Chaos and confusion were the unfortunate themes for February as 2022 continues to exhibit increasingly volatile characteristics, highlighted this month by the Russia/Ukraine crisis which has commandeered all the headlines. We won’t pretend to be Russian experts in the pages below or have claim to any geo-political insight that one couldn’t get from reading practically any news source online.
But what we are focused on is how it has affected various commodities, currencies, and rates. The obvious one being energy. Russia and Ukraine are both large providers of oil and natural gas and the recent events have pushed prices understandably higher. Also, Russia produces 1/3 of the world’s wheat and 1/5 of the world’s corn and makes 80% of the world’s sunflower oil. Russia also is a big producer of fertilizer, and the surging prices have led to much higher grain prices globally.
In normal times this all would be a minor inconvenience, but in this central-bank- inflation- fighting obsessed world we find ourselves in a Russian/Ukraine skirmish that sprouts many more negative tentacles than it would during more sedate times. Also, adding to the woes is the fact that a heightened global skirmish – if it does come to that, would wreak more havoc on the already fragile supply chain issues we are just starting to thaw from and fuel more inflation.
This latest headline just another complicated layer in what already is a very problematic year. The above-mentioned war on inflation and the now-hawkish Fed were giving us plenty to chew on through the first two months, but now we have geo-political strife to contend with on a seemingly hourly basis. All championed by a leader who is increasingly showing unnerving signs of mental instability.
But this is what we signed up for so there’s no point in complaining about all the current odd moving pieces the world continues to throw at us. As we have repeatedly said, this unsure environment has created tremendous volatility which in theory creates tremendous opportunities. Now, some of the negatives that this new environment has also created is a lack of liquidity and very irrational price action. The thin liquidity being the real difficulty, especially in the commodity space in which we are witnessing some of the most outsized moves we have seen in years.
So, let’s be clear on one thing the whole investing paradigm has changed for the first time since the financial crisis of 2008. Also, this is not 2018 when the Fed tried to go at it alone to normalize its policy but was quickly rebuffed by the markets and kowtowed to them. This time we have global synchronization plus all major banks and runaway inflation to attack. All the factors that were present after the crisis of 2008 are reversing.
Inflation has sapped any purchasing power that investors had and now makes money market funds or fixed CDs seem like wastelands. So, it’s not a big surprise when we come across tidbits like this from Lipper’s:
Investors pulled nearly $160 billion from money-market funds and $17.5 billion from bond mutual funds and exchange-traded funds in the first seven weeks of the year, according to Refinitiv Lipper. The exodus is already on pace to be the biggest in at least seven years
Looking Forward and other Market Commentary:
The main of event of March will no doubt be the Fed meeting on the 16th when they will in all likelihood raise rates by .25% basis points and lay out their strategy for reducing the balance sheet in the immediate future. But before the big powwow we will have some more economic data to ponder that will possibly influence the Fed’s decision starting with the February employment data on March 4th and then followed by the all-important CPI print on March 10th. Last month the CPI showed inflation at 7.4% – which was a 42-year high. Regardless of this month’s result, the Fed is well aware that inflation is their top enemy right now and therefore the print on the 10th, unless it’s dramatically above or below expectations, won’t change the narrative,
Fed Futures are now pricing in the almost 100% probability of a 25-basis point rate hike on March 16th, and about a 71% probability that the FOMC gets in 125-basis points worth of rate hikes for all of 2022.
Interestingly, the ECB will meet one day before the Fed on the 15th. They have also taken a more hawkish tone lately and the debt markets in Europe were taking notice and yields had been on a steady move higher, highlighted by the German 10-year Bund which switched to a positive yield for the first time in two years. But the onset of war has forced yields globally to retreat quickly. The US 10-year went from a high of 2.06% to 1.80% where it resides now.
Also, on the 17th the Bank of England will meet and is expected to raise rates another quarter point as it did at the last meeting. So, we will have three straight days with the three most influential central bankers on the globe all theoretically stating their hawkish cases and need for further tightening. The multi-trillion question is much closer to an answer than ever before.
The ironic part of all this is that the various markets were beginning to adapt to the new hawkish Fed/global policy that we have been harping on since late last year, but all that was violently disrupted by the Russia/Ukraine crisis. So now we find ourselves in a bit of a “macro hell”, meaning that we are undergoing massive changes in both monetary policy and geo-political repositioning. Both of which are experiments without any great historical precedents to use as guidelines for just how this all ends.
Some feel that the Russian invasion of Ukraine is a dress rehearsal for China’s inevitable attempted takeover of Taiwan. If, and it’s a big if, this were to occur, and it turns out that Russia and China are indeed partners in re-setting the global map, then the world has a political crisis the likes we have not seen in decades. And with that (again, hopefully not) the pricing of all assets will be seriously re-adjusted and the one thing markets hate most – uncertainty – will be at the forefront of every buy and sell button on the planet.
We are not predicting this or expecting it really but do have to admit that it’s a possibility. Many “experts” believed when the rumblings began about Russia invading Ukraine, it was just a ploy for Putin to garner some attention and help the price of his country’s biggest asset, oil. But he defied the experts and marched right into Ukraine after blaming the US and NATO for forcing his hand. The point being that maybe this all is a lot more than posturing and more so the beginning of a long-term mission.
Many are now wondering what this means for the Fed and their meeting on the 16th of this month? The Fed Funds futures have essentially priced away a 50-basis point hike but have now guaranteed a 25-point hike. As much as the Fed would probably like to pull back and stay on the sidelines until these global issues are resolved, the overwhelming thorn in their side remains inflation. And, with this latest skirmish we have seen drastic upside moves in crude, wheat, soybeans, corn, natural gas, and palladium. These are all essential inputs for everyday use that will add further pain to the consumer dealing with higher living costs across the board.
That’s a long-winded way of saying that the Fed, and other central banks, simply can’t ignore the inflation genie that has most definitely escaped its bottle – war or not. All this makes the meeting on the 16th and more importantly the press conference after one of the most important days of the year, and in recent years.
Bitcoin Update:
Bitcoin and most other tokens continue to lag and demonstrate bear market characteristics. Meaning, weak bounces met by consistent selling. The charts of most of the tokens we follow are admittedly broken as are all the equity plays related to crypto: Coinbase, MicroStrategy, Riot Blockchain, and Hut 8 mining.
We surely sound like a broken record every month as we highlight all the positive news we are seeing in this arena and then see how poor the price action is surrounding it. Which makes us wonder 1) Are we ignoring the fact that price action and the news are in complete disagreement, and we are kidding ourselves? Or 2) Is the market simply not incorporating all these positive developments and has massively mispriced the assets?
News like this for example:
Venture funding in 2021 went parabolic in the crypto sector as VCs continue to place big bets on bitcoin and crypto companies. The crypto industry received more than $30B in funding across 1,700 deals in 2021, which represents a 709% year-over-year increase in total funding.
Or this:
The big development in the crypto industry yesterday was that KPMG, one of the big 4 accounting firms, announced that they have purchased bitcoin and Ethereum for their corporate treasury
Also, this month Blackrock, which has over $4 trillion under management, announced they would soon be offering a crypto trading service due to high customer demand. Additionally, legendary venture capital fund Sequoia announced they are raising between $500 and $600 million for a new fund that excessively focuses on cryptocurrency startups. This after last year when they allocated 20% of all new investments into the sector. Sequoia has previously purchased shares and tokens in cryptocurrency projects through investments in DeSo and data storage network Filecoin.
Citadel, the world’s largest market maker, said this month they would be “engaging in the making markets in cryptocurrencies” in the coming months.
Coinbase, in their latest quarterly report, said that institutional clients traded $1.14 trillion worth of cryptocurrencies in 2021. Up from just $120 billion from the prior year and more than twice the $535 billion traded by retail. Which aids our thesis that the crypto market is maturing monthly and becoming more of an institutional landing place.
So again, more and more good news continues to flow into the sector and the price action for the most part remains underwhelming. We view Bitcoin as more an investment than a trade, so patience is required. However, we are finding ourselves more actively trading the crypto themed equites and Bitcoin futures due to the favorable levels of volatility.
But there is one negative take on Bitcoin that we must confess to, and it became very apparent after seeing the swift adoption of Bitcoin as a currency in the Ottawa trucker protests and the Ukraine invasion. There is no arguing the US wants the dollar to remain the world’s reserve currency and maintain all the benefits that come with it. With that being said, it’s in the government’s best interest to not let Bitcoin continue to slowly eat away at the dollar’s credibility. Granted, Bitcoin is not a US product, it’s global but has been banned or restricted in some countries such as China and Iran. It’s hard to see how the government could severely restrict or outright ban Bitcoin given the massive global adoption and the fact it now rests on many American companies’ balance sheets and treasuries.
But anything is possible as we all know, and US has a strong incentive to keep the dollar on top. We are already seeing China form a digital currency and could see the same from the ECB at some point. There is no doubt that during the next few years we will all be engrossed in a high stake’s currency war – digital or not.
Sticking with tokens. This month we initiated a small position in a token named tZero. tZero was a spinoff from Overstock.com but now is a stand-alone subsidiary that operates a SEC-regulated alternative trading system and broker dealer for the issuance and trading of tokenized stocks.
On February 23rd the Intercontinental Exchange or ICE invested an undisclosed amount into tZero (rumored to be $30 million). This gives tZero some instant credibility and will likely lead to further partnerships with trading giants as the shift to blockchain-powered business becomes more embraced. This is a rather illiquid investment hence the reason it is small. We may look to add on an unwarranted large dip but for now are content with a starter position as we try and expand our investment horizon.
We will further detail our tZero investment in next month’s report.
It’s time for Bitcoin and the whole cryptocurrency space to get out of its funk and prove themselves as a worthy asset class. The unfortunate situation in Ukraine is ironically the perfect catalyst to spring to life. The test for Bitcoin as a store of value and an alternative to traditional currencies is right in front of us. This combined with all the good news we have chronicled in these pages serves as perfect fuel for a surge higher – possibly back to all-time highs. We added to our Bitcoin theme using some derivatives in the form of the Bitcoin ETF and Hut 8 mining in hopes that this challenge is met.
The metal complex came to life in February after seemingly years of underperformance and max frustration for the gold bugs (of which we are not). Many have assumed that higher yields and Fed rate hikes should serve as a negative for metals. But the price action has vehemently disagreed as of late and this month we saw gold rally nearly 5%, silver +5.7%, and the miners leapt 11.9%
Part of the jump was due to the Russia invasion headlines and the predictable flight to safety. But more so the move was predicated on the real fear of inflation and the perceived safe haven that it has acted as in history. We have been long silver, and to a lesser extent, gold for a good portion of 2022 and this month we were finally rewarded with a sharp move up.
There has been much debate, especially in the Twitter verse, between gold and Bitcoin as the true inflation hedge. And so far at least in 2022 gold has won the battle. Gold is up 7.9% YTD while Bitcoin is down almost 10%. We don’t necessarily view Bitcoin as an inflation hedge, more as a new way to conduct business and less reliance on bloated government balance sheets and irresponsible policy. But that doesn’t mean we won’t participate in a metals rally or trade the mining stock ETF.
There is absolutely no reason not to participate in all these markets regardless of any logical edge you may perceive you have.
It’s good to see the metal complex back “in play” after years of lethargy. It’s our opinion that we will likely see higher prices this year than where they currently stand in spite of a tightening Fed and possibly higher yields. The caveat being if inflation suddenly plunged -which unfortunately is not a scenario many foresee for the immediate future.
As for stocks, they obviously have had a rough go so far in 2022. But there are a few bright spots to point out. For example, the S&P 500 should have no problem earning $240/share this year. At an 18x multiple that makes for an S&P 500 at 4,560, which is right where we are trading. If markets can grow to believe $240/share is a reasonable baseline, then there is upside to US large caps.
Just keep in mind, from June 2004 to June 2006 Fed Funds went from 1.00% to 5.25%. There was a total of 17 rate increases across this period, each 25 basis points and the SP-500 rose over 30%.
Also keep in mind however, from the summer of 2016 to the fall of 2018, 10-year Treasury yields jumped from 1.4% to over +3.0% yet the NASDAQ was still able to increase by over +45%.
If anyone is wondering how stocks fare during global strife, we have some answers in the graph below. The quick answer is better than many probably expect.
A name that has piqued our interest as a longer-term holding is Viacom. They are an under-the-radar company with a tremendous streaming library that feels like the market is ignoring and certainly undervaluing the content, especially when compared to the Netflix valuation. Viacom’s market cap is currently $18 billion, and it trades at 9x current earnings estimates. That market cap is about 1/10 of Netflix, which trades at 36x earnings.
Viacom reported earnings on February 16th and missed estimates by a wide margin. But they have decided to beak-up the company into 3 segments: Streaming, TV Media (CBS, Nickelodeon, and Filmed Entertainment. Much like Disney did in 2020.
The company is targeting 100 million streaming subscribers by 2024, up from a previous goal of 65-75 million. They also project direct-to-consumer revenue to hit $9 billion by 2024, up from $6 billion.
The stock has never recovered from the Archipelago debacle as the chart below clearly shows. But with a promising streaming library (Yellowstone being the current hit) combined with the marked undervaluation for a list of impressive assets (Nickelodeon come to mind) we think this stock, that pays a 2.7% dividend to boot, is worth a look as a longer-term hold. It’s not really our style to hold stocks for a longer term. We are more in the moving business than the storage business. But this is a very interesting situation surrounding an area we likely all agree will have continued surging demand going forward (streaming).
We could also see this company as a nice fit for an Apple or Amazon. Two companies that have their own streaming services but lack the content needed to compete with Netflix. At $9 billion it seems like a cheap way for one of these deep-pocketed companies to instantly become a much larger competitor to Netflix.
We have often harped on just how bad the underlying action has been for individual stocks, particularly last year, but as we continually survey the landscape the sheer destruction in some individual tech names is stunning. Here are some examples:
Roku – 67% from highs
PayPal – 65% from highs
Block – 54% from highs
Draft Kings – 61% from highs
Beyond Meat – 68% from highs
Roblox – 59% from highs
Palantir – 53% from highs
On a more general level: 70% of S&P 500 stocks are now down 10% or more from 52-week highs. Of these 350 stocks, almost 60% are down more than 20% from 52-week highs. Statistics like these seem to always escape the financial TV anchors.
The path of destruction even seeped into the well-known bigger cap tech stocks that have shown such resilience over the past few years. Facebook saw its market cap drop by a stunning 23% in one day after reporting less than stellar earnings on the 3rd.
Google reported blow out numbers when they reported on the 2nd and announced a 20:1 stock split – and have been rewarded with a 9% drop since. Again, these types of moves suggest we are in a much different environment than 2021. Adapt to the changes.
Occasio Partners, LLC 465 California Street, San Francisco, CA