May 15 • 8M

Fishing For A Bottom.

05/15/2022. Catch up with all you need to know from the entire previous week in financial markets in less than ten minutes every Sunday by reading or listening to my weekly market review.

 
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In Angles, Anglia Advisors founder Simon Brady CFP® talks about financial markets. This podcast is informational only and should not be used as the sole basis for making any investment decision.

The stock market is fishing around for a bottom. 2021’s favorite pastime, BTFD, stopped working a while ago, dips have become dives. Plenty of stocks have fallen by 50%, paused to let the BTFD crowd come in and then promptly crushed them by dissolving another 30%-40% from there.

A sixth week in a row of lower stock prices began with the twin geopolitical headwinds of China and Ukraine tipping markets lower but the main driver of these declines appeared to be momentum, fear and, importantly, apparent forced selling (as a result of margin calls, options activity, algorithms and fund mandates), all of which fed upon themselves as they tend to do when sentiment is as universally negative as it is. By the closing bell on Tuesday, all the gains made in the last twelve months by the S&P 500 had been wiped out.

And then there’s the Fed. What has often brought past bear markets to an end has been the Federal Reserve’s willingness to inject loads of excess liquidity to support asset prices and bolster domestic activity. But given where inflation is, none of that is going to happen any time soon. As one analyst put it; “Rather than being investors’ friend, the Fed has now become a foe, intent on tightening monetary conditions. One can debate how aggressive it will be, but the Fed is unlikely to help out soon.”

Here’s the latest state of play in that very debate. The positioning of aggregated fixed income traders’ futures positions gives us the following probabilities for what the Fed will do the rest of the year.

  • 0.50% interest rate increase at the June 15th meeting (87% odds)

  • 0.50% interest rate increase at the July 27th meeting (81% odds)

  • 0.50% interest rate increase at the September 21st meeting (51% odds), with 0.25% a possibility (38% odds)

  • 0.25% interest rate increase at the November 2nd and December 14th meetings, with combined odds of 51%, bringing the year-end Fed Funds rate to 2.75% – 3.00%.

The point here is that deviations from these expected levels will likely trigger a market reaction. More aggressive rate hikes than expected will push the market lower and less aggressive raises could see swift, significant rallies.

But Fed actions are not the be-all and end-all. A big issue is that raising rates into a low-supply environment can decrease demand as it is intended to do, but it doesn’t solve the lack of supply. The reasons for that lie in idle, backed-up shipping ports around the world, locked-down Chinese cities and on the battlefields of Ukraine. None of which the Fed can do anything about.

Real US interest rates are finally positive again. Real rates are the difference between nominal rates and expected future inflation. For example, with the 10-year Treasury rate at 3.0% and expected 10-year future inflation at 2.7% (according to Treasury Inflation Protected Securities, TIPS, pricing), then real interest rates are +0.3%. This is important because, while the transition to positive real rates can be painful since it sends bond prices lower as discussed in last weeks report, it means we may be through the most painful part of that process now and that is good news for holders of bond funds

But remember, there’s a flip-side to this. The argument for holding stocks becomes less attractive when investors have, for the first time in a long while, an essentially risk-free alternative on their hands that actually pays a positive real rate of return.

Nevertheless, Bank of America strategists last week were the first to come out and suggest that the recent sell-off shows that the stock market may have reached “true capitulation” [see FINANCIAL TERM OF THE WEEK below] - usually a pre-requisite to a sustained recovery in stock prices.

The Consumer Price Index (CPI) measure of US retail inflation rose 0.3% in April and was up 8.3% from a year earlier, the Labor Department said last week. The previous year-over-year inflation rate had been 8.5%. So, directionally the headline rate is going the right way. But more worrying, "core inflation," which excludes volatile food and energy, surged ahead by 0.6%. That number was an acceleration from March’s 0.3%. Even more concerning is that this hot core reading was driven mostly by an increase in the cost of non-energy services and not goods.

This spreading of inflation pressures away from goods and into services is a troubling sign as supply chain problems can't be so easily blamed and the resulting sense is that the Fed will need to, as one analyst put it, “act harder and act faster”. The obvious risk is that the more aggressive the Fed gets, the more likely it is that the economy tips into a recession.

Things weren’t helped the next day when it was announced that inflation at the wholesale level rose more than expected in April, pushed higher by rising commodity and energy prices. The Producer Price Index (PPI) rose at a year-on-year rate of 11.0% last month, worse than economists’ estimates and March’s number was revised upward to 11.5%. The silver lining? The PPI core annualized rate of wholesale inflation, leaving out volatile food and energy prices, was “only” up 8.8%, which was less than forecast.

And then there was Friday. Stock markets catapulted higher, turning a catastrophic week into simply a bad one. It was brought about by a couple of things, firstly an oversold environment with RSI readings having dipped below 30 (see LAST WEEK BY THE NUMBERS below) but another catalyst was that we finally got some positive news concerning one of the three main market drivers (China, Ukraine and the Fed) as Chinese authorities dangled the possibility of a lifting of some of its more dramatic lockdowns (including in Shanghai) by May 20th.

When this market does eventually bottom out, it will look and feel rather like it did on Friday. However, that does not necessarily mean that Friday was the market bottoming out. Indeed, avid readers of the Under The Hood part of this report will know that conditions specifically do NOT point to this being the bottom.

An important question is, who was doing the buying on Friday? Professional institutional traders forced into buying by margin calls to cover short positions or by options hedging? High frequency traders looking for a quick scalp who will have sold everything they bought on Friday before lunch on Monday? Battered BTFD’ers giving it one final try? Or actual investors who genuinely feel we have now reached the bottom and it’s finally time to start loading up again on stocks in a fully washed-out market?

Unfortunately, we won’t know the answer to this until knowing it is of no practical use.


Other News (Digital Edition):

Crypto’s horror week ..

Bitcoin, the largest cryptocurrency, hit a peak price of around $68,000 in November 2021. On Friday last week, the price fell to $29,300. Similar (indeed worse) declines have occurred everywhere across the entire crypto eco-system. As reported last week in the Wall Street Journal, over a trillion dollars (that’s $1 + twelve zeros) of crypto has simply vanished in losses over those six months.

Until last Friday, Bitcoin had essentially become indistinguishable in its price movements from tech stocks. Its recent correlation to the NASDAQ index was 82%. The different thing about this crypto crash as opposed to the countless number of previous ones is that now two-thirds of crypto volumes come not from retail, entitled, backwards-baseball-cap-wearing, rich-kid bros born on third base in California any more but by real institutional money, including hedge funds. The biggest owners of Bitcoin now also own grandad stocks like Exxon, Coca Cola, IBM and GE. But these funds also own lots of the incinerated stocks like Peloton, Shopify, Zoom, Sofi etc on margin and leveraged which is absolutely killing them and they need to sell stuff to meet margin calls. Selling some Paypal stock isn’t exactly going to raise much $$, so many are selling crypto instead.

Coinbase’s trading volumes fell more than 40 per cent in the first quarter, net losses of $430m were reported, far greater than the $47m expected by Wall Street analysts. Revenues were far worse than expectations too. The company’s investors have run out of patience, headed for the exits and told the firm that they are no longer prepared to listen to any more empty promises about “potential” future profits. With its stock price down 80% from its IPO, Coinbase Global CEO Brian Armstrong even had to come out and deny that the company was at risk of bankruptcy, barely a year after going public.

Why is this so important? Because, in its 10-Q filing, Coinbase revealed that customers who custody their crypto with the company would be treated as unsecured creditors in the event of a bankruptcy. Translation? Your investment held on the platform can be taken from you by Coinbase in the case of bankruptcy and used by them to pay off their creditors. You could lose up to .. everything.

The Ponzi scheme built on cotton candy and Tinkerbell’s fairy dust known as the TerraUSD “stable”coin (see here for an explainer of what it is and what happened to it last week), designed to be pegged 1-to-1 to the fiat U.S. dollar and therefore always have a $1.00 value, broke last week and saw its price plunge to 11 cents - showing that crypto world can suffer destabilizing “runs on the bank” just like the real world. The coin’s outspoken creator, Do Kwon, directed that huge sums of money be spent to try to rescue this vanity project of his and pleaded for help from his army of Twitter followers, helpfully pointing out that he was “gonna keep making noise”. I’m sure that was a real comfort to investors. So far the contagion does not yet seem to have spread meaningfully to other so-called stablecoins like Tether, USDC and Binance USD but there are a lot of nervous bros out there right now.

The NFT market is in the process of totally disintegrating. NFTs are digital tokens that act like a certificates of ownership that live on a blockchain. The sale of non-fungible tokens fell to a daily average of about 19,000 last week, a 92% decline from the peak last September according to the data website, NonFungible. The number of active wallets in the NFT market has fallen 88% to about 14,000 last week from a high of more than 119,000 in November. A NFT of the first tweet from Twitter co-founder Jack Dorsey sold in March 2021 for $2.9 million to Sina Estavi, the chief executive of some Malaysia-based blockchain company. Estavi then put the same NFT up for auction earlier this year and the highest bid he saw was less than $14,000.

Crypto myths busted .. “Crypto is an inflation hedge”. Er, no it isn’t. It’s been heading steadily lower the whole time that inflation has been ripping higher. Just overlay the chart of one on the other for definitive proof that we can toss this myth out of the window.

“The days of the US dollar as the world’s reserve currency are numbered”. Hmmm, the USD Index just hit its highest level since 2002 and is up almost 10% just since February. The world has hardly ever wanted dollars as badly as it does now, which does indicate significant global risk aversion. When the world is this hungry for “safe” dollars, you know that “return on capital” is not foremost in investors’ minds, “return of capital” is. Risky assets like crypto have been jettisoned.

El Salvador’s bonkers decision last September to make Bitcoin legal tender in the country is coming back to bite. Hard. Praised by giddy crypto bros safely chilling in their smart homes in the US as forward-thinking and genius at the time, the move has recently caused the country’s international credit rating to get slashed to international junk status which raises the interest it now has to pay on its foreign debt - right at the time that its legal currency held by millions of its citizens has just lost 50% of its value in a few months. The government, having faced understandably furious riots on its streets, now finds itself looking for a handout from the International Monetary Fund (IMF) as the crypto crash has meant that it may well not even be able to meet its upcoming international debt obligations. Negotiations are not going well as the IMF has understandably said that any bailout would be contingent on El Salvador dropping its Bitcoin legal tender policy which 43-year old President Bukele seems reluctant to do, despite the economic damage caused by such a policy.

Important: None of this means that you can’t be long-term optimistic about crypto as an investment, but if you are going to wait it out, you clearly need to be ready for a lot of very frequent, very intense periods of pain over what may be a pretty long haul. If you cannot stomach somewhat regular 80%+ declines in the value of your investment with no guarantee of a bounce back at any time, then you have likely mis-allocated to the asset class. In my view, a total of 1-2% of your investable assets in crypto is perfectly fine but that should probably be the maximum for a normal human being, although of course each individual’s case is different. And maybe - given what we learned last week - you may want to look into platforms other than Coinbase to hold it (Anglia Advisors has an option available exclusively for our clients, contact me for more details).


Under The Hood:

There’s an old saying on Wall Street; A bear market doesn’t end until the last bull throws in the towel. We likely need to see total panic, blind selling and capitulation (see FINANCIAL TERM OF THE WEEK below) from the universe of trapped investors who see no other option other than dumping all their stocks as a sign that the bottom might be near. However, this kind of blow-off selling is typically accompanied by a large spike in volume.

While a small uptick in trading volume has been evident lately, it has still remained quite muted during recent large declines, suggesting what we are seeing is not yet the required level of blind panic. Having said that, the bottom will be found one day and some of the apparent capitulation on display last week may be inching us closer to it.

Consider these stats for the Russell 3000 index, which is essentially the entire US stock market .. 40% of stocks in the index have lost a third or more of their value this year, close to 20% of them are now down 80% or more from their highs and almost 10% of the index has now crashed 90% or more. Just last week alone, over 30% of NASDAQ stocks broke down to new one year lows, as did six of the S&P 500’s eleven sectors.

These is brutal data and could be interpreted (as indeed kind of happened on Friday) as indicative of things being oversold or even washed out. But, as I have described, “oversold” is not a synonym for “buyable”. Rather, it is simply a technical analysis term that means the market may have moved too far, too fast in the short term (see the RSI readings that I update weekly in LAST WEEK BY THE NUMBERS below). At best, it is a call for a potential opposite-direction reaction, such as we saw on Friday and is not necessarily indicative of a change in trend. Remember as well that oversold can also easily become “even more oversold”.

I think we still need to see a sustained bounce from some panic selling before we can seriously contemplate the bottom being in.

Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.


The upcoming week’s calendar .. 

We’re at the tail end of the Q1 2022 earnings season, but we will be hearing from Walmart, Home Depot, Target, Caterpillar, John Deere, Moderna, Cisco, Take Two Interactive, Applied Materials, TJX and Lowe’s.

The economic data highlight of the week will be the release of April’s retail sales data on Tuesday morning. Expectations are for a 0.8% month-over-month increase.

There will also be several housing-market indicators out next week: The National Association of Home Builders releases its housing market index for May, the Census Bureau reports new residential construction data for April and we learn about existing home sales.

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US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):

  • Bullish ↑ 24% (down from 27% the previous week)

  • Neutral → 26% (up from 20% the previous week)

  • Bearish ↓ 50% (down from 53% the previous week)

  • Net Bull/Bear spread .. Bearish ↓ by 26 (Unchanged: Bearish by 26 the previous week)

Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Bull-Bear spread: Bullish by 8
Source: American Association of Individual Investors (AAII). All numbers rounded.

LAST WEEK BY THE NUMBERS:

- Last week’s best performing US sector: Consumer Staples (two biggest holdings: Proctor & Gamble, Coca-Cola) - up 0.3%

- Last week’s worst performing US sector: Real Estate for the second week in a row (two biggest holdings: American Tower, Prologis) - down 4.0%

- The NASDAQ-100 and the S&P 500 had an identically poor week

- US Markets lagged both Emerging Markets and International Developed Markets

- Small Cap performed less badly than Mid which in turn performed less badly than Large Cap

- Once again, Growth underperformed Value

- The proprietary Lowry's measure for US Market Buying Power rose by 3 points last week while that of US Market Selling Pressure rose by 4 points

SPY, the S&P 500 ETF is still below both its 50-day moving average and its 90-day and remains well below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 39**. SPY ended the week 15.9% below its all-time high (01/03/2022)

QQQ, the NASDAQ-100 ETF, is still below both its 50-day moving average and its 90-day and remains well below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 40**. QQQ ended the week 25.3% below its all-time high (11/19/2021)

** RSI readings range from 0-100. Readings below 30 indicate an over-sold condition, possibly primed for a technical short term rebound and above 70 are considered over-bought, possibly primed for a technical short term decline.


ARTICLE OF THE WEEK:
Each week I'll link to an interesting article I have come across recently.

This week: You have to hand it to the stock-pickers. Like Monty Python’s Black Knight, they just keep coming back over and over again with their fake news no matter how many times a new mountain of evidence disproves their losing philosophy, no matter how many times their loudly-howled assertions are proved to be entirely wrong and no matter how many times the stock market chops off one of their arms or legs.

Ritholtz discusses their latest blame-game strategy to try to get you to invest all wrong.


FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia (may be edited at times for clarity).

CAPITULATION

Capitulation means surrender. In financial markets, capitulation marks the point in time when a large enough proportion of investors simultaneously give up hopes of recouping recent losses, typically as the decline in prices gathers speed.

Suppose a stock you own dropped by 30% but you were sure it would bounce back. Imagine it then fell another 20% but it was clear the fundamentals were solid. Maybe you bought a little more on the dip. Now imagine the same stock is down 15% intraday and the grind of daily disappointment has given way to certain knowledge that you bought a loser that could go even lower. Selling the stock as a result would be an act of capitulation.

Note that the stock was already down 15% in a day, suggesting others felt the same. While misery may like company, a capitulation requires a panicked crowd.

Capitulation means that the sellers were "wrong" or the buyers "right." While a short-term rebound follows capitulation by definition, it doesn't mean prices can't go even lower later, if future reverses turn the new "strong hands" into sellers.

Bear markets can feature repeat high-volume plunges in price and premature calls of capitulation. The truth is that the condition can be diagnosed conclusively only in hindsight, if the price rebounds.

While capitulations can be impossible to tell apart from run-of-the-mill high-volume declines in real time, they're easy to spot with the benefit of hindsight: just look for a significant rebound in the price.

On March 18, 2020, the S&P 500 index was down nearly 10% from the prior day's close amid the COVID-19 market collapse, only to reverse and close down 5.2% on the day and 1.6% below where it opened. That wasn't quite capitulation, however, in retrospect.

On March 23, 2020, the S&P 500 plunged nearly 5% intraday at its lows but managed to close with a loss of "just" 2.9%. We know that was capitulation because the index went on to gain 17% over the next week.


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