It’s hard to think of a month more depressing than the one we just went through. Sentiment is at laughable extremes of bearishness. The mood amongst traders and investors is downright apocalyptic. And the price action in just about every asset on the planet (ex., the US dollar) coincides with the melancholy.
However, October has a history of being a bear market killer, the Fed may be nearing the end of its rate rampage, inflation may have peaked (chart below), and the upcoming earnings season may not be as dreadful as many are already pricing in.
It’s just too easy to be bearish right now, but too scary to be long. The caveat is accurate if the central banks really have “broken” something in the world’s financial plumbing. The sudden shift of bond buying in the UK to bail out pension funds this month certainly falls in that category. October will be very telling.
The trading environment remains fertile, yet very tricky and treacherous. There is no urgency to begin building any long-term positions at this juncture. The current landscape favors those with short time frames and tight stops. The odd behavior and verbiage emitting from the world’s central banks have us, and everyone else on edge.
This is no time to be a hero. We won’t catch the bottom, nor will we try. But we will protect assets and hunt out quick trades to take advantage of the volatility – which inexplicably still has not registered 40 on the VIX.
Fed Fund Futures are pricing in another 125bps of rate hikes with two meetings left in 2022. Which would place the Fed Funds target rate at 4.5%-4.75% by year’s end. How much of that is priced now or how much of that will actually take place is the overriding input for the final quarter of 2022. If you’ve always wanted to live in interesting times-you’ve got it.
Yes, it’s tough out there for sure. But it’s not supposed to be easy, or everyone would do it, as they say. However, before we go on with this update, we want to reiterate a point that hopefully everyone will take to heart:
The trading environment and the formation of opportunities are as good as we have ever seen. And the ability to produce solid returns in the coming years has never been better. Not in spite of the current environment, but because of the current environment.
Fed Cred: We are now hours into the final 25% of 2022, and what a 75% it has been thus far. Those who thought the end of the pandemic would provide some serenity and stability to the world were sorely misguided in 2022. The heightened volatility and prominent drawdowns in just about every asset class on the planet were, at least in our (strong) opinion, caused by the reversal in policy by the Fed and other developed countries central banks. Yes, we are well aware that we sound like a broken record highlighting Fed policy ad nauseam. But we have heard too much on financial television and, anecdotally, we have heard too many conversations out and about that lay the blame for this year’s bloodbath on other exogenous factors that we feel are misplaced.
Hey, maybe we are wrong and reading the tea leaves incorrectly. It sure wouldn’t be the first time – nor the last. But rates equate to the cost of capital and that has risen significantly in 2022. The highlight of September was…wait for it. The FOMC meeting on the 21st in which the Fed raised rates by 75bps and retained their hawkish stance to try and stamp out inflation or at least bring it down to responsible levels.
Here are 3 bullet points we took away from the meeting and the press conference that followed:
“I make a living supposedly forecasting changes in the economic environment and financial markets and with the caveat that I have been doing this 45-years and between the pandemic, and the war and the crazy policy response in the US and worldwide, this is the hardest environment I have ever encountered to try and have any confidence in a forecast six to twelve months ahead. – Stanley Druckenmiller, 9/26, on CNBC
What we are seeing currently unfolding in front of our eyes on the global stage are the bond markets finally taking away the printing presses from the developed central banks. It is most prevalent right now in England where panic selling in the Gilts and Pound have left yields at 4.1% and the Pound/dollar cross currently at 1.13 versus 1.40 just weeks ago.
The disorderly selling was really the recognition that the big supply of debt that will have to be sold by the government is much too much for the demand to soak up. You can take the above sentence and apply it to the ECB, BOJ, and to a much lesser extent the Fed. So far, the BOJ has been the most resistant to change and has really been proactive in keeping the yields on the JGB in a tight, controlled range – better known as yield curve control (YCC). They also intervened in the currency markets on September 23rd for the first time since 1998 to try and stem the ongoing destruction of the yen. Thus far, the level of intervention has held (around the 146 level), and it will be a real signpost for the macro stage to see if indeed government interventions can still command the respect they used to when attempting to support prices artificially.
There was much speculation this month that with the unrelenting dollar strength and the ill-effects it creates for US multinationals that the treasury or Fed may attempt to jawbone our currency lower to relieve some global pressures and stem the volatility. But that is a pretty rare event, and we doubt we would hear anything out of Powell or Yellen unless the dollar really ramped up from here to the 1.50ish level on the DXY index.
Back to the main point, and that is that the global bond markets are in a revolt against past policies and are shaping the future in a truly unruly fashion. Global yields are surging and the cost to service the massive debt created (out of thin air) has reached uncomfortable levels, which has taken a tremendous toll on most currencies, namely the Euro, Pound, Yen, and Yuan and has led to a tremendous flow of capital into the dollar.
The simplistic theory behind this flow of capital is that the US has become the cleanest shirt in a pile of dirty laundry. Which is evidenced by the dollar’s strength.
Bear markets don’t scare you out – they wear you out. And this current one sure is displaying some classic wearing out characteristics. Morale is low, to be kind, and sentiment is as skewed as we have seen in years. Be it the AAII polls or put/call ratios, the numbers are overwhelmingly bearish – and are getting more negative as prices falter.
Daily Sentiment Indicators (DSI) is a metric we follow daily. It’s a simple ratio from 1-100, with 100 being the maximum overbought and 1 obviously being the most oversold. This month, we saw the SP-500, Nasdaq, and 30-year bonds all register DSI’s of 5. A number we have never seen before. Does that mean they are automatic buys there? No, but it sure makes one wary of selling out longs or initiating shorts at such extremes. In contrast, the dollar index, or DXY, registered as high as 94 this month which is also near record overbought levels.
This is just another sentiment indicator that highlights the skewed sentiment. However, this does not mean it’s time to load up the cart and call the bottom. Oversold indicators tend to remain oversold (same for overbought) and can eventually wear off to the extreme levels without producing much of a reversion. It’s hard to imagine a 5 reading on any asset class not inspiring some sort of bounce, but we all need to take into account the current extreme tightening financial environment we are in and the fact that the Fed and other central banks are now working against you in regard to asset appreciation. That fact has been hard for many to accept and grasp and has led to a very, very tough year for the 60/40 model.
The world has been awash in passive investing for a number of years now. Spurred on by easy monetary policy and respectable economic growth, combined with a relatively benign political and societal background, it has been the source of low stress, decent returns.
We aren’t breaking any news here by saying that those days are over. They are. The Fed told you so again this month. The passive party has ended with a thud in 2022 and the hangover is unfortunately only in the early stages. But that does not mean all hope is lost or it’s time to retreat to the sidelines. It isn’t. What is required to prosper in this new environment is an open mind and tolerance for different kinds of risk.
We have gone on endlessly in these pages about how a new line of thinking will allow those willing to acknowledge it a defined edge over others more stubborn. This year, and surely this month, has put that thesis to the test.
Active management combined with new asset classes outside the static stock/bonds will be the way to generate outsized returns in the coming years. And if anyone doesn’t think there are tremendous ways to capitalize on this in the world we are living in, then they just aren’t paying close enough attention.
What are we talking about specifically? For starters, commodities and by default inflation, are no longer a dormant asset class. One that was so disregarded, major banks shut down their commodity trading desks only years ago. Climate change, global strife, and supply chain transfigurements are all aiding to a more volatile ecosystem that will be a haven for active traders for years to come.
Despite 2022 being one of the worst years ever for fixed income, the one positive takeaway is that that market, much like commodities, has awakened from their 25+ year slumber and now are some of the most volatile markets on the globe. Bad for mortgages and certain aspects of banking, but great for active managers willing to adopt volatility and use it to their advantage.
We highlight Bitcoin and cryptocurrencies every month on these pages. And despite the bloodletting that has been 2022, the future in this new asset class is neither dead nor forgotten. It’s certainly mired in a deep, dark, bear market. But there is a future here in some capacity and it will enrich those willing to look past the naysayers and suddenly overwhelming negative sentiment with an asset class that was being cheered the new leader only 20 months ago.
The sudden spike in the cost of capital has and will continue to take its toll on the private equity world. Suddenly, companies that were running business models based on 2.5% rates are now required to run those same metrics at 4% or higher. This is an obvious impediment that will hinder the ability to raise additional capital. Or will it?
These three headlines both appeared near the end of the month:
Goldman Sachs has closed $9.7 billion PE fund – Reuters
Cathie Wood’s new fund gives small investors access to the VC market – CNBC
Apollo said to explore takeover of Ryder System – Bloomberg TV
Who knows what success these ventures will ultimately achieve. But it does reiterate the fact that people are still willing to take risks even with the unsettling conditions that have dominated the landscape in 2022.
The bigger point is that, despite all the negative headlines and even worse awful price action across the board, there is still a great deal of opportunity on the horizon for those willing to look past the immediate signposts and focus on a bigger picture/future.
Bitcoin Update: Let’s begin this portion of the update by stating the obvious, as painful as it is to admit. This has been a lost year for cryptocurrencies and the vast majority of businesses that encompass them. Now, we are aware there are still three full months left in 2022, and anything can happen in this crazy world. But even a sustained rally in Bitcoin, Ethereum, and the altcoins would have few reverberations in the current doldrums surrounding the industry. One clear lesson we have learned this year is that Bitcoin isn’t a 1) inflation hedge 2) alternative to gold 3) replacement for the dollar 4) a differentiated asset class that trades counterintuitive to other asset classes.
These “lessons” have been obvious for some time now, but the hardcore believers have been reticent to admit that their decentralized “come to Jesus” way has just not caught on as quickly or violently as had hoped and has also suffered the fate of other asset classes during a contraction in liquidity. 2022, so far at least, has provided a sobering reality that this new asset class isn’t really any different from the other asset classes it once thought it was.
But, and yes there always is a but, this by no means is meant to sound like an obituary for Bitcoin and crypto currency. Long, rough, often dull stretches are emblematic of all asset classes over a long period. And Bitcoin is only 13 years old (compare that to gold, for example). Bitcoin, and more so the blockchain, are not going away. Despite the lethargic price action currently, the push for both more institutional and retail products continues to grow. Something we have diligently highlighted on these pages for almost all of 2022. Yes, there is a large swath of altcoins that will eventually go by the wayside and melt to zero. Just as there were a large number of internet companies over time that people also rode to zero (anyone remember Ask Jeeves?)
As anywhere in life, the best will remain resilient and outlast the competition. Survivors will pave the way for the future, and in our estimation, which is still Bitcoin – scars and all -it’s also why we have been reluctant to venture into the altcoin arena, and will continue to do so, but we are keeping a watchful eye on: Monero, Sol, and Stellar Lumen.
This month, Ethereum did the following:
- Transitioned from Proof of Work to Proof of Stake consensus mechanism.
- Ethereum is now much more environmentally friendly by reducing its carbon footprint by 99%
- Ethereum’s security becomes more decentralized because now anyone can stake ETH, as opposed to having to build large mining farms with economies of scale.
- The yearly issuance of ETH is reduced significantly, as much as 90%.
All data points are in theory a positive for Ethereum, especially the reduced supply. The response to this news has been a 21% drop for the month. Further confirmation that bear markets act like bear markets, good news be dammed.
Speaking of more good news. This month we once again saw further proof that the demand for exposure is not waning, despite the depressed environment. Fidelity, one of the world’s largest brokers, is weighing a plan to allow individual investors to trade bitcoin on its brokerage platform. They are also partnering with Charles Schwab and Citadel to launch a bitcoin and cryptocurrency exchange. Reportedly, to be named EDX Markets. Big players are going forward with their plans despite the dour state of affairs in the industry. There is a lesson in that.
Lastly on Bitcoin, with all the carnage that unfolded during September, and we aren’t even counting stocks, the price of Bitcoin has actually held up, relatively at least.
After dipping to $18,100ish on the 22nd, it has bounced back to the $19,300-$20,000 level. So, the question we have to ask is…has the forced selling we chronicled this summer with the liquidation of 3AC, Celsius, and some other smaller players finally subsided and allowed Bitcoin to find a floor at approximately $18,000? Also, has the disorderly action in both the world’s bond and currency markets finally steered some capital into cryptocurrencies as a further sign of weakening faith in the central banks?
We are aware that we just stated that crypto is dead money right now. And it likely is, (or hopefully we are wrong?), but it does seem like a floor has been set and if there is a global rebound in Q4 we could actually see a nice rally ensue.
Looking Forward and other Market Commentary: We spent all of September obsessing over global central bank policies and the ramifications of all asset classes, particularly rates and currencies. We are in a world where we can’t tune out central banks for the foreseeable future. But this month it’s time to shift our focus more to the micro side of the ledger and hone in on the immense number of corporate earnings that are about to come across the tape starting in Mid-October and lasting over a month.
The “season” begins in earnest on the 14th when JP Morgan and other large money center banks begin to report. It will be interesting to see their commentary surrounding the sharp rise in rates, (steeper yield curves a positive right?), the loan delinquency rates, and if the credit card metrics do indeed show a weakening consumer demand?
Large cap tech will begin to report the last week of October. All eyes will be on Apple on the 27th for another gauge on consumer strength and if indeed they are planning to go through with their plans on shifting some production to India and cementing further quivers between China and US relations.
The relentless strength in the US dollar is surely wreaking havoc with CFOs across America. We have already heard warnings from Microsoft and Oracle regarding this and surely will hear a lot more grumbling in conference calls in the coming weeks about the lessening competitive environment facing American companies doing substantial business overseas.
In fact, we would not be surprised to hear a litany of complaints from companies in the coming weeks regarding business and, more importantly, outlooks. If there was ever a time for CFOs to complain about business and lower expectations, it’s now. From increased cost of capital and goods to stronger dollar headwinds, to continued hiring issues – we imagine there are plenty of excuses coming down the pipeline for the conference calls that start in a few weeks.
There weren’t a whole lot of earnings reports to dissect this month. But we did want to highlight two companies that are very economic centric to the everyday economy machinations. Both Paychex and Cintas reported stellar numbers on the 28th and raised guidance. Cintas is the nation’s largest provider of service uniforms to hospitals, restaurants, etc. We’ll assume everyone knows the service Paychex provides.
Two earnings reports don’t signal a humming economy. But a wonky warning out of Fed Ex this month, despite the lack of confirmation from UPS, sent the market into a tizzy. We just wanted to provide a different perspective.
The three largest macro scheduled events for October are the same as they have been for months now: The jobs data on the 7th, the PPI on the 12th, and the now all-important CPI report on the 13th. It’s hard to imagine the CPI not coming in a little lighter than last month, especially when looking at the 10Y breakeven chart below, but we will have to wait for confirmation.
OPEC will hold a meeting on October 5th where they are expected to curb production.
A less talked about event takes place on the 16th in China where their leaders will convene for a political meeting in which President Xi will solidify his top ranking and launch plans for a “new economic cycle.” Which translated implies less reliance on the West, less reliance on the US dollar, an end to Covid restrictions? And a push for production of chips in China, among other items. The dollar/yuan crossed over 7 this month for the first time since 2020. That can’t make China too happy.
We earlier touched on the idea that Bitcoin was showing clear signs of bottoming at these levels. Another asset that has frustrated a certain segment of the population (i.e., gold bugs) may have finally found a floor and is ready to make a sustained move higher are the precious metals. We are aware that we lambasted ourselves last month regarding our poor trading in silver. But we also said a poor record with one individual asset doesn’t warrant ignoring it forever.
Gold and silver have performed horribly in 2022 despite the perceived tailwinds. Everyone knows that. But we are beginning to think that with the Bank of England’s reversal from QT to QE announced in the wee hours of the 28th to bail out the pension funds (and maybe Blackrock?) that helped light a small fire under the metals which could lead to a raging inferno if momentum finally returns to this space.
Also, sticking with the central banks has lost the faith of the public thesis, a thesis that continues to gain traction the more we hear comments from various Fed governors and the rapidly changing narrative from the UK, maybe unsure capital will begin to flow into an asset that traditionally is a haven in uncertain times – although it has been woefully absent in providing any shelter for years now. Gold was trading at approximately $1625 when the news hit. Now it stands at $1,665. Is this what bottoms look like?
Interestingly enough, gold priced in non-US currency has performed terrifically in 2022. Up 26.5% in euro terms, and 44.5% in yen. Maybe it’s time for a USD/gold catch-up move?
We have added some gold exposure around the $1655 levels and supplemented the position with some gold ETF October calls. Our theory is once (and if) these metals can get some upside traction it will be both fast and violent and therefore we decided to go with shorter-dated calls.
On the night of the 27th Bloomberg ran a story regarding Apple and its production:
Apple would be telling suppliers to pull back from plans to increase production of the iPhone 14 family of products by as many as 6M units over the second half of the year as an expected surge in demand had failed to materialize. Apple will instead focus on producing 90M handsets for the season, which would be even with the previous year and “in line” with the company’s original projection this past summer.
Apple is 28.2x forward 12-month on 4.8% rev growth and 6.2 earnings growth . Not “cheap” by any means. But it has the biggest moat in world and has immense international exposure
The stock quickly dropped $6 on the news but slowly clawed its way back all day and only finished down 1.27%. Despite this “bad news” the Nasdaq 100 closed up 2% on the day. We would also note that the small cap Russell 2K Index has not broken the June lows like the Dow Jones, S&P 500, and Nasdaq have.
There has been a lot of discussion this month on whether the Fed will be able to “pivot” from their current hardline stance and become more accommodative – which is exactly what the Bank of England did on the 28th. Many pundits on TV are in the camp that they will lose credibility if they attempt such a plan.
What credibility? How does a Fed that spent years trying to get inflation over 2%, then do nothing when it hit 5% last year – calling it “transitory” and now is hell-bent on raising rates to squash it back to this mythical 2% level credible? Their economic forecasts are woefully off the mark and have been for years now, and their policies have without a doubt helped widen the swath of social classes in America. Driving up asset pieces to benefit the well-off while keeping savings rates low and inflation high for those with fewer means.
And now that inflation has gotten out of control, which affects the middle and lower classes much harsher, they are determined to cool the economy, and get the unemployment rate higher which will also take aim at the lower class.
Not a very credible record. And before we all start piling on Jerome Powell, who does deserve some criticism, let’s keep in mind that Janet Yellen, while Fed governor from 2014-2018, during low inflation and record stock prices, and well beyond the 2008 financial crisis, refused to raise rates even 25bps. Rate hikes that could have now been cut during the Pandemic and this year’s turmoil.
The market is short Fed credibility, and a pivot would only reinforce the trade. The price action following a (possible) Fed confession or a US version of what the UK pulled this month in their Gilt market will be truly fascinating to watch.
We have gone from QE to QT to now QC – or quantitative confusion. There is no current credibility with the Fed.
Let’s wrap up with some good news. Despite all the talk of raging inflation, the chart below is the 10Y breakeven, which is closely watched by the Fed. It clearly shows inflation peaking mid-year and has dropped back down to 2-year mid-range. It makes sense when you consider oil, gas, lumber, and some of the soft commodities are down 40%+ from their peaks. We will revisit this chart at year’s end as well.
Also, this stat from Trend Spider might help reassure those who always view October as such a negative month:
October, over the past 40 years, is surprisingly positive on average, even though this period includes the stock market crash of October 1987 as well as the mini-crash of October 1989. Over the past 40 Octobers, the month has closed positive for 25 of them and posted a median return of 1.87% and a mean return of 1.08%.
Finally, we probably should have included this in the Looking Forward section, and as much as we try to avoid this topic, the fact is that the mid-terms are only 6 weeks away and they are expected to draw some of the largest voter turnout ever.
The control of the Senate is hanging by just 1 seat and there are 9 races that will likely be most contentious. They are highlighted by the contests in Arizona and Georgia. Republicans need a net pickup of 5 House seats to take control – it’s the fewest number of seats an out-of-power party has needed since 1932.
There are also 8 gubernatorial races up for grabs on November 8th. But the real test will be how we as a nation actually perform on the 8th. Meaning, will we come together and let democracy do its thing? Or will we continue to devolve into a nation of halves that refuses to cede one iota to the other side regardless of official results?
It’s a test run for 2024 when we will likely face one of our biggest tests ever. Will both sides actually accept the verified results and move on? Or will democracy die a violent death as sacred elections are now rendered null and void?
It’s a scary proposition and one that obviously affects us all. Let’s all hope that the elections on the 8th go smoothly and we set the stage for a civil 2024.