If you have a positive attitude and constantly strive to give your best effort, eventually you will overcome your immediate problems and find you are ready for greater challenges. ~ Pat Riley
No one said this was going to be easy, and it’s certainly not. So far this year there have been few, if any places to hide. The fixed income markets have been eviscerated to the likes of which we have not seen in decades, and it is the most underreported story of the year, at least for financial news. Investors suddenly find themselves in an environment void of any shelter and it is wreaking havoc with pension funds and traditional 401ks that offer little variety in their investment choices and are also traditionally laden with a decent-sized bond weighting.
Even conventional cash these days provides little solace when inflation is taken into consideration. Using a 2% savings rate and a 7% inflation rate (both generous rates), one is still losing approximately 5% in savings power or purchasing power. Which is why inflation is so brutal on all fronts and has become public enemy number one for the Fed.
We have been getting a lot of inquiries lately about where exactly investors can put their money right now in order to not only get some sort of return but also to have a sense of safety. It’s a tough question to answer and one that elicits responses that obviously come with many nuances. But we will try and answer the question here and hope it serves all who are reading, or at least shine a light on where our thinking is for the next few years.
For starters, there are no risk-free assets to park money in. Bonds this year are a painful reminder of that and even back in 2008 we saw money markets “break the buck” as the commercial paper market disintegrated. There are obviously varying levels of risk, which are constantly changing as evidenced in 2022.
The fact that stocks and bonds are moving down in tandem and are down an average of 10% combined so far in 2022 is certainly something most investors are not used to and as we have repeatedly mentioned is laying waste to the “60/40” model that is engrained in so many.
This is nothing new and something we have been saying all this year. But now, as we find ourselves 1/3 through 2022, we feel the realization has set in. Meaning that the disgust and hopelessness many are feeling with the current markets (and world) are permeating the investment community and the retail world as well.
As we mentioned in one of our notes this month: Bear markets don’t scare you out, they wear you out. They drift lower seemingly every day and then are punctuated by sharp rallies that inspire hope- only to be reversed quickly and resume their dreary path lower. Eventually, worn-out participants just surrender and sell to avoid the daily pain. That is how bottoms are formed.
This month in particular, the bear market characteristics we are describing were on display in April and particularly highlighted on April 26th; that was the day after both the S&P 500 and the Nasdaq put in meaningful reversal bottoms after days of consistent selling, only to see all those gains washed away in the in the first few hours of trading the following day. Thus, quickly dashing any hopes buyers had of catching a meaningful bottom and now having to face now even deeper losses. Only to reverse sharply again on the 28th, after making lower lows across the board and likely forcing recent buyers out.
It is this exact type of action that exemplifies why investors are wearing out. It was a classic bear market trap and likely caused some real damage to aggressive individuals. At some point, when the market has dashed almost all hope, we will have a meaningful sustained rally that many will be caught watching from the sidelines as they sold out near the bottom.
The market’s job is to frustrate the maximum number of people the majority of the time. That’s why it is so hard – and so potentially lucrative. Like it or not, the markets are doing exactly what they are supposed to be doing and it’s been perfectly reflected in investor angst.
We all need to recognize this and accept it. That doesn’t mean to give up or accept poor performance, but more so to accept the environment we are in and recognize the potential ill effects and opportunities that will emerge.
April was the worst month for tech since 2008 and is now down 23% year-to-date. We are in an adult swim market and that’s not changing anytime soon, if ever.
As we said, the bond market has essentially crashed this year and is off to its worse start to the year ever. Let that comment sink in for minute. The perceived safety valve of practically every balanced portfolio has crashed and burned in just four months’ time. And this is before the Fed has raised rates significantly and begun to taper their balance sheet.
Obviously, the markets are pricing this to some extent and since it is the first time in history that the Fed is attempting both endeavors, the markets are having a tough time trying to figure levels which reflect that.
Which could be construed as good news for the bulls. Meaning, that markets tend to overshoot on the upside and downside as emotions and margin selling take over rational thinking.
So, if we indeed are seeing an overreaction to the Fed policy or China lockdowns, or overblown inflation fears, then we could be setting ourselves up for a huge relief rally. This makes the next Fed meeting on May 4th one of the most important in recent years. Not so much for the raise, 50bps is expected with a possibility of 75bps. But much more importantly for the verbiage surrounding future rate hikes and when and to what degree the Fed plans on attacking their grossly bloated balance sheet.
2022 is and will continue to be a tough slog for investors. We are in the early innings of a long due hangover emanating from the Fed party that went on way too long in our opinion. We will come out of all this with a more sane, rationally priced market. And with less debt and better fiscal discipline (hopefully)
The US private sector sits on more than $35 trillion of debt and mortgage rates and corporate bond yields above 5%. This will have a major impact on the system.
“I cannot foresee any scenario at all where you’re not going to have a lot of volatility in markets going forward,” “Q.T., inflation, war, commodity prices. There’s almost no chance you won’t have volatile markets.” –JP Morgan CEO Jamie Dimon
There are essentially four headwinds facing the markets right now. Let’s look at them and give a status report per se:
1. The Fed and its rate raising campaign along with the balance sheet tapering. This is a huge bogey to the markets and is not likely to dissipate anytime soon.
2. The war in Ukraine. Not likely to dissipate anytime soon either and has the real threat of widening out to other regions. Which would obviously be terrible for the world.
3. Inflation and its ill effects on both Fed policy and the possible consequences of slowing the economy via demand destruction. The Q1 GDP came in at a -1.4% which was woefully off the mark.
4. The strange goings on in China regarding massively restrictive Covid lockdowns near some of the busiest ports all while the rest of the world lives more covid free every day. The conspiracy theorists think it’s an attempt to ramp up US inflation and damage our economy. Maybe, who knows. But inflicting purposeful pain on your biggest customer seems counterintuitive to us.
Four large headwinds without any clear resolve anytime soon. These are what are facing the markets right now and it’s a gigantic wall of worry to climb, and one that they have not maneuvered well in 2022.
At some point, the above inputs will be priced in (although Russia seems like a permanent wild card now). We will get more clarity from the Fed on the 4th which could really go a long way to stabilizing the markets. Also, any break in the Covid restrictions or tepid inflation readings will ease some concerns and could lead to a nice relief rally. A Russian cease-fire would likely pop the market up 10% – but that doesn’t seem plausible anytime soon.
However, before we come out on the other side, we will have to endure some more pain. The good news, and, yes, there is good news, is that the number of opportunities lining up is astronomical in non-traditional areas. The markets are changing character and those who recognize it will come out of this better than where they entered – but it’s going to be a painful fight.
It’s becoming clear that the immediate future of better returns is in the alternative space. That is not only us talking our book, but it’s substantiated by facts as the graph below clearly shows.
Boston Consulting Group points out that the $15 trillion currently managed in alternatives accounted for only 15% of total assets under management, but 42% of the industry’s revenue. That is expected to rise to 46% cent by 2025. No other asset class is projected to grow that much in the next 2-3 years. Not even close.
As we have hopefully made clear with our missives this year, the environment has changed, and one must change with it if we expect any type of respectable return in the coming years. There are just too many variables for that to make the traditional way of thinking viable for future gains, particularly outsized ones. The overwhelming catalyst being the change in Fed policy and the fight against inflation.
We wanted to highlight a graph to show everyone just how early we are into the alternative asset game and how there is so much more room to run in the coming years. The current assets under management are approximately $12.9 trillion; that is expected to grow to close to $17.5 trillion by 2025.
We would just simply ask that with the current landscape and knowing that in that same time period we will be dealing with a hawkish Fed, is there a better area for growth anywhere than alternatives?
Alternative assets are in the early innings of a long, profitable game.
We aren’t claiming it will be an easy game to win. But the old way of playing isn’t working anymore and is inflicting some real pain thus far in 2022.
We stand by our comment that the best growth stock for the next 3-5 years is alternative assets.
The cryptocurrency market continues to meander through a lower trading range. The enthusiasm and volatility have both been vastly reduced. Part of the reduction of volatility has to do with 2 factors: 1) the Redditt or retail type traders have lost their enthusiasm (and capital) to move these thinner markets around. 2) and most importantly – the institutional crowd has continued to seep into this space and that has added liquidity and volume and tightened spreads. Both factors that have helped “mature” this market and lessen the wild price swings.
This month Fidelity announced 401k participants will soon be able to invest in Bitcoin via their retirement plans. This move could enable millions of people to invest in the digital asset without having to set up separate accounts on a cryptocurrency exchange. We would imagine many other players in this field will follow suit soon rather than lose potential business to Fidelity.
Also, Goldman Sachs announced they were offering Bitcoin-backed loans for the first time ever. There will be others to follow given how good the margins should be there. And, despite the pullback in private equity funding, it doesn’t seem to be hitting the crypto space yet according to an April report out by Genesis Global.
One area that has not fared well lately is the NFT market. Coinbase reported that they had less than 900 transactions in the opening week. Also, prices of some NFTs, particularly Jack Dorsey’s first tweet which was originally offered at $48 million and is now offered at $280, are down as much as 80% from their peaks only a year or so ago.
Despite more examples of good news in the cryptocurrency world, the assets continue to meander at their lower end of their trading ranges. There has been a correlated pattern between tech stocks and Bitcoin in recent months and we don’t see that changing anytime soon. Also, it’s hard to see Bitcoin and other digital assets moving back to their highs as long as the Fed continues to raise rates. The same could be said about the precious metals despite the insistence that they are the “perfect” inflation hedge.
The alt-coins are also dwelling near the lower end of their trading ranges and offer little in terms of excitement or opportunity lately. We continue to monitor a few of our favorites such as: Luna, Crypto.com, and Stellar.
We are frustrated, bewildered, and just plain worn out trying to figure the metals out. They make impressive run-ups and just when they look to be breaking out they plunge a quick 10% lower. After a nice few profitable months the past 6 weeks have been costly and frustrating. We have flattened out our positions into May and will likely take a break from that area for a while or until a real meaningful technical event takes place.
Our long national nightmare has finally ended. Twitter is going private (maybe). Without a doubt one of the most frustrating stocks/companies we have ever embraced has agreed to be bought by Elon Musk for $54.20 per share. We still contend that it’s selling at too low a price and is worth at least $100 billion, not $44 billion. But, we have been saying this for years now and have been proven incorrect.
It will be interesting to see what Musk, who is a wildcard for sure, has in store for Twitter? Subscription model? Edit button? Allow Trump back on the platform? Also, how many employees will be retained or will stay on? There are already reports of dissatisfaction amongst employees regarding Musk and he doesn’t come off as an owner who is going to show much sympathy for employee “feelings”
It’s sort of sad to see Twitter go as a publicly traded company. Not that we had much success with it (we didn’t), but it would have been nice to see this all play out in the public forum rather than a private company that isn’t required to disclose financials.
Twitter currently stands at $49, and the buyout price is $54.20. Some would suggest owning it here and waiting for the deal to close is “free money”. Very well could be. But we don’t like locking up that much capital (deal could take 6 months to complete) to earn a small spread. Also, the options market has not surprisingly priced in the $54.20 price
Also, with all the political wrangling that surrounds Twitter these days and all the free speech arguments it creates, we would not be surprised to see some serious brushback by the Democrat-heavy Congress to attempt to block Elon Musk from having unchecked reign of one of the biggest social media platforms in the world. That is a fight we want no part of with our time or capital. Also, Musk has a history of getting excited about projects and then losing interest. It should also be noted that he has a $1 billion break-up fee to pay if he does indeed walk away.
Also, Twitter released their earnings on the 28th and disclosed that they have been overstating their users since 2019. Not a great piece of information to hear when spending $44 billion.
We would also guess that at some point Musk will look to take Twitter public again via an IPO. If he can finally find a way to monetize this powerful platform, make it less of a cesspool of hate, and change the management/culture it could come back as one of the hottest issues in a while. Time will tell.
One very interesting derivative of this buy is how it is going to affect Tesla’s stock price. Musk has allegedly pledged $12.5 billion in Tesla stock to help finance the Twitter purchase. This has led to some intense selling pressure lately on Tesla stock – it fell 11% the last week of April. Part of that selling was also likely due to some redemptions coming in from the ARK funds – which are down 49.6% YTD and their largest position is indeed Tesla.
Looking Forward and other Market Commentary:
Without a doubt, the biggest event of May will be the Fed meeting on the 4th. We have touched upon that enough on the pages above so will just reiterate that the verbiage is the key to the meeting, not the actual hike which everyone has likely priced in.
There are no other big central bank announcements in May. The ECB and BOJ had their meetings in April and are off until June. June will be a HUGE month for central bank policy, but we will deal with May first before we worry about June.
The jobs report on the 6th will be highly scrutinized seeing that the yield curves have been contracting and un-contracting for the last several weeks throwing economists in a tizzy and spurning much macro debate. So, every bit of economic data is being extra scrutinized these days.
However, the main economic data event these days are the CPI and PPI releases. They will occur on May 10th and 11th, respectively.
Fed Funds Futures continue to expect aggressive US central bank monetary policy. The odds of a 50-basis point increase at the upcoming May 4th meeting are still 94%. The odds of 75 basis points at the June 15th meeting sit at 70% . By the end of the year, Futures still expect Fed Funds will be higher than 2.50% (61 pct odds).
The July futures are pricing in an 86% chance of a 50+bps hike and see the Fed Funds rate at 2.25% by then, which is 175bps higher than today.
This would place the Fed Fund Rate at 3.25% to 3.5% one year from now, all while probably knocking more than $1 trillion off of the balance sheet. Keep all that in mind when people advocate buying dips. We live in a new world now – adjust.
“Earnings don’t move the overall market; it the Federal Reserve Board…focus on the central banks and the movement of liquidity. Most people are looking at earnings and conventional measures. It’s liquidity that moves markets.” – Stanley Drukenmiller
Earnings aren’t done and actually there are a large number of companies we are very interested in hearing from. Specifically: Airbnb, Square, Trade Desk, Snowflake, Uber, Shopify, Datadog, MongoDB, and Zscaler – to name a few.
We will have a full earnings recap in the May Update after everyone has reported and we can sift through the winners and losers and generate some ideas. But, according to FactSet, 55% of the S&P 500 has already reported first quarter performance. 80% of those companies have beaten earnings expectations, while 72% beat on sales.
Google reported some unspectacular results on the 26ty. After recording record revenues in 2021, they are off to a slow start in 2022 (theme here?). Surprisingly, You Tube was a real drag on earnings, missing estimates for the second year in a row. That,
combined with the Netflix disastrous quarter in which they lost 200k subscribers, has us wondering if the whole streaming services story has worn out its welcome or is Tik Tok the new Netflix?
CNN+ shut down its streaming launch after just 30 days and took a $250 million loss. Amazon’s Prime’s numbers were fine, but uninspiring. We would surmise that cost-cutting is coming hard and fast to the content world.
Paramount reports on the 5th, we would be surprised if they have any good things to say about streaming given the above news, but we will wait and see before judging.
There are some real positives in this “new” financial environment we now dwell in. One is the rebirth the always important but often overlooked staple stocks, energy stocks, mining stocks, steel stocks, and agriculture stocks. As much as we like following and trading tech, there continues to be ample opportunities in other areas. That has expanded the playing field immensely and created a swath of new opportunities. That is a good thing.
Visa reported a blowout quarter on the 26th and hopefully put some recession fears to rest- at least for a while. They beat their earnings by $0.14 and saw revenues climb by 25.5% year-over-year. But it was the commentary that was encouraging. Visa said global payments have remained strong and stable relative to pre-Covid levels and that they continue to see robust recovery in the travel sector, a theme that jives well with commentary from the airlines this month.
In fact, Visa said they have not seen decline in spending at all thus far in 2022 and don’t project that to change in the immediate future. Once again proving that betting against the consumer is a tough bet to win.
Discover Financial and Mastercard echoed similar sentiments in their reports also released the last week of April. Further proving that the anecdotal economy is likely a lot stronger than the markets are currently reflecting. At least with regard to consumer spending.
But then Amazon came out and said Q1 revenues were the slowest year-over-year growth rate in company history?
This is one of the most confusing times in years to try and judge the health of the economy. Consumer spending seems good, or is it just pent-up Covid demand? Is inflation tamping down demand? What are bond yields telling us and how much of it is actually Fed policy versus economic statistics? Jobs are plentiful and wages are rising. But then why are equities so persistently weak?
We don’t pretend to have the answers and are more focused on price action as our guides. But it sure is causing a lot of head scratching.
Is the Yen the ultimate canary in the coal mine for central bank policy? The yen has fallen a stunning 24% against the dollar already in 2022. This may seem irrelevant to many, especially the retail crowd, but what it does do is affect is our treasury market. The Japanese are some of the biggest buyers of our bonds, especially seeing that their 10-year JGB yields a paltry 0.25% (which they have capped) compared to almost 3% for the same duration here.
The BOJ is playing a dangerous game of yield control curve and using their currency as fodder for it. Apparently, for a nation that relies heavily on imports, they aren’t too worried about inflation, which seems odd.
But a weakening yen forces Japanese investors with dollar-denominated assets to have to pay more to hedge against the risk of currency fluctuations. Not a great time to lose a large buyer of US treasuries while the Fed begins to pare (sell) off their massive treasury holdings. And it’s pretty safe to assume Russia won’t be a much of a buyer either.
Assuming the budget deficit doesn’t change, there are about $1 Trillion new Treasuries coming into the market each year. Now, combine that with a Fed balance sheet runoff of $90 billion a month and there’s about $2 trillion Treasuries coming into the market each year. Who will the buyers be, and will this supply/demand potential imbalance force the Fed to reverse its course? And if they do reverse course for that reason (dearth of buyers) will that be construed as a positive or negative for the markets?
We would view it is a negative because it would effectively prove that the Fed is now trapped in this liquidity bubble they created, and the bond market is now in control. Akin to what the yen is doing to Japan.
But it’s not just the yen that is falling wayside to the dollar. The euro is down to 105 versus the dollar and the Swiss Franc is barely above 103. In fact, the best performing asset in 2022 is the dollar. The textbooks would tell you a strong dollar would be a negative for commodities, but anyone who has been to the grocery store or gas pump this month would surely dispute that.
However, the dollar is wreaking havoc with emerging country stock markets; they are down double-digits across the board.
Keep in mind that the majority of global financial crises in history have begun with the currency markets. Most notably the Asian “tiger” crisis in 1997, the Russian Ruble crisis of 1998, and the Venezuela crisis in 2016.
“This is the currency market vigilantes coming for the Bank of Japan” – Chris Verrone, Strategas Securities
We will end the Update with a chart of Yen/Dollar cross.
Keep in mind that is a chart of the currency of an economy which ranks 3rd in the world.
There isn’t going to be a return to normal for quite some time.