by Franklin J. Parker, CFA
The Summary
- This morning we saw data on the pending sales of homes, which surprised to the upside: +0.7% vs. -3.7% expected. This is the first positive figure since October 2021. Looking ahead, we get data on home prices, consumer confidence (another drop expected), personal incomes and consumption, and a couple of indices on manufacturing. Overall a pretty busy week in data. With data we have seen this quarter, the narrative of slower growth is gaining traction. And, although the word is thrown around a lot lately, the evidence of a looming recession is scant (of course, that isn’t to say a recession cannot happen anyway).
- Ever-more isolated by sanctions, for the first time in 100 years Russia officially defaulted on her debt this weekend. Thanks to ongoing oil and gas payments, Russia does have the cash to pay the overdue interest payments, but is not able to transfer payments to bondholders due to sanctions. Technically this is a default, though Russian officials have pushed back on that word. The significance of a major economy failing to make interest payments on its sovereign debt cannot be understated. Despite the situation, it does hurt the general confidence of market participants, and it is a stark reminder of very real (and often forgotten) political risk.
- Markets have rallied strongly over the past week, yet the S&P 500 still remains almost 20% off of its highs. If the US economy is or is about to be in a recession, last week’s rally will be one of many bear market rallies on the way down. If, however, a recession is not forthcoming, I would expect markets to continue higher. How you view the current economy will inform how you interpret recent market rallies (and selloffs). As always, understanding these events through the lens of the data is of paramount importance. While our feelings get loud during times like this, they are not a good guide for strategy in their raw form.
The Details
Let’s talk about what is going on with cryptocurrencies.
Bitcoin, a good proxy for the crypto market as a whole, is down almost 70% from last year’s high. Using traditional lines of thinking, this should not be the market reaction to higher inflation. Inflation is, at heart, a loss of value in your domestic currency. Meaning other currencies should gain in value. Were bitcoin a traditional currency, this line of thinking might apply.
However, bitcoin (and other crypto assets) are not traditional currencies. Rather, as their recent price action has shown, they are very risky assets. As such, they are governed more by liquidity flows than traditional valuation models. Let’s dig into that a bit.
Cash flows across markets in fairly predictable ways. During times of cash inflows, investors allocate to safer assets first, then they allocate cash to risky assets (like stocks or high yield bonds), then they allocate to more speculative markets (like angel investments, hedge funds, or cryptocurrencies). When cash flows away from investors, it is pulled from the last market first. So, speculative investments get liquidated first, then risky investments, then safer investments.
In many ways, this makes crypto a sort of “canary in the coal mine.” The selloff began there first because it is a liquid and speculative investment. As cash flowed away from investors, they began to re-allocate away from these markets and into others (pushing stocks higher and crypto down). Of course, cash kept flowing away from investors (in the form of quantitative tightening and inflation) so that selloff continued into risky markets. Now with less cash available to it than before, prices in this market may struggle to regain their previous levels (at least until cash begins to move back toward investors).
And, of course, as good times turn to bad times, we find out which organizations have the fortitude and foresight to survive. This is a good thing, long term, for that marketplace. After this, the crypto market should be a somewhat less speculative place to be.
Chart of the Week
The Federal Reserve has repeatedly talked about inflation expectations as a source of policy frustration. Along with very real policy tools, the Fed actively attempts to influence sentiment among both market participants and the general public. A public that believes inflation will continue marching higher is a public that will actively push inflation higher through the aggregation of their individual actions.
So, charts like this week’s are not good news to the Fed. As consumer sentiment has plunged, expectations for inflation—across both 1-year and 5-year windows—have increased substantially. As a keen observer will note, as inflation expectations increase, the general mood among consumers tends to decrease.
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