Edition #193
Recession or Bust, De-Risk Opportunities, Bitcoin Accumulation Signals
Investors,
Thank you for your continued support of Cubic Analytics and the research that I produce on Twitter, YouTube, and here on Substack. Readership of Cubic Analytics has officially crossed 1,600 subscribers! If you’ve found these publications valuable and/or insightful, it would be tremendous if you could spread the word and share Cubic Analytics with your colleagues, friends, family, and fellow investors. I have big plans for this publication and they will only be feasible if we continue to grow at a +30% compounded monthly rate. Let’s keep the momentum going!
Macroeconomics:
The macro picture was very dynamic this past week, with plenty of new and continuing developments. I think the most shocking of which was that the European Central Bank voted to raise their equivalent of the federal funds rate by 50 basis points (+0.5%). This was their first rate hike since 2011; however, they increased their base rate from -0.5% to 0.00%. Essentially, they are still providing historic levels of monetary stimulus by keeping interest rates artificially suppressed:
Domestically, my focus continues to remain on the factors driving yield dynamics: inflation, economic growth/activity, and monetary policy. We didn’t get any inflation-specific data this week, so my primary focus was on three economic reports:
Existing Home Sales for June 2022
The Conference Board’s Leading Economic Index for June 2022
S&P Global U.S. PMI (Services, Manufacturing, and Composite Index)
In attempt to summarize each of these reports in a single sentence, the headline data for each report came in worse than estimates and worse than the prior month readings. After a brief wave of some encouraging/resilient economic data, it seems that we remain on a trend of steadily deteriorating economic fundamentals.
Existing home sales in June 2022 totaled 5.12M, representing a decline of -5.4% relative to May 2022. Median estimates were predicting total sales of 5.35M and a decline of -1.1%, so this was a substantial miss to the downside. While activity in the real estate market is slowing down, housing prices continue to climb higher, albeit at a slower rate. For the month of June, the median sales price of existing homes increased by +13.4% year-over-year to $416,000. For context, here’s the YoY change in the median sales price for each month since Q3 2016:
With the average 30-year fixed mortgage rate trading at 5.54% as of 7/21/22, it’s no surprise that activity is slowing down. From my perspective, the longer that rates remain above 4%, I expect to see transaction activity moderate and price appreciation trend towards neutral.
Regarding data from The Conference Board, the Leading Economic Index declined for the fourth consecutive month, falling by -0.8% in June 2022 vs. -0.6% in May 2022. The key concerns for economic growth in the U.S. were driven by “high inflation and rapidly tightening monetary policy”. This report is extremely straight-forward & concise, so I was merely focused on the headline data and the continued trend of accelerating weakness in leading economic indicators.
The PMI data released on Friday morning was the key report in my opinion, particularly considering that services, manufacturing, and the composite index have been trending lower for several months. This latest report was significant because it would indicate whether or not the trend was continuing to steadily deteriorate, improve, or drastically worsen. As the Federal Reserve continues to target monetary policy that will produce a recession, the PMI data is one of the more meaningful reports to provide a pulse on economic trends. Here were the results:
Manufacturing PMI: 52.3 vs. prior 52.7 and estimates of 52.0
Services PMI: 47.0 vs. prior 52.7 and estimates of 52.6
Composite PMI: 47.5 vs prior 52.3
Considering that manufacturing accounted for roughly 11% of U.S. economic activity in 2021, according to the National Association of Manufacturers, I think it’s more relevant to focus on the services & composite data. For the first time since mid-2020, services and the composite index are officially in contractionary territory below 50. According to the report, the “rate of decline [for the Composite PMI] was the sharpest since the initial stages of the pandemic in May 2020.” In addition, business confidence slumped to the lowest level since September 2020. The key part of the report can be summarized in this single sentence:
“Companies noted that weak demand conditions stemmed from severe inflationary pressures and hikes in interest rates, which have exerted further strain on domestic client spending.”
It doesn’t get much clearer than that…
With my baseline expectation being persistent inflation and a further weakening in economic activity, this PMI data reaffirms my base-case. We haven’t seen signs of inflation slowing down or any indication that the Federal Reserve is taking their foot off the gas pedal. In fact, we’ve only seen evidence to the contrary: accelerating inflation & heightened aggression by the Fed.
If we continue to see inflation accelerate, coupled with a further deterioration in economic data, stagflation risks will increase. While I believed that stagflation was a minimal risk in Q4 2021, I did acknowledge the growing risk of stagflation in the thread below. If you haven’t already, I’d suggest giving it a quick read:
Stock Market:
I don’t have a substantive update for this report. As always, I’ll be providing in-depth market analysis in tomorrow’s report for premium members, discussing the key data I’m watching and my expectations for the market. If you’d like to upgrade your membership, consider taking advantage of this 10% discount link:
Generally speaking, my view on risk assets is the same as it’s been all year. In a rising-rate environment, stocks & crypto will struggle to rise and investors should position themselves to manage risk. We’ve seen defensive dynamics all year, in what was considered to be one of the worst first-halves in U.S. history. Earlier this week, I posted the following thoughts on Twitter, reaffirming the sentiment that I’ve been sharing with premium research members:
Bitcoin:
For the past month, I’ve been hyper-focused on analyzing a key relationship for Bitcoin. Specifically, the correlation between Bitcoin and Micron Technologies MU 0.00%↑, a leading semiconductor company. I continue to be amazed at the long-term correlation between these two assets. While some may argue that there’s a relationship in terms of compute-power and mining, of which I would agree, semiconductor sales to crypto-mining entities were fairly irrelevant in the grand-scheme of total semiconductor sales. In June 2021, Advanced Micro Devices AMD 0.00%↑ CEO, Lisa Su, said that crypto miners account for 5-10% of semiconductor demand.
Either way, the correlation is mind blowing. No other semiconductor stock, or the semiconductor industry on the whole, move so tightly with the price of Bitcoin as MU does:
I’ve been thinking critically about how this information can be used, especially in order to analyze “buy” signals or accumulation zones for Bitcoin going forward. Through my research, I wanted to share the best indicator that I’ve found so far.
Traditionally, we denominate BTC in USD terms and therefore quote the value of Bitcoin in a real-time basis. For example, at the time of writing, the price of Bitcoin is $22,750. However, we can also denominate BTC by other assets in order to analyze relative value, therefore viewing BTC in a different lens. Some of my favorite denominations & comparisons include:
BTC / M2 Money Supply
BTC / U.S. Treasuries
BTC / Total Loans & Leases
BTC / S&P 500
BTC / Japanese Yen
This prompted me to analyze a new dynamic: BTC / Micron Technologies (BTC/MU).
Considering the tightness of their long-term correlation, this relationship can provide valuable perspectives about the risk/reward of Bitcoin relative to a highly correlated asset. In turn, we can analyze BTC/MU as a way to identify relative value signals that wouldn’t normally be present when analyzing the pure chart of Bitcoin.
This analysis focuses on three indicators, but relies on two signals:
The 26-week EMA (half-year moving average) crosses below the 52-week EMA (1-year moving average).
Bullish RSI divergence (when the RSI proceeds to make higher lows while price makes lower lows).
By combining these two criteria, we can highlight times when BTC/MU is trading in the late-innings of the bear market (26 EMA < 52 EMA) and then produces a bullish reversal signal (RSI divergence). Here are the findings:
When the 26 EMA (yellow) crosses below the 52 EMA (teal), I’ve highlighted those areas with green vertical lines. The RSI is in the lower-bound, using red trendlines to highlight the divergence in price action (lower lows) & underlying strength (higher lows). This signal has only happened two times over the past 10 years, perfectly identifying the bottom of each bear market in BTC/MU.
Why is this so important? Because a sustained decline in BTC/MU indicates that BTC is drastically underperforming MU, whereas a sustained rise in BTC/MU indicates that BTC is drastically outperforming MU. As such, we’d ideally want to be long BTC during these periods of drastic outperformance vs. the correlated semiconductor stock! Considering that they move up and down in tandem, this means that BTC’s price during BTC/MU uptrends is rising at magnitudes significantly faster than MU.
For example, after the bullish RSI divergence occurred after the September 2014 signal, roughly in mid-February 2015, the price of Bitcoin gained +3,600% over a three-year period. After the bullish RSI divergence occurred after the July 2018 signal, roughly in mid-February 2019, the price of BTC gained as much as +1,700% and is presently up more than +500%.
While both of these prior signals had almost perfectly identified the start of a new bull market, there was still downside volatility after these signals were produced. The price of Bitcoin experienced max drawdowns (peak to trough declines) of -47% and -70% after the bullish RSI divergence signal, giving investors additional opportunities to invest before the exponential phases of the bull run.
With Step #1 of this signal flashing 6 weeks ago (26 EMA < 52 EMA), I am officially on alert to identify a bullish RSI divergence. Considering that we haven’t produced the bullish RSI divergence yet, I don’t have much confidence in the recent crypto rally that we’ve experienced over the past few weeks. As such, I am still prepared for new YTD lows or, at the very least, a retest of the $19k level.
I hope that you find this new indicator useful and I will continue to update investors about these development on Twitter and conduct more research that could provide strong trading signals.
Best,
Caleb Franzen
DISCLAIMER:
My investment thesis, risk appetite, and time frames are strictly my own and are significantly different than that of my readership. As such, the investments & stocks covered in this publication are not to be considered investment advice and should be regarded as information only. I encourage everyone to conduct their own due diligence, understand the risks associated with any information that is reviewed, and to recognize that my investment approach is not necessarily suitable for your specific portfolio & investing needs. Please consult a registered & licensed financial advisor for any topics related to your portfolio, exercise strong risk controls, and understand that I have no responsibility for any gains or losses incurred in your portfolio.
What period was used for the RSI?
Great findings 👍
Great work as always, Caleb!