out on the 8th this month due to the 4th of July.  It was interesting this month to see that United Airlines approved a 14% pay raise over the next 18 months to help keep pace with living costs.  We can only assume other airlines (and many other companies) will have to follow suit to keep workers satisfied in this still tight labor market, despite a perceived softening economy. All this just adds to the inflation woes Chairman Powell is in battle with.

Staying with inflation, we note that the now all-important CPI number is released pre-market on the 13th


Last month, it came in hot, over 8%, and led to a swift 5%+ correction in equities.  This month we will wait and see how, if any, of the recent decline in commodities and cooling off in parts of the housing and labor markets will have any impact on June’s reading.  The PPI is set to be released on the 14th and the also now-so-important PCE price data will be released on the 29th.

We started positively so let’s finish positively. The chart below shows the Purchasing Managers Index, over 50 is expansionary.  Yes, it has dipped quickly from 64 to 57 but is nowhere near the pandemic levels of 42 or the 2008 crash of 33. And all this after the worst six months for stocks in 40 years, inflation worries, war, and declining consumer confidence.

purchasing managers index