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Daily Analysis 27 January 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as markets turn course on the prospect of a U.S. Federal Reserve that has provided plenty of outs for policy tightening and multiple rate hikes.

In brief (TL:DR)

  • U.S. stocks were mostly lower on Wednesday with the Dow Jones Industrial Average (-0.38%) and the S&P 500 (-0.15%) lower, while the Nasdaq Composite (+0.02%) eked out a minor day in the green as investors reacted to potential policy tightening as soon as March.

  • Asian stocks were hammered on Thursday, with some indices sinking to their lowest levels in 14 months and South Korea and China set to stare down bear markets.

  • Benchmark U.S. 10-year Treasury yields roared to 1.852% (yields rise when bond prices fall) on the prospect of the Fed trimming its balance sheet.

  • The dollar hit a one-month high against major trading partners as traders sold down Treasuries and gold.

  • Oil slipped with March 2022 contracts for WTI Crude Oil (Nymex) (-0.94%) at US$86.53 on the back of a rising dollar and concerns over demand outlook coupled with supply side excess.

  • Gold fell with April 2022 contracts for Gold (Comex) (-0.82%) at US$1,816.90 as the dollar surged.

  • Bitcoin (-4.88%) saw a sharp dip to US$35,951 moving in lockstep with the broader market for risk assets as investors grow increasingly concerned over the prospect of U.S. monetary policy tightening.

In today's issue...

  1. No Surprise Fed Sticks to Its Plan

  2. The King of Short Sellers Goes Long on Netflix

  3. Bitcoin Has a Weird Way of Demonstrating its Inflation Hedge

Market Overview

It was the U.S. Federal Open Market Committee meeting that wasn't.

To be fair, none of the proclamations made by U.S. Federal Reserve Chairman Jerome Powell came as any real surprise to market participants who had broadly anticipated that the central bank would stick to its script of ending asset purchases by March and committing to rate hikes to combat inflation.

But hidden beneath the texture of the narrative were signs that the Fed is adopting an almost month-to-month policy stance, with the language used by Powell suggestive of a central bank that wants to remain "nimble" enough to respond to any number of possible outcomes.

And that spells bad news for investors who have been used to markets that seemed until fairly recently to only travel in one direction - volatility is here for some time to come.

In Asia, markets tumbled into Thursday morning with Tokyo's Nikkei 225 (-3.01%), Seoul's Kospi Index (-2.90%), Hong Kong's Hang Seng (-2.57%) and Sydney’s ASX 200 (-1.93%) all sharply lower and South Korea and Australia on the precipice of a bear market.

1. No Surprise Fed Sticks to Its Plan

  • Risk assets continue to slide as the U.S. Federal Reserve sticks to its narrative to cut asset purchases by March and to pave the way for rate hikes

  • Fed policy is increasingly indeterminate as flexibility and nimbleness is being emphasized which necessarily means higher levels of volatility in the coming weeks and months

Monetary policy has taken on the role of theater these days as years of easy liquidity have divorced asset prices from traditional valuation metrics.

Whereas investors may have in the past scoured reams of financial data, these days, many are glued to U.S. Federal Reserve pronouncements post policy meetings to divine clues as to what liquidity conditions are likely to be going forward and how that will affect allegedly inflated asset prices.

In this regard, U.S. Federal Reserve Jerome Powell did not disappoint yesterday – providing the perfect balance of ambiguity and certainty to the markets so that they could make of the Fed’s policy direction what they will.

To be sure, Powell made clear the Fed would act as needed to cool the hottest U.S. inflation in almost four decades and endorsed a rate liftoff in March, while opening the door to more frequent and potentially larger hikes than anticipated.

But, and this is an important “but” Powell also stressed the uncertainty on the economic outlook, including the risk that price pressures could fail to abate as forecast, telling reporters yesterday that policy must be “nimble” to confront risks to its mandate for price stability and maximum employment.

Investors took Powell’s comments to mean that the Fed would be more aggressive in its tightening than previously expected, yet there isn’t a whole lot to suggest that it will.

Even as Powell was speaking, stocks, which had rebounded in recent sessions, erased gains, bond yields surged, and the dollar advanced.

If nothing else, the language that Powell used to chart the path forward was perhaps the most waffled in recent times,

“There’s a risk that the high inflation we’re seeing will be prolonged, there’s a risk that it will move even higher. We have to be in a position with our monetary policy to address all of those plausible outcomes.”

Significantly, Powell said that the Fed was “of a mind” to raise rates in March – far from a certainty.

To be sure, there are plenty of conflicting data points in the U.S. economy right now that would be sufficient to give even the most hawkish policymaker pause for thought.

Employment growth has slowed in the last month of 2021 and it’s unclear if that’s a function of the Omicron variant, or a slowing economic recovery.

Corporate earnings have also disappointed for the last quarter of 2021, meanwhile Consumer Price Index data suggests inflation is confined to a few components that are unlikely to be durable such as used vehicles, while the pace of advance of other items that are larger contributors to prolonged inflation like meat and fuel are slowing.

And while the Federal Open Market Committee confirmed that it would end its asset purchase program in March – which makes sense considering that the U.S. economy is no longer in pandemic mode, it would only begin to shrink its bond holdings after rate increases commence.

When that is however is less clear.

The Fed has a substantial balance sheet now, more than at any point in its history.

With US$8.9 trillion to offload, the Fed’s sale of U.S. Treasuries and Mortgage-backed securities could flood the market and send yields soaring – hurting borrowers on everything from auto loans to mortgages.

It’s likely that January and February’s economic data out of the U.S. will reflect the effects of the Omicron variant rippling through the United States which makes it much harder for the Fed making policy on the fly to determine what the appropriate action should be in March.

While a 0.25% rate hike is all but a given in March, urges to tighten will be tempered by live economic data, and given that monetary policy is a blunt and lagging tool that could affect inflation possibly well after price pressures abate, may weigh on the Fed’s urgency to turn off the taps just yet.

2. The King of Short Sellers Goes Long on Netflix

  • Pershing Square's Bill Ackman takes big bet on Netflix even as its share price languishes amid slowing subscriber growth and increasing competition

  • Ackman's bet on Netflix may yet prove prescient given the streaming company's ability to churn out gripping content and raise prices with limited impact on subscription numbers as well as a strong overseas footprint outside of the U.S.

Made famous by his short bets against the multi-level marketing company Herbalife, Pershing Square’s Bill Ackman is not popularly known as a “long” investor.

Yet long is exactly the position he took on Netflix (-1.83%) as the firm’s battered share price made it sufficiently attractive to Ackman.

Netflix has suffered in recent times as competitors have seen the company’s subscriber growth slow as well as recent market volatility thanks to the prospect of monetary policy tightening.

News of Pershing Square’s investment in Netflix sent shares of the company increasing by 4% in after hours trading.

Netflix is down about 40% for the year, versus its high in November even as the streaming company said it expects to add much smaller number of subscribers this quarter than a year ago as it contends with an increasingly crowded streaming marketplace and ongoing disruptions from the Omicron variant.

Investors may have been disappointed by Netflix’s recent results and forecast but it is still far and away the leading streaming service provider, with 222 million paying subscribers and US$29.1 billion in revenue with net income of US$5.1 billion.

It also helps that Netflix appears to be able to find hits like the South Korean Squid Game and increase prices for subscriptions with seemingly limited consequences.

3. Bitcoin Has a Weird Way of Demonstrating its Inflation Hedge

  • Bitcoin correlation with Nasdaq Composite and S&P 500 are strongest during times of price drops - but have also undermined its alleged role as an inflation hedge

  • Negative correlation of Bitcoin with Treasury yields could provide a potential play for investors looking to ballast these two assets within a portfolio

Bitcoin could be mistaken these days as a proxy for the Nasdaq 100, rather than gold when it comes to asset correlation.

Long touted as a potential hedge against inflation, Bitcoin has struggled in 2022, a result of the prospect of monetary policy tightening by the U.S. Federal Reserve to combat the highest levesl of inflation in four decades.

If nothing else, Bitcoin’s struggles of late reflect how sensitive it is to broader market sentiments, hurting claims that it can offset the eroding price of inflation.

In that vein, while flows to gold have been increasing, similar withdrawals from Bitcoin have also been noticed.

But where Bitcoin could yet shine though is in that class of risk assets which would stand to gain as investors squeeze out whatever remaining juice there is from a rotation into “value” stocks more exposed to economic cycles.

In fact, Bitcoin and the stock market only tend to travel in the same direction on the worst performing days of the S&P 500 and the Nasdaq Composite, on days when the market tends to move sideways, returns are less closely correlated.

That makes for an interesting investment thesis on Bitcoin because the days ahead are likely to be volatile across the board for all assets.

Considering that the 120-day correlation coefficient with Bitcoin and the yield on the U.S. 10-year Treasury note is -0.1 – a negative correlation suggesting that the two assets move in opposite directions.

While Bitcoin may not be acting as a hedge against inflation right now, it could provide a potential ballast effect in a portfolio as bonds get roiled against a backdrop of the U.S. Federal Reserve’s reduction of its balance sheet of US$8.9 trillion in Treasuries and mortgage-backed securities.

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