What I Care About This Week | 2022 June 27

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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.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

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