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Daily Analysis 25 January 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as stocks turn upwards amidst a last minute rebound in the aftermath of a retail capitulation.

In brief (TL:DR)

  • U.S. stocks closed higher Monday in a volatile session with the Dow Jones Industrial Average (+0.29%), the S&P 500 (+0.28%) and the Nasdaq Composite (+0.63%) all recovering with intraday swings of as high as 4% erased and eking out gains before the close.

  • Asian stocks sank Tuesday as volatility on Wall Street and concerns over the U.S. Federal Reserve tightening rattled nerves.

  • Benchmark U.S. 10-year Treasury yields remained flat at to 1.77% (yields rise when bond prices fall) as traders sat on the sidelines ahead of a Fed policy meeting later this week.

  • The dollar held gains.

  • Oil climbed with March 2022 contracts for WTI Crude Oil (Nymex) (+0.50%) at US$83.73 as traders focused on the demand outlook.

  • Gold was flat with April 2022 contracts for Gold (Comex) (-0.05%) at US$1,843.20.

  • Bitcoin (+2.60%) recovered to US$36,260 in line with the rebound in stocks and with correlation between the benchmark cryptocurrency and the Nasdaq 100 at its highest in over a decade.

In today's issue...

  1. How does this one end?

  2. Mom-and-Pop Investors Bailed on the Market, then it Rallied Hard

  3. Is US$30,000 Bitcoin's Newest Floor?

Market Overview

Nothing quite like a good geopolitical crisis to rattle already frayed investor nerves.

With Russian troops conducting "exercises" on its border with Ukraine and the U.S. mobilizing additional troops should there be an invasion, there are plenty of things for investors to worry about, not least of which is a U.S. Federal Reserve that is threatening to take the punchbowl away.

Markets punch-drunk with liquidity are in for a period of introspection as the prospect of higher interest rates dampens appetite for risk assets and increases the potential to slow economic growth.

In Asia, markets fell Tuesday morning with Tokyo's Nikkei 225 (-2.03%), Seoul's Kospi Index (-2.50%), Hong Kong's Hang Seng (-1.32%) and Sydney’s ASX 200 (-2.57%) all sharply lower.

1. How does this one end?

  • Implied U.S. Federal Reserve "put" to rescue markets and investors should asset prices and economy crash encourages risk-taking long-term

  • Staying invested while dollar-cost averaging is one possible way to keep on even keel regardless of what happens next

Investors watching the market should be getting whiplash by now – with an incredible 11th hour about turn for stocks which saw a sharp rebound from a 4% rout to push higher.

On Monday, U.S. retail, energy and industrial companies led a charge in equities that saw the benchmark S&P 500 rebound despite tumbling as much as 4% earlier in the trading session, as seller exhaustion gave way to dip buying.

Investors watching the gyrations will be wondering how this epoch plays out – a massive deleveraging that sees a sharp crash across all asset markets or a speed bump in the otherwise relentless upwards march of asset prices.

To be sure, this time is different because not since the eve of the 2008 Financial Crisis have all assets across the board reached such heady valuations.

From real estate to stocks, cryptocurrencies to commodities, asset prices are on a tear and there’s a growing chorus of voices that are calling for the bubble to burst and markets to crash, but the bigger question is can they?

The aftermath of the 2008 Financial Crisis and the Covid-19 pandemic has demonstrated that when markets get flushed out, the U.S. Federal Reserve is on hand to bail out the entire economy through massive monetary and fiscal stimulus.

Whether it’s buying up assets such as U.S. Treasuries and Mortgage-backed Securities or keeping rates near zero, the Fed has intervened in previously unprecedented ways which are growing increasingly expected.

To be sure, the implied Fed “put” to bailout the market should things go awry has led to profligate risk taking in everything from meme stocks to cryptocurrencies but it’s unclear if the entire psychology of the market has mutated.

If investors know that even if there should be a very sharp crash, the Fed will be there to rescue or bailout the economy, then they’ll be tempted to take risk once asset prices start to flounder, an opportunity to “buy the dip” knowing that they can never go to zero.

And while there are similarities between our current epoch and previous bubbles such as the 2001 Dotcom Bubble and the 2008 Mortgage Bubble, before 2008, there was no expectation that the economy could rely on bailouts.

Risk-taking no longer has the same finality of consequences that it once had – the chips don’t lie where they fall when there’s always the prospect of the Fed helping you to pick them up.

And that’s why it’s difficult to call markets at the moment – too much pessimism that causes the entire market to crash and expectations increase for the Fed and Washington to intervene, buoying asset prices yet again.

More so than at any time in the past, markets are driven by sentiment, rather then metrics – the implied Fed “put” provides for that.

So what should investors do?

The only logical thing to do given the circumstances is to dollar cost average and stay invested because it’s impossible to call a bottom or a top – these times are different.

Looking to 2001 and 2008 provide few if any clues – there wasn’t an implied guarantee that the Fed wouldn’t allow the U.S. economy to fall into a 1920s style Great Depression.

When then U.S. Treasury Secretary Hank Paulson spoke about “moral hazard” – that intervening in the markets would remove the consequences out of risk-taking – these are precisely the sort of times he was talking about.

That stocks staged a late rebound yesterday suggests that for now at least, more investors believe that the Fed has their backs than less.

And the irony is that if more investors rather than less pull out of the markets and cause a crash, you can bet your bottom dollar that the Fed will rush in to shore up markets, as they have done so reliably since 2008 providing every incentive for risktakers to buy the dip.

2. Mom-and-Pop Investors Bailed on the Market, then it Rallied Hard

  • Retail investors had a gut-wrenching moment on Monday after selling out only to see the market rebound sharply in the wake of their selloff

  • Investors unused to the volatility of the markets are getting short shrift and trying to time bottoms which may or may not be reflective of the overall market

Trying to time the market especially for retail investors assumes that they know when the bottom has hit.

And while there’s no way to call a market bottom without the benefit of hindsight, it seems that there is also no shortage of retail investors who are willing to give it a try.

Spooked by the sharp decline in equities this year and the looming prospect of higher interest rates, combined with doomsday prophets proclaiming as many as eight rate increases this year culminated in a full-blown rout on Monday morning.

In a spasm of panicked selling early Monday, retail investors, who for the most part could be counted on to “buy the dip” offloaded a net US$1.36 billion worth of stock by noon, according to data from JPMorgan Chase (-0.09%).

But almost immediately after the wave of selling landed, a breathtaking reversal, one of several such turnarounds in recent weeks erased all earlier falls and sent major indices higher and share volume and severe price action in major trading vehicles suggests the worst of the selling in that round had been reached.

Yet even as retail investors appear ready to throw in the towel, another investor class has moved in to pick up the gauntlet – the so-called “smart money.”

While hedge funds and other professional speculators have slashed equity exposure and trimmed leverage, many have yet to actively unwind their positions and even more have dollar-cost averaged.

And overall levels of leverage, according to JPMorgan Chase analysts, have not reached the stage which suggests that sentiment is completely risk-off either, a view shared in a separate analysis by Goldman Sachs (-0.15%).

For mom-and-pop investors, many of whom just started trading in over the past year, the volatility may have been just too much for them to stomach, and the sudden and sharp rebound after they sold off would have been gut-wrenching for them.

Nevertheless, more speculative segments of the stock market have yet to see the light of day, including meme stocks which were richly valued and have been hemorrhaging money, were caught in a violent selloff and are down by around half of their November peak.

3. Is US$30,000 Bitcoin's Newest Floor?

  • Many analysts point to US$30,000 being the next important psychological level of support for Bitcoin

  • US$30,000 was last tested in May 2021, when China banned cryptocurrency mining

Not so long ago, in a cryptosphere not so far away, US$40,000 was the “floor” price for Bitcoin and an important psychological level of support.

But now that Bitcoin has crashed through just about every recent technical support level, traders are having to consider US$30,000 as the next line in the sand.

For investors who had bought Bitcoin in the depths of the so-called “Crypto Winter” of 2018 though, when Bitcoin was closer to US$3,400, they would be still looking at returns of almost 10 times their capital, but recent market entrants would be licking wounds of 50% drops or more.

Bitcoin is now over 50% down from its November peak but the selloff has also pushed its Relative Strength Index or RSI score to an oversold region of 19 and for now, it appears that US$30,000 is strengthening as a level of support, which some traders are calling a near-term floor.

Assets are generally considered oversold if the RSI falls below 30 and overbought if over 70, but many cryptocurrency traders use wider gauges given the volatility of the asset class, with 20 being oversold and 80 being overbought, given the vastness of the swings.

While a 50% drop in Bitcoin from peak to trough is par for the course in cryptocurrencies, that also happened at a time when far less people were paying attention to the nascent asset class.

US$30,000 is also an important level because that price point was tested last May after China declared its Bitcoin mining ban.

Many retail cryptocurrency traders have been shaken out of markets in recent days, with traders spooked by hawkish signals from the U.S. Federal Reserve and geopolitical tension escalating between Russia and Ukraine.

Although cryptocurrency traders often use technical signals (looking at chart patterns) to determine where prices will head next, macro factors are increasingly having greater influence on volatility than at any time in crypto’s trading past.

With support levels smashed through in a matter of days and the 40-day correlation coefficient between Bitcoin and the tech-heavy Nasdaq 100 at 0.66, its highest since 2010, according to Bloomberg, other assets are having an outsized influence on the benchmark cryptocurrency.

(A perfect correlation where two assets move identically in price and magnitude is represented by 1 while a perfectly negative correlation is represented by -1.)

To be sure, that correlation is to be expected, given the higher level of institutional participation in cryptocurrencies and many of Wall Street’s biggest banks offering crypto trading to their well-heeled clientele.

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