Edition #134
Federal Reserve Takes Aggressive Stance, Stocks Rally Higher, Encouraging Bitcoin Data
Economy:
The key event for the week that all financial markets were hinging on was the Federal Reserve Policy Decision meeting that took place on 12/14 & 15. Amidst a further acceleration in the rate of inflation & strong data in the labor market, financial markets were expecting to see a more aggressive policy decision stance from the Fed. It’s most likely the reason for the -1.67% decline in the S&P 500 in the Monday & Tuesday sessions.
The critical announcements from the policy decision were the following:
• The Federal Reserve would double the magnitude of their tapering process, reducing their cumulative purchases of Treasuries and mortgage-backed securities by $30Bn/month vs. the prior rate of $15Bn/month. It is now expected that the Fed will target $90Bn/month in total asset purchases.
• The Federal Reserve’s officials are projecting a median of three rate hikes in 2022, with a completion of the tapering process in March 2022. The Fed also projects a median of three rate hikes in 2023.
From my perspective, there wasn’t anything in the press release or Jerome Powell’s press conference that I found surprising or out of the ordinary. I believe the Fed is justified to accelerate the rate of their tapering process in light of a 39-year record level of inflation and continued improvements in the labor market. While those improvements in the labor market have had some holes in them, particularly in regards to the labor force participation rate, the Fed is making the case that declines in the unemployment rate, rising nominal wages, and 52-year lows in initial unemployment claims warrant a deceleration in asset purchases.
Earlier in the week the producer price index, the sister of the consumer price index, was updated for November 2021. Keeping in mind that the 12-month CPI inflation rate was +6.8% for November, there was a lot of focus on PPI. The headline figure for November’s PPI was +9.6% compared to November 2020. This was the largest increase in wholesale producer prices since the data started to be collected in 2010.
This was a significant increase from the prior month result, which reflected an +8.6% increase on a 12-month basis, and was higher than consensus estimates of +9.2%. Core PPI, which excludes food & energy prices, increased at +7.7% and is reflected by the orange line above. This is further evidence that inflation has not been transitory, as we’ve continued to see price pressures accelerate as the year has progressed. It’s no wonder why the Federal Reserve is now rushing to accelerate their taper & liftoff process in order to combat price pressures. Under their economic framework, a tightening of monetary policy is intended to slow down economic activity and reduce inflationary pressures. Yes, the Fed is currently attempting to reduce economic activity as it’s the only cure they think they have to fight inflation.
David Rosenberg, the Chief Economist & Strategist of Rosenberg Research & Associates, recently said the following on Twitter:
This is an absolutely blasphemous statement, which I was stunned to hear uttered from the mouth of an economist. It’s the equivalent of saying, “in order to combat higher prices, we must have economic turmoil and reduce incomes to get people to stop spending”. It shows just how steep of a predicament the Federal Reserve is currently facing.
Stock Market:
While the policy decision by the Fed wasn’t very surprising, the response by the stock market surely had me scratching my head. After all, a Federal Reserve that plans to end their monetary stimulus sooner rather than later, thereby accelerating their monetary tightening, should be a drag on equity prices. In the immediate aftermath of the press release and throughout Powell’s press conference, bond yield rose sharply. As we have consistently covered in this newsletter, all else being equal, we would expect to see an inverse correlation between yields and asset prices. Specifically:
Yields ↑, Stock Prices ↓
Yields ↓, Stock Prices ↑
Oddly enough, stocks had a significant rally on Wednesday in the wake of the Fed’s announcement. In fact, the S&P 500 gained +2.05% in the final 2 hours of the trading session. Similarly, the Nasdaq-100 gained +3.29%! To conclude the session, here were the results in terms of the daily performance of each major U.S. index:
• Dow Jones Industrial Average +1.08%
• S&P 500 +1.63%
• Nasdaq-100 +2.35%
All of the indexes were negative for the day prior to the Fed’s announcement. The only logical explanation that I have for this, which may not even be worthwhile, is that the market was expecting the Federal Reserve to be even more aggressive than they were in their announcement. The reason I say that this opinion may not even be worthwhile is because I’m reminded of my favorite adage in investing, which is that “the market can stay irrational longer than you can stay solvent”. This essentially means that the market notoriously behaves irrationally, and using logic to explain irrational behavior is simply an exercise in futility.
I continue to remain optimistic on U.S. equities; however, I am taking a more cautious approach with the expectation that the path of least resistance for yields is likely to the upside. The S&P 500 currently needs to gain +0.77% to hit new all-time highs.
Cryptocurrency:
The entire crypto market continues to face pressure since the November highs. At a current price of $48,900, Bitcoin has fallen -29% from the all-time highs on 11/9/21. Despite this deep correction, I remain optimistic about the current cycle and have a strong conviction that price will make new ATH’s again in the near future. My plan is to publish a special newsletter on interesting research I’ve been doing on Bitcoin based on macroeconomic factors by the end of the year, so I encourage you to keep an eye out for that post in the coming weeks.
I want to cover two key charts that I’m currently watching. The first is my own analysis of the current price chart, one that I have been highlighting since early November.
If we look at the price of Bitcoin going back to January 2019 in logarithmic scale, we can identify some extremely interesting similarities between the current price dynamics and the prior base from 2019-2020. I continue to believe that an acceleration above the blue levels would foreshadow an extension move extremely similar to what we witnessed in Q4 2020. Following the breakout in Q4 2020, the price of Bitcoin rallied from $13k to $64k in roughly 6 months. Based on the price chart above, the y-axis is maximized at $200k. I recognize that it appears as if the maximum figure is $177k, but the logarithmic scaling can be deceiving for those who aren’t used to it. I continue to believe that the likely case is for the price of Bitcoin to peak between $135k-$190k this cycle. Has that outlook been threatened by the recent correction? Absolutely. Have I been concerned? Sure. Have I sold any of my crypto? No. I have continued to buy more at what I consider to be discounted prices.
The second chart that I wanted to discuss was created by Glassnode and Willy Woo, showing the strong demand for Bitcoin by smaller retail wallets, defined as a wallet with less than 1 BTC.
In his post on Twitter, Woo explains that “the last time retail bought the dip this hard was at the bottom of the COVID crash.” As we can see by the data at the lower-bound of the chart, the 7-day change in coin balances by wallets with less than 1 BTC has experienced a massive increase during this market correction. What does this mean exactly? Investors with relatively small BTC exposure are showing extreme conviction and a strong appetite for the digital asset.
We saw similar upticks in this data point during the May-July 2021 correction, which helps to give me confidence that this consolidation phase of the market cycle could be coming to an end in the near-future. Imagine that the inverse were true and that we were witnessing demand evaporate despite lower prices. That would give me cause for concern because it would signify an inflection point in investor demand for the asset. Considering that we’re seeing rapidly increasing demand at lower prices is encouraging, at the very least.
Talk soon,
Caleb Franzen