Edition #129
Powell Discusses Inflation, Stocks Face Continued Pressure, ETH/BTC Breakout
Economy:
Jerome Powell spoke on Monday in front of the Senate Banking Committee, in which he covered important topics on inflation, the labor market, and general economic activity. During his prepared comments and the Q&A, there were two important aspects that I wanted to specifically cover in this newsletter.
The first is that Powell made the case for a faster-than-anticipated taper schedule, based on continued improvements in the labor market. Recall, the Federal Reserve has seemingly expressed that their inflation targets have been met (even overshooting their expectations) and that the labor market is where the Fed was hoping to see the most notable improvements. When they announced their taper at the start of November, the Fed expressed that their planned timeline was to end the taper process in June 2022, but was absolutely subject to change based on the developments of economic data. With notable improvements being made, Powell said the following:
“The economy is very strong and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner.”
Essentially, financial markets are responding to the news by pricing in a more aggressive tapering process which would pull away monetary stimulus faster than originally anticipated. If consumption trends and the labor market continue to recover/grow at a strong rate, we might need to anticipate the tapering to end in March or April 2022 instead of June.
5-year yields, both domestic and overseas, continue to ramp higher. More specifically, the 5-year inflation swap, a measure of inflation yield premium, is making multi-year highs.
This is a combination of nominal yields continuing to press higher in light of an increasing rate of inflation. Should these rates continue to sustainably move higher, there is a case to be made that it will put the brakes on economic activity.
The second aspect that I wanted to cover was Powell’s comment on the term “transitory”. As we know, Federal Reserve members, economists, and members of government have continuously pounded the table that inflation would be transitory, meaning the U.S. economy would experience a period of high inflation (well-above 2%) followed by a moderation back towards the long-term goal of 2%. When the 12-month inflation rate in January 2021 rose from +1.4% to +4.2% in May 2021, we were told it was transitory. When the 12-month rate hit +5.4% in June, we were told it was transitory. When inflation hit +6.3% in October, we were once again told it was transitory. In Edition #118, I criticized Janet Yellen’s consistent inaccuracy in her outlook on inflation and repeated adjustments of the goal post.
Now, the comments on Tuesday from Jerome Powell add a new comedic element to this whole saga on transitory inflation. Powell has now stated that “it’s probably a good time to retire that word and explain more clearly what we mean.” Once again, moving the goal post entirely. After nearly a year of resoundingly saying that they expect inflation to be transitory, they’ve decided that the persistence and magnitude of inflation can no longer fit within their definitions. Their decision is to simply change the definition entirely, blaming the public’s misconception and lack of understanding around the terminology.
In my opinion, Powell’s hearing in front of the Senate Banking Committee was a sad day for integrity in the field of economics.
Stock Market:
In my newsletter to all subscribers on Saturday morning, I covered the heightened degree of uncertainty surrounding COVID and the subsequent selloff in U.S. equities and risk assets. Later on Saturday, I sent an email to premium members that discussed how the rate environment was the key determinant factor for why certain stocks were holding up better than others. In that note, I wrote the following:
“Therefore, if we expect that rates are likely to rise going forward, we are likely better off by limiting and reducing our exposure to non-profitable tech. At the very least, it’s a reminder that if we invest in any non-profitable tech stocks, we must be extremely diligent in our analysis of those companies and believe in the long-term potential with the intent of dollar-cost averaging into said stocks.”
So far this week, this guidance has been extremely impactful and timely. While the S&P 500 has declined by -1.77% since Friday’s close, $ARKK has fallen by -7.97% and $IPO has fallen by -8.8%. Both of these funds have experienced significant downside in the past several sessions, with drastic underperformance relative to the broader market. Powell’s comments that we reviewed above, insinuating that the Fed is more amenable to speeding up the tapering process, caused rates to bump higher and put even more pressure on these non-profitable tech/growth stocks. Somewhat surprisingly, the Nasdaq-100 has even outperformed the S&P 500, only falling -0.92% since last Friday’s close. The negative response we’re seeing this week has been a perfect follow-up to the commentary that I provided investors over the weekend.
Clearly, the market is facing pressure, which I think is being caused by three primary aspects.
Heightened uncertainty around the Omicron variant.
A faster-than-expected tapering schedule, which will pull away monetary stimulus more quickly.
Investor sentiment.
Considering that we’ve already touched on the first two points, it’s worthwhile to briefly discuss the third. With the stock market just hitting new ATH’s on 11/22, the fundamental pressures caused by Points 1 & 2 have caused a cascade of psychological selling behavior. In fact, this behavior is almost programmatic. Since the highs on 11/22, we can identify some clear patterns that have been taking place. If we examine the chart of the S&P 500 with 30 minute candles, we see the following:
This is clear cascading behavior, typically shown by large gaps to the upside for the start of each session, followed by consistent selling pressure throughout the session. From my perspective, this almost looks like scheduled selling from large institutions, potentially using algorithms to trigger strong selling behavior. When these algo’s begin to work, normal market participants and retail investors get spooked, causing additional selling pressure. It becomes a self-fulfilling mechanism.
Based on what I’m seeing on this chart, we can clearly identify that price was fluctuating within the green channel, using the upper-bound as resistance and the lower-bound as support. On Wednesday’s session, that pattern finally failed. The “knife through butter” slice through the bottom of the channel could foreshadow additional selling pressure ahead for the remainder of the week. Clearly, nothing’s for certain but I think the most likely case is for the pressure to continue in the short-term.
I want to be extremely clear, this is not a signal to sell stocks. I continue to remain very bullish on U.S. equities going forward, but I think there’s value in setting expectations that we could be set for a further decline. Considering that we’re currently down -4.9% from ATH’s, I don’t think there’s much at all to be worried about for the majority of investors.
Cryptocurrency:
While the cryptocurrency market continues to chop along, it can be important to compare various cryptocurrencies against each other in order to determine relative strength or relative performance. The key relationship within the crypto sector is to compare Ethereum vs. Bitcoin, which can simply be done by dividing the price of ETH by BTC. We can then track the relative value of these two investments in order to identify trends in the behavior, which is exactly what I’ve done below.
This pattern, a lengthy consolidation channel with multiple rejections at the upper-bound and an eventual breakout, could signal a new leg of outperformance by Ethereum relative to Bitcoin. This chart pattern is used extremely often by market technicians, who highlight breakouts from an extensive consolidation zone. One example that I recently highlighted to premium members when the breakout was occurring was for the stock Calix Inc. ($CALX).
We can spot similar behavior in the two charts: a general uptrend that experiences a multi-month rejection zone. Once the breakout occurred, the stock ramped higher, gaining more than +56% in 48 days.
As we can see from the ETH/BTC chart, Ethereum has generally outperformed Bitcoin over the past 12 months, showing that we’re in a clear uptrend. Therefore, as we begin to breakout of the consolidation range, a new leg of outperformance wouldn’t necessarily be anything new. The comparison to $CALX shouldn’t be misconstrued as a prediction that ETH will outperform BTC by +56%, but simply to point out the dynamics that occur when price moves out of a consolidation range. I continue to remain extremely bullish on Bitcoin, Ethereum, and a variety of other layer 1 and layer 2 protocols.
Talk soon,
Caleb Franzen