We are now 25% through 2022, and what a 25% it has been. The current market negatives are abundant and very transparent. Let’s list them and then comment on how, or if, they have affected the global markets.
- A hawkish Fed hellbent on raising rates likely up to the 3.0% range on Fed Funds (currently 0.50% after a 0.25% raise on March 16th)
- Continued supply chain issues adding to inflation woes, exacerbated this month by fresh China port cities lockdowns (although somewhat abating here according to the latest LA port data)
- Inflation woes that have permeated all of society, especially at the gas pump and supermarket.
- Yield curves (2s/10s) that are close to inverting – typically a sign of pending recession, but not necessarily automatic lower stock prices.
- The ongoing war in Ukraine. Adding to the inflation woes (particularly wheat, industrial metals, fertilizers, and natural gas). The real fear here is that the war spreads in Europe, China gets involved via Taiwan, or God forbid, chemical or nuclear weapons are deployed.
If someone was given these headlines late last year and asked to predict where stocks would be on April 1, the generic answer would have likely been “down big.” And while we certainly saw a nasty drawdown in January, and again after the invasion began, few would have likely guessed that stocks (as measured by the SP-500) after Q1, with none of the above issues resolved, would only be down 5.5% YTD.
The real carnage, however, has been in fixed income. This snippet from Bloomberg best sums up the year so far:
The Bloomberg Global Aggregate Index, a benchmark for government and corporate debt total returns, has fallen 11% from a high in January 2021. That’s the biggest decline from a peak in data stretching back to 1990, surpassing a 10.8% drawdown during the financial crisis in 2008. It equates to a drop in the index market value of about $2.6 trillion, worse than about $2 trillion in 2008.
Those statistics, combined with the sketchy performance from equities, have laid waste the traditional “60/40” portfolio balanced models that have been so popular for so long now. We warned late last year that a hawkish change in Fed policy could have a material effect on this strategy. Few were willing to pay much attention to the warning after being lulled to complacency the past 10+ years on the back of uber easy monetary policy.
If it seems odd that US markets are holding up so well, it may boil down to the old cliché that we are the cleanest shirt in the hamper. Meaning, with all the war-induced turmoil in Europe, the ongoing odd behavior from China, the plunging yen and likely huge inflation problems brewing in Japan (although Nikkei friendly?), and the fact that despite our blemishes, the US economy remains upbeat, there is a pent-up demand for services and to a lesser extent goods, and it is still a tight labor market with a plenty of jobs for those who actually want to work.
We would even argue that the wonky action in the yield curves is more a function of the unwinding mechanisms from years of a perverse monetary policy than a sign that the economy is barreling towards a recession. We are very cognizant that history accurately forecasts recessions based on yield curves, but we would counter that history has never been through a monetary expansion/contraction attempt. Which, in our minds wipes the slate clean as we trudge forward into these most uncertain of times. It also seems that many are using different yield curve spreads to fit their narratives and are equating a recession to automatic lower equity prices; a narrative that is not always symbolic.
The ongoing war in Ukraine is painful to watch from a humane perspective. No sane person enjoys war, and the complete unnecessaries of it make it all the more loathsome. But in a pure economic sense it may be mostly a non-starter and likely a short-term event that will eventually be overshadowed again by the changing monetary policies around the globe.
In fact, as of 3/31/2022, the SP-500 is 5.45% higher than where it was when Russia first began invading Ukraine. And it’s safe to say that there haven’t been many positive developments since the invasion.
So why are markets, at least the overall indices, back near the highs seeing as the war is still uncertain, rates continue to rise, bond prices continually sink, and the Fed is even more aggressively pursuing their hawkish policies?
“The main purpose of the stock market is to make fools of as many men as possible.”
-Bernard Bauch
Market statistics and data from Goldman Sachs’s prime brokerage shows that there were massive amounts of selling near the lows seen on February 23rd and that was furthermore evidenced by the AAII Investors Intelligence poll that also hit multi-year lows around the same time we hit lows seen in February. The point being, as perverse as it may sound, that a sharp move up back toward all-time highs (only 5.3% away in the SP-500) would bring maximum pain to investors and money managers, thereby exemplifying the above quote.
All this while the globe battles supply problems, Covid outbreaks, fixed-income carnage, a crisis in Ukraine, and some of the highest inflation in 30 years. All presumable inputs that would confirm a bearish thesis for equities.
There are some that feel the US is the lone port in the global storm we are all witnessing. Europe and Japan have a host of problems and China is just too temperamental and self-directed to trust with any large portion of a portfolio. Not to mention the sanctions the US has placed on their listings here.
One more potential headwind for equities may come in the form of earnings. The bar for Q1 2022 earnings is rather high when viewed on a year-over-year basis; it is significantly higher than the past two pandemic years. In fact, the SP-500 must earn $56/share this quarter to just to surpass 1% sequential growth from Q1 2021.
We will begin to sort out the earnings in April when the big money center banks begin to report their results. The last few weeks in April will be heavily influenced by corporate America results from a swath of different industries. These results, despite all the consistent macro negative permeations, will likely be the next big driver of stock prices (up or down)
The Ukraine invasion has taken away a lot of the previous focus on inflation and the Fed’s attempt to engineer a soft landing all while trying to unwind the biggest monetary experiment in history, during a commodity price shock to boot. Bond markets are reflecting a hard landing, rather than a soft one. The bond market is obviously concerned, and Chairman Powell spent parts of March hinting that 50bp rate hikes were on the way along with the need to raise rates from zero to nearly 3% in just two years.
We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.” –Chairman Powell, 3/
The 2-year yield is up to 2.32% and is currently reflecting 6-7 more hikes in 2022 and 5 more in 2023. Do markets believe this or are they whistling past the proverbial graveyards?
Bitcoin Update:
Last month we opined that it was time for Bitcoin to reassert itself as a leading asset class and to start to begin to reflect the plethora of good news that we are consistently highlighting on these pages. Well, the cryptocurrency world finally listened to our pleas and recorded a respectable month of gains. We can’t place a specific catalyst for the move up, but we continue seeing more and more positive news flow. Highlighted this month by:
- The world’s biggest asset manager, Bridgewater, doing a 180 on cryptocurrency and announcing they were now interested in investing in the space. However, they were very vague with details for now
- VC-backed cybersecurity startups raised $1.8 billion in January 2022 versus a little over $1 billion in January of last year.
- This industry also raised almost $2.6 billion through just the first three-and-a-half weeks of February compared to $682 million in all of February 2021.
- Block chain-related startups have raised $3.8 billion so far this year, more than all of 2020 ($2.1 billion) and 2019 ($2.9 billion). It’s also already “surpassing even last year’s record pace” according to Crunchbase; last year’s total was $17.9 billion.
- VCs have invested over $173 million so far this year into startups that use “Web3” and the “decentralized web” in their descriptions. That’s already almost half of the funding that backed self-described Web3 startups in all of last year ($380 million)
- Crypto has now become a huge part of top US universities. Of the top 10: 4 now have dedicated crypto centers (Stanford, MIT, Columbia, Princeton)
On a more fundamental note, the available supply for Bitcoin continues to shrink adding to the illiquidity of supply. All while institutional demand increases monthly, highlighted recently by the behemoths Bridgewater and Black Rock. This demand/supply imbalance has the potential to allow Bitcoin to move back near its all-time highs of $68,000; and we could see that unfolding in the next two quarters.
Technically, as demonstrated below, the price has broken out of a descending triangle after consolidating in the mid-to-upper $30,000s and is threatening to break above $52,000 with a hopeful run back to all-time highs.
But possibly the best news this month is that the government came out with its cryptocurrency regulatory decree – and the market barely flinched. There have been on-going concerns that pending government regulations would cripple the industry and even destroy it, although that always seemed a bit outlandish to us. The fact that this potentially negative catalyst has come and gone – and prices are now higher, is a huge sigh of relief for crypto bulls.
Specifically, the Executive Order calls for 4 specific measures:
- Protect U.S. Consumers, Investors, and Businesses
- Protect U.S. and Global Financial Stability and Mitigate Systemic Risk
- Promote U.S. Leadership in Technology and Economic Competitiveness
- Support Technological Advances and Ensure Responsible Development and Use of Digital Assets
One of the cryptocurrencies research letters we subscribe to has an interesting take on the future of money, and we thought it was worthy of passing along – from UTXO Management:
“Also, it must be remembered that millennials – who are set to be the beneficiaries of the largest ever generational transfer of wealth [according to some estimates US$60 trillion] – have been raised on technology, they’re digital natives. As such, the future of money is also, without doubt, going to be digital.
For this reason, around 90% of governments around the world, representing 90% of global GDP, are actively pursuing their own central bank digital currencies (CBDCs).
Gold has had quite a run this year and is finally acting as the inflation hedge it has always been advertised as. Some argue Bitcoin will serve the same purpose. So, if in fact that proves true we have to wonder if this recent leg up was more like a catch-up move to gold (which has taken a bit of a pause). As we have said in previous updates, you do not need to pick a side between gold or Bitcoin. There is room for both. This year, unlike any recently, will put the inflation hedge theory to a test
We disclosed last month a “starter” position in the token tZERO, in which the ICE exchange made an investment earlier this year. tZero is a spin-off from Overstock.com and is effectively their initial coin offering (ICO). While we have little interest in Overstock, the coin they have created, and the future functionality it may be able to provide, especially with securities trading clearing, is why ICE decided to invest in the coin and we feel they have much bigger plans ahead – including the eventual elimination of T+2 trading settlement.
tZERO is not without its controversy. Former Overstock CEO Patrick Byrne has a bit of a tarnished reputation and has made some outlandish claims in the past. He, however, is no longer involved here and David Goone from ICE is now joining the company as the new CEO.
If you own the tZERO token, you are entitled to 10% of “net revenues” (gross profits). There are roughly 20 million tokens outstanding, and as of yesterday at a price of around $6; that means the market cap is roughly $120 million. To decide what the tokens might be worth, you have to decide what the “gross profits” of this entity are liable to be, then you have to decide what multiple you’re willing to put on that. What multiple is fair to assign is the obvious sticky question that surely will conjure up a variety of answers.
But in reality, owning tZERO, at least in our opinion, is essentially a call option on the potential change it could bring to financial markets, again as ICE validated earlier this year. It’s a long-term play with low price risk, but certainly will require some patience. We also feel it could end up being a nice cornerstone of a crypto portfolio and could well complement Bitcoin.
We are going to rehash something we sent in a weekly letter update this month only because we think it’s important and some may have missed the first iteration.
Let’s say you are China. You just saw the world essentially erase Russia’s reserves with a stroke of a pen. China currently has $3.3 trillion in FX reserves invested in Western debt. Couple that with a 7.9% inflation rate that is already ravaging their holdings and all of sudden shifting a portion of that debt into hard goods doesn’t seem as far-fetched as it did, say 1-year ago.
So, yes, commodities have already been on quite a tear in the past few months. But if central banks and foreign treasuries begin to make the shift from obligations (debt) to hard assets (commodities) then the “new” FANG (below) still has plenty of room to run.
Is this the new FAANG trade?:
F– FacebookA – AppleA -AmazonN– NetflixG – Google |
F – FuelA – AerospaceA – AgriculturalN – Nuclear/renewablesG – Gold/precious metals |
One area we feel may be ripe for a rally is the small-cap biotech space. This sector, as represented by the Nasdaq Biotechnology Index (IBB) has fallen almost 25% since its August 2021 highs. It’s obviously a volatile and highly speculative sector. But it is seeing solid institutional support in recent weeks and comes with the protection of not being as recession/economic sensitive as other areas.
The rotational flows have been violent thus far in 2022, and that likely won’t change. As the yield curves begin to worry institutional investors of potential economic contraction, we could see more and more flows come into biotech as an economic neutral play – as ironic as that sounds.
The most underreported story so far in 2022 is the destruction of the yen/dollar cross. Japan has been running a zombie economy for years now and has essentially nationalized its bond market. But we are now seeing yields actually perk up and cause some consternation amongst the BOJ, who has irresponsibly allowed the debt/GDP ratio in that country to skyrocket up to 242%.
The yield on the 10-year JGB note is now 0.22% – up 140 bps from one year ago. Meanwhile the Yen has fallen 6.7% in 2022 and the Nikkei is flattish on the year.
We have to wonder if what we are seeing in Japan is a test run for the rest of the world’s central bankers. Meaning, are the bond and currency markets in that country effectively trying to take away the printing press from the BOJ?
Japan is a huge importer of goods and as their currency plummets they will be importing more and more inflation into an economy that has stagnated for years, but which has been supported by the massive money printing campaign (sound familiar?)
Sound familiar?
Looking Forward and other Market Commentary:
Unless we see a significant announcement out of Ukraine soon (cease fire), we could envision the first couple of weeks in April being on the slower side, due to spring breaks and Easter. But April 12th will be the all-important CPI release and on April 13th we kick off the earnings season with JP Morgan and slew of other financials.
The markets have had a tumultuous first quarter and after this month’s strong equity bounce, resting or consolidating at these levels would make some sense. Of course, in this crazy world we live in fraught with headline risk, there are obviously no guarantees of anything.
The MEMEs are back! After taking a few months the return if the meme-themed stocks, fueled in-large by massive call buying (gamma) roared back in the last couple weeks of March. Gamestop +90%, AMC +51%, Bed Bath and Beyond +89%, and Tesla +27% led the charge higher.
We think the MEME “revolution” is great and we fully support any persons who think they can enter this arena and leave with more money than they started with. With that, we are looking into Robinhood as a play on this rejuvenated sector.
The theme for 2022 has been tactical trading. That isn’t going to change anytime soon and certainly isn’t as simplistic as it may sound. Looking at the current landscape, it is very difficult to ascertain a “safe” area to park capital. Even cash, using a 7.9% inflation rate (based on February CPI readings) equates to a negative real return. -7.9% + 2% CD rate = -5.9% real rate of return. Inflation simply eats away at any saving or purchasing power.
So, we will continue to deploy the strategies that have been moderately successful thus far in 2022. That is, identify sectors that are seeing heavy rotation (biotech?) and remain flexible both long and short various markets with tighter time frames and lower risk profiles given the surge, then drop, in volatility and the massive amount of headline risk we are undergoing.
Simply put, for equities, bonds, or commodities to stabilize over the next few years we need oil under $130, supply-chains to de-bottleneck, a Fed smooth landing with their tightening endeavors, no corporate profit recession, peace in Europe, growth in Europe, stability in Japan, and less abrasiveness out of China.
Possible? Sure, but it’s unlikely all those boxes will be checked and even more unlikely they will be checked in a timely manner.
Once the Fed removes accommodation, we will have price discovery mechanisms back. Over the last decade stocks went up despite events, not because of them. We now enter a time when bad news will be bad news and markets will actually respond to macro developments, to the surprise of many, and that alone will eventually change market dynamics.
Finally, for the last written page of Q1-2022 we are going to do a quick synopsis of all the brilliant political leaders currently out there leading us mere simpletons.
The world leaders have shunned Russian oil and wheat. Great! Let’s show them who’s boss. Well, except for China and India, who would surely be considered rather large consumers, and are allegedly purchasing oil from Russia at about a 30% discount. Filling up their reserves and instantly lowering their energy costs while also enabling themselves to stockpile food supplies in light of the coming shortages (as both Biden and NATO warned of last week).
The US energy policy is apparently to shut down key pipelines, limit fracking, limit drilling sites, and encourage producers to lessen their output. All in the name of green climate change, and the push for ESG wokeness. Ignoring the fact that domestic tax revenue and American jobs are the sacrificial lambs. We however have no problem purchasing oil from Iran, Saudi Arabia, and Yemen (all at surely higher prices and larger transportation costs than home produced energy), countries that are hardly in-line up with American values (think women and 9/11) or political beliefs.
On March 31st, the White House announced they would drain our nation’s SPR by 180 million barrels, which would take it to the lowest levels since 1984. That’s a scary level should a real crisis ever ensue. And this does nothing to address the structural deficit currently in place in the oil markets; it simply pushes out demand to a later date.
Here in California, America’s awesome energy policy, combined with insane state environmental taxes, have pushed prices at the pump to nearly $6/gallon in many areas, and even higher in some.
In response our Governor has decided that in the most inflationary environment since the 1970s, it would be a good idea to sprinkle $400 debit cards for gasoline from the sky to the tune of $9 billion dollars (+ $2 billion in free public transportation fees, which admittedly is an admirable idea)
“Too much money chasing too few goods” is a classic definition of inflation. Adding $9 billion to the mix (and not until July?) is akin to adding a log onto an already out-of-control fire.
Maybe he didn’t recall his first day in Economics 101?
And then there is this from a recent NY Fed paper:
Approximately 95% of 37 million student loan borrowers of 195 billion dollars have not made a payment since the forbearance started at the beginning of the pandemic, which works out to 50 basis points of GDP/year. Forbearance programs are set to expire May 1, but odds are it will be extended.
330 million Americans and this is the best we can do for leaders?
Occasio Partners, LLC 465 California Street, San Francisco, CA