Edition #126
New Variant Spooks Markets
Economy & Stock Market:
For the first time, I’m combining both of these sections in order to discuss the same news/data, in order to discuss the potential implications of the new COVID variant in South Africa. I’ll never try to discuss the potential health implications or differences between Variant ABC vs. Variant XYZ, but I am certainly interested in the exploring the implications that this new strain could have on economic conditions and financial markets.
While financial markets were closed on Thursday, the news about the South African variant was being disseminated across social media and various news outlets, but really began to pick up steam later in the evening and early Friday morning. In response, risk assets & equities experienced a sharp selloff, seeing each of the major U.S. indexes falling more than -2%. The explanation for this is really quite simple: the securities markets are a pricing mechanism for unforeseen events & news that impacts economic activity or risk/reward preferences. While it’s possible that market participants were previously wary of new variants arising in the near future, it’s clear that the market reaction on Friday is indicative that the significant majority of market participants weren’t expecting a suddenly new variant with potential for greater transmissibility or worse adverse reactions. The negative reaction in asset prices on Friday is directly the result of two factors: the potential impacts to fundamental economic conditions (supply bottlenecks, enforced social restrictions, shutdowns) and the ability of the market to respond to and price-in uncertainty.
With the dissemination that this new variant could pose new/additional risks, the market is beginning to price in that risk. In my opinion, a -2% haircut in a single day is likely a bit of an overreaction, but I can’t say for certain. Clearly, the market is preparing for the potential policies that could ensue in the event that the variant is more transmissible and dangerous than the existing variants. It’s clear that hospitality and service sectors (dining, tourism, etc.) would be most impacted by potential lockdowns, social distancing guidelines/policies, and the impacts of people being less likely to go out to consume goods/services.
In addition to the impacts this would have on consumption trends, economic growth, and overall business sentiment, this will likely have an exacerbating effect on the supply shortages and bottlenecks that we’re currently experiencing. It’s very possible that a slowdown in general economic activity could dampen inflationary pressures, which could be potentially offset by the supply-side inflation challenges. If so, the Federal Reserve could be persuaded by the data to slow down their tapering schedule or push out the liftoff phase of monetary policy. This is merely a possibility worth considering, but isn’t necessarily a prediction about how the dynamics will unfold.
The most interesting aspect about the financial markets yesterday was the behavior of yields and asset prices. On 11/18, I posted the following on Twitter, which is extremely appropriate for today’s conversation about the markets:
In the above, I clearly specify that we would only expect to see yields and asset prices move in the same direction when there is a flood of capital moving into safe-haven assets. These “risk-off” events are identified when investors reduce their exposure to stocks/crypto and convert their capital into cash or Treasuries. That’s exactly what we saw yesterday, as yields on 5, 10, and 30-year Treasuries nosedived (reflective of a sudden & substantial increase in demand), while stocks also declined substantially. As I said, the relationship between yields and stock prices don’t typically move together unless there’s a flood into safe assets.
The bullish outlook that I interpreted from that post turned out to be true until we saw an actual reason (new COVID variant) that forced investors to consider heightened uncertainty and shift into less risky assets. In fact, in the aftermath of the analysis I posted on Twitter, U.S. stocks proceeded to make new all-time highs over the next few trading days. As of right now, based on the close from Friday, the S&P 500 has only fallen -3.1% from the ATH’s set earlier in the week.
While the market seemingly made a risk-off transition on Friday, an intriguing dynamic was the extremely strong demand for stay-at-home stocks and pandemic-related healthcare companies. Here are some of the notable companies and their respective returns from Friday’s session:
Moderna ($MRNA) +20%
BioNTech ($BNTX) +14%
Fulgent Genetics ($FLGT) +9%
Pfizer ($PFE) +6%
Peloton ($PTON) +6%
Zoom Video Communications ($ZM) +5%
Logitech ($LOGI) +5%
Teladoc Health ($TDOC) +3%
Docusign ($DOCU) +2%
On a day where the Dow Jones, S&P 500 and Nasdaq-100 were all down worse than -2%, this level of outperformance is extremely notable. If a selloff in the broader market continues, perhaps in the window of another -2% to -7%, this could provide an excellent buying opportunity in some amazing companies that are already trading at a discount relative to their recent ATH’s. Some companies that come to the top of mind, in no particular order are:
Crowdstrike ($CRWD), Sea Limited ($SE), Disney ($DIS), DigitalOcean Holdings ($DOCN), Shopify ($SHOP), Square Inc. ($SQ), Roku Inc. ($ROKU), MongoDB ($MDB), Domo Inc. ($DOMO), Salesforce.com ($CRM), Yeti Holdings ($YETI), Snap Inc. ($SNAP), Celsius Holdings ($CELH), Applied Materials ($AMAT), Coinbase ($COIN), Okta Inc. ($OKTA), Twilio Inc. ($TWLO), Airbnb ($ABNB).
It’s worth noting that if the market experiences a pullback between -2% to -7%, it’s likely that many of these stocks will be down between -5% to -15%.
Cryptocurrency:
First of all, it’s worth noting that crypto was certainly not immune from the selloff that occurred yesterday. As we discussed, during a flood to safe-haven assets, investors will typically reduce their exposure to their riskiest assets by the largest magnitude. As such, crypto markets fell even harder than equities.
At the time of writing, around 5pm ET on Friday evening, Bitcoin is trading around $54,100 and Ethereum is right around $4,100. These means that both of the major crypto assets are currently down -21% and -16% from their recent ATH’s, respectively. One aspect that I find surprising is that Ethereum has held up stronger than Bitcoin has over the past few weeks, which I’m sure is an encouraging sign for those overweight ETH/BTC.
The only data that I’d like to cover is an update of the stock-to-flow model, which helps to analyze the underlying value of Bitcoin as a commodity relative to it’s flow of current new supply and future new supply. Because Bitcoin’s monetary policy is programmatic and we are able to easily project the future total supply of the cryptocurrency, an analyst named PlanB used his background as a commodity analyst to forecast the price of Bitcoin as a function of its total supply. The model, which PlanB created in 2019, has been applied to Bitcoin’s previous supply path and has been able to accurately project the price of Bitcoin in logarithmic scale, which we see below:
While it’s fully possible that this model can be invalidated, as PlanB has acknowledged as a possibility, it’s done a remarkable job of being an accurate guideline for price over the 11-year history we see in the chart above. The chart above is kind enough to provide the first and second standard deviations from the pure S2F forecast, giving us the “clouds” that we see above. In my opinion, a dip into the bottom of the second standard deviation would provide an attractive buying opportunity for long-term investors.
Talk soon,
Caleb Franzen