Edition #45 - 7.12.2021
Crude Oil & Inflation, Taper Impact on the S&P 500, BTC Price Structure Update
Economy:
Returning to the topic of inflation, I found the following graph provided by the Federal Reserve Bank of St. Louis detailing the cost of gasoline prices in the United States.
As oil & gasoline prices rise, this sends a ripple effect through the economy in terms of supply-side factors, increasing transportation costs, operating costs, and a variety of other input/raw material dynamics. From a demand-side, higher prices at the pump put pressure on consumers’ wallets, reducing the disposable income they can allocate to other consumer goods/services. Therefore, rising gasoline prices have a strong correlation to inflation, as shown in the chart below, comparing the price of crude oil & 5-year inflation expectations.
If we expect to see inflationary pressures slow down, it will be paramount that crude oil prices also decelerate & give back some of the gains from the pandemic lows. Considering that the closing price of WTI crude oil was $16.50 on 4/20/2020, crude has gained +353.7% to the current price of $74.86. So far in 2021, crude oil prices have increased by +54.5%, rapidly outpacing the stock market, U.S. Treasury market, and even bitcoin so far.
I continue to monitor developments in the oil market to keep a day-to-day pulse on inflation expectations, which has impacts on nominal & real yields, forecasts on economic growth, and asset prices.
Stock Market:
It has become increasingly more evident that the Federal Reserve will begin to taper their purchases of Treasury securities and agency-MBS sometime in the next 24 months. The market continues to be influenced by evolving rhetoric & data that provides clarity around when the taper announcement & initiation will be coming. When data comes out that could motivate the Fed to tighten monetary policy sooner rather than later, equity markets respond by selling off. In my opinion, we still have a long way to go before we actually enter a period of monetary tightening, but it’s worth preparing mentally & setting expectations for how equities can react once that day comes.
Here’s an excellent chart that I saw from Callum Thomas (@Callum_Thomas) on Twitter that highlights this exact environment.
With liquidity put into the financial system at a slower rate, these tightening conditions may have caused the markets to take a breath. Shortly following the taper remarks in May 2013, the S&P 500 had a maximum drawdown (peak to trough) of -7.8% over the course of 33 calendar days. 6 months after the bottom, the S&P had gained roughly +17%. When tapering was actually initiated at the onset of 2014, the S&P 500 experienced a maximum drawdown of -6.1% over 13 days, then proceeded to gain +10.6% over the next 6 months. The forward 12-month returns from the trough of each drawdown was +25% % and +17.8%.
The bottom line, based on what the market experienced during the last taper announcement and initiation, is that the U.S. equity market typically experiences a moderate drawdown over a quick period of time, then continues to ascend along the prior trend & trajectory.
Cryptocurrency:
No update, the price of Bitcoin continues to consolidate in the lower-$30k range. I think we’re seeing good action at these levels, but need to see some decisive movement in price. I believe that we may be seeing early signs of an acceleration. Attentive followers will recognize the below chart, as I’ve been outlining these same technical levels in terms of price structure going back to early June 2021. Here is an update of those levels:
Price has remained steadily within the white channel range, but will need to break out of the descending red trend line to foreshadow a move back to the upper-bound of the channel. This is somewhat of a mini inflection point, as I expect price will either get rejected at this specific level, as it has over the last month, or will indicate early signs of a breakout. I’m not holding my breath for the breakout to unfold, but this kind of action is at the very least encouraging. Time will tell.
Until tomorrow,
Caleb Franzen