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Daily Analysis 26 January 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as stocks take a dive ahead of theU.S. Federal Reserve policy meeting, where expectations are high that central bankers will stick to their hawkish pivot, regardless of the turmoil in the markets.

In brief (TL:DR)

  • U.S. stocks tanked Tuesday in a dramatic reversal from Monday, with the Dow Jones Industrial Average (-0.19%), the S&P 500 (-1.22%) and the Nasdaq Composite (-2.28%) all declining in another volatile session as traders bet on continued bearishness for risk assets.

  • Asian stocks were lower on Wednesday as traders kept mainly to the sidelines ahead of a Fed meeting that most are betting will be shaped by tighter monetary policy.

  • Benchmark U.S. 10-year Treasury yields remained flat at 1.776% (yields rise when bond prices fall).

  • The dollar was unchanged.

  • Oil slipped with March 2022 contracts for WTI Crude Oil (Nymex) (-0.11%) at US$85.51.

  • Gold fell with April 2022 contracts for Gold (Comex) (-0.26%) at US$1,850.20 as the dollar remained stable.

  • Bitcoin (+3.76%) saw a sharp and unexpected rebound to US$37,260 breaking off correlation with tech stocks and other risk assets and staging an exhilarating reversal for the benchmark cryptocurrency that many had expected to fall in the run-up to the Fed's policy meeting.

In today's issue...

  1. What will it take for the Fed to blink?

  2. Ark Invest's Cathie Wood Declares "Innovation on Sale"

  3. Facebook's Stablecoin Dreams Have Ended in a Facepalm

Market Overview

It could go either way at this point - while U.S. tech stocks were hammered in another volatile session yesterday, Bitcoin staged a whiplash-inducing turnaround to trade above US$37,000 even as analysts are betting on the U.S. Federal Reserve to stick to its hawkish pivot.

Be that as it may, there are clues that U.S. Federal Reserve Chairman Jerome Powell may temper his language and positioning somewhat - with signs that the central bank is making policy on the fly, with supply chains improving and indications that inflation could be peaking.

It's entirely possible that markets may yet rally because even a moderately hawkish Powell would be sufficient to convince investors hungry for any good news that it's off to the races once again.

In Asia, markets fell Wednesday morning with Tokyo's Nikkei 225 (-0.44%), Seoul's Kospi Index (-0.41%), Hong Kong's Hang Seng (-0.05%) and Sydney’s ASX 200 (-2.49%) all lower.

1. What will it take for the Fed to blink?

  • Taking some froth out of eye-watering valuations may be in the Fed's interest to deflate any potential bubbles rather than precipitate a ruinous crash

  • Host of macro factors create a backdrop that provide the perfect context for the Fed to raise rates, including the fastest inflation in four decades

Facing down the highest levels of inflation in four decades, investors are increasingly wondering what it will take for the U.S. Federal Reserve to reverse its hawkish pivot, if at all.

Extremely loose financial conditions, skyrocketing inflation and eye-watering valuations are creating a backdrop for policymakers to turn a blind eye to markets which have been bleeding.

U.S. equities have doubled in three years, buoyed largely by the Fed’s apparent willingness to bail out investors when times get tough and it may be that just giving up some of those gains to reign in the cost of living is a small price that policymakers are willing to charge investors.

Some clues as to the scale of the excess could provide guidance for the scale of the contraction – the Nasdaq 100, even accounting for recent corrections, is still at five times the value of sales, close to where it was during the dotcom bubble.

The S&P 500 is trading at 24 times price-to-earnings, about 20% higher than its 10-year average.

Even if markets were to correct by a fifth, they’d still be in a long-term growth trajectory, but will provide cold comfort to investors who bought in at the height.

It’s unlikely that the Fed will step up with a put – markets would need to correct a whole lot more for that to happen and there would need to be a real risk of a recession.

Because earnings are robust and even companies with shaky finances are still performing decently, there is little to move the minds of policymakers who appear focused on inflation.

Some traders though are betting that the Fed will tone down its hawkish positioning at this week’s Federal Open Market Committee meeting, especially given the recent gyrations in markets.

There is some precedent for this view – the last two times stocks threw a tantrum like this, in March 2020 and December 2018, the Fed either turned outright dovish or put a halt to its tightening.

But those periods were different from the current – inflation was muted and economic conditions were relatively stagnant.

With the U.S. economy on a tear and political pressure on the Fed to make good on inflation, it’s unlikely that ever-optimistic investors can rely on the Fed’s implied put to shore up risk-taking.

Ark Invest's Cathie Wood Declares "Innovation on Sale"

  • Ark Invest Innovation ETF down by almost half from all-time-high, could be potential entry point for investors or those looking to dollar-cost average

  • Concentrated bets on disruptive technology could provide superlative returns in years to come, even if only a handful of bets come to fruition

With some of the pandemic’s most-loved technology stocks in virtual freefall despite Monday’s 11th hour turnaround of the Nasdaq 100, Ark Invest founder Cathie Wood is doubling down on innovation, urging investors to look beyond recent market volatility.

She may be right.

While most retail investors baulk at volatility, Wood and her ilk know that a long-term bet on innovation is precisely that – a long-term bet that will take years to play out.

And while many of the companies that Ark Invest has backed are likely to fall out along the way, the superlative performance of just a handful of them could dramatically alter the long-term performance of her Wood’s flagship US$12 billion Ark Innovation ETF, better known by its ticker ARKK.

ARKK is down some 27% this year alone and half of its value from its peak last February – but many of the companies and technologies that Ark Invest backs will take years if not a decade at least, to come to fruition.

Concentrated bets on high-growth U.S.-listed companies, in areas related to DNA technology, automation, robotics, energy storage, artificial intelligence and fintech are likely to pay out in spades, just not in the timeframe that an average investor may be prepared to hold on to such convictions.

And that would be a shame.

Many of the technologies that we take for granted today were viewed with the same skepticism when they were first mooted – from e-commerce to the mobile phone.

And many of the companies that were the darlings of the stock market then, no longer even constitute key indices like the Dow Jones Industrial Average.

Some investors are rotating into so-called “value” stocks, as the prospect of higher interest rates puts greater focus on the here and now – with financials, energy and industrials all seeing an uptick in buying.

But those companies represent the world of yesterday – the same way that railroads have fully priced in all of their growth potential today, there was no way of knowing when they launched the transformative technology of rail travel.

Similarly, it’s hard to value the digital technologies of today, in the context of their transformative potential for years and decades to come.

Which is why Wood may have a point – innovation may really be on sale.

Speaking at Ark Invest’s virtual Big Ideas Summit 2022, Wood noted,

“Many people associate volatility with risk. We use volatility to our advantage. We concentrate towards our highest conviction names and that tends to work very well as we go through these corrections.”

“Innovation is on sale and it will be really important to investors to get to move towards the right side of change, given the amount of disruption that we do expect.”

3. Facebook's Stablecoin Dreams Have Ended in a Facepalm

  • Bloomberg reports that Meta (-2.77%) is rumored to be looking to a sale of assets of its Diem stablecoin project

  • Meta's Diem stablecoin's prospects of success are now effectively zero, given hesitance to launch before receiving regulatory approval and against a backdrop of enhanced scrutiny of the impact of social networks on political systems and outcomes

It’s been said that it’s sometimes easier to say sorry than it is to ask for permission – in Meta’s (formerly known as Facebook) case, it did neither, when it came to the launch of its since-aborted stablecoin project, first named Libra then Diem.

Neither asking regulators for permission to launch the project or going right out and getting it done – Diem was to all intents and purposes an exercise in arrogance – an assumption that given Meta’s immense social media influence and with a user base larger than any sovereign nation, others would necessarily bow to its global currency ambitions.

Had Meta just gone ahead and launched its stablecoin, it might already be the top digital currency by now.

Instead, what lies in the wake of Meta’s stablecoin ambitions are half measures and whole levels of disappointment and unrealized potential.

According to a recent Bloomberg report, the Diem Association is weighing a sale of its assets as a way to return capital to its investor members, including the sale of intellectual property and a way to transfer its engineers who developed the technology, out of the venture.

Compared to other more high-profile stablecoin ventures – Meta’s failure has been spectacular and very public.

Coming at a time when global distrust in social networks was at its zenith, Meta had neither the credibility from the decentralized cryptocurrency community, nor the blessing of regulators in its foray to create the one stablecoin that would unite them all.

And last November, the Biden administration put the final nail in Diem’s coffin – stablecoin issuers would need to be regulated banks if the tokens were to be used as a means of buying and selling things, according to the President’s Working Group on Financial Markets.

To be sure, Diem was never going to be able to meaningfully compete with the likes of Tether, issuer of the controversial USDT – long the stablecoin of choice for the cryptocurrency community, or even USDC, a rival stablecoin issued by Circle.

Payment services providers who were key to Diem’s success also dropped out of the initiative relatively early on, from PayPal (-2.45%) to Visa (+0.07%) and Mastercard (-3.05%), each with their own agendas to develop their own cryptocurrency or stablecoin solutions, rather than concentrate power in Meta’s various social media platforms.

Ironically, had Meta gone ahead to launch its own stablecoin regardless of the consequences, there was an outside chance that it would have gained sufficient momentum that it would be hard for regulators to bust it up, once it had reached exit velocity.

Meta’s since abandoned founding ethos of “moving fast and breaking things” would have set it in good stead when it came to the cryptocurrency sector – where the default approach has always been to apologize than to request for permission to act.

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