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Market Whipsaw: Crypto Collapse and a Lower-than-Expected Inflation Print
publication date: Nov 10, 2022
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author/source: Brian Nelson, CFA
 Image: Uncertainty in the cryptocurrency markets has surged with concerns over the liquidity of a key exchange. Investors are weighing the spillover effects of crypto with the view that the pace of inflation may have peaked.
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By Brian Nelson, CFA
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The U.S. equity market continues to be highly volatile as it whipsaws between concerns over the health and sustainability of cryptocurrency and optimism over lower-than-feared inflation readings. We maintain our bearish/defensive stance on equities, but at the same time, we continue to be “fully-invested” across the simulated newsletter portfolios in part because we don’t want to miss out on days like today, November 10, when the markets are soaring ~2.5%-5.5% depending on which index you are monitoring. We’re also not ruling out a Santa Claus rally through the end of the year. Merry Dow Jones, as they say!
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The simulated newsletter portfolios continue to do relatively well in 2022, despite what has happened this year with Meta Platforms (META), PayPal (PYPL) and Disney (DIS) – all three of which have previously been removed from the simulated Best Ideas Newsletter portfolio. We measure the success of the VBI on how well it is implemented through the Best Ideas Newsletter portfolio, and year-to-date through the October 28 close (the last tally), we estimate that the Best Ideas Newsletter portfolio is beating the SPY by ~6.3 percentage points. Though there may be some long/short hedge funds taking on more risk and doing better this year than our simulated results, we are pleased with the relative “outperformance” in 2022.
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During the past couple weeks, there has been a significant disruption in the cryptocurrency markets, an area that we haven’t allocated many research resources to given that cryptocurrencies are hard to value—or perhaps better said, impossible to value given their lack of traditional free cash flow characteristics as that found within general equities. Reports have indicated that a major cryptocurrency exchange is having liquidity issues, and uncertainty is proliferating as regulators are probing whether the cryptocurrency exchange handled funds inappropriately. The situation continues to be fast-moving, and news has been hitting the wires frequently the past few days. We expect more news on this front to come as additional information is brought to light.
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Our general view on cryptocurrencies has not changed in that they are largely “un-investable” considerations, and more accurately described as speculative instruments tied to “greater fool” theory. Unlike equities that can be taken private to reap their cash flows, cryptocurrency relies on someone else, a “greater fool” in finance jargon, to pay a higher price. It remains to be seen how the latest series of events will play out with respect to cryptocurrencies, but confidence looks to be shattered among many speculators, with the prices of major cryptocurrencies such as Bitcoin and Ethereum down more than ~63% and ~67%, respectively, so far this year.
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We commented earlier this year that the collapse in cryptocurrencies and disruptive innovation stocks were the key reasons for broader weakness in the equity markets during the first quarter of 2022 (inflation readings had been elevated for much of 2021, so inflation wasn’t the initial domino, per se). As of today, the ARK Innovation ETF (ARKK) is down more than 60% so far this year, and based on fund flows, estimates indicate significant money has been lost on this ETF, even considering its run up to its 2021 highs. In our view, weakness from cryptocurrency and disruptive innovation stocks generated a negative wealth effect across Silicon Valley earlier this year, putting the pressure on big cap tech, where the tech-heavy NASDAQ started to feel pain.
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As inflation headlines started to become top of mind through the course of 2022 with equity markets faltering, consumers then started to pull back spending on discretionary items, as witnessed through the fundamental performance at Walmart (WMT), Target (TGT), Nike (NKE), FedEx (FDX) and others. The Fed then, in its battle to stem the rise in inflation, started to increase rates aggressively, and this put a further dent in equity prices (higher discount rates generally translate to lower values). The Fed’s aggressive moves also contributed to the pain in the prices of other assets, including bonds and housing. For example, through November 9, according to estimates from Morningstar, the 60/40 stock/bond portfolio [VBIAX] is down more than 19%, and we’ve yet to see a major adjustment in housing prices that we can only expect given affordability changes from higher rates.
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Fast-forward to today, and third-quarter results across S&P 500 companies weren’t as bad as we thought they could be. According to FactSet, for the third quarter, “the blended earnings growth rate for the S&P 500 is 2.2%,” with roughly 85% of S&P 500 companies reporting results. Most of this resilience has come from the energy sector, but FactSet also noted that ~70% of S&P 500 companies reported a positive revenue and earnings surprise in the quarter, which isn’t bad by any stretch. However, looking out to the current calendar fourth quarter, expectations are for S&P 500 earnings to decline slightly, but we don’t think readers should overreact. The simulated newsletter portfolios continue to be well-positioned, given the strong cash-flow-supported ideas and significant overweight “position” in energy that was allocated across the Best Ideas Newsletter portfolio, Dividend Growth Newsletter portfolio, and High Yield Dividend Newsletter portfolio last year.
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With a negative wealth effect from collapsing stock and bond prices this year, and soon housing equity due to the abrupt increase in mortgage rates, there still is the potential for some very tough sledding ahead in equity prices, but at the same time, we may start to see some easing with respect to the pace of inflation, too, at least as it relates to the latest readings. For example, used car prices have been coming down, housing prices are on their way down, and consumers seem to be finding a way to stretch their budgets by trading down across staples for cereal and other off-brand items. Job losses across Silicon Valley have also accelerated, with Twitter and Meta announcing major layoffs recently.
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Today, it was reported that year-over-year core CPI inflation came in at +6.3% in October versus +6.6% expected, which the market is viewing as a sign that the pace of inflation expansion has peaked, with the news potentially having implications on the magnitude of Fed rate hikes going forward, which could ease the pain across asset values experienced so far in 2022. There are many variables that go into the CPI measurement, and many have noted that given impending weakness in the housing market and implications on owners’ equivalent rent, actual inflation may be much lower than what was reported for October today.
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At the time of this writing during the trading session November 10, the Dow Jones is up ~2.5%, the S&P 500 is up ~4%, and the NASDAQ is up ~5.5%. Though key risks to the equity markets remain--not the least of which is an impending negative wealth effect from lower stock and bond prices and deteriorating housing equity coupled with still-elevated inflation levels--we continue to like how the simulated newsletter portfolios are positioned. Our best ideas for consideration remain in the simulated newsletter portfolios, across the Exclusive publication, and within our options ideas emails. We’re available for any questions, and thank you for reading!
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Tickerized for holdings in the SPY. Also: BITO, HUT, GBTC, RIOT, MARA, BITF, BTBT, MSTR, COIN, NVDA, PYPL, V, ETHE, SI, BRPHF, XPDI, SQ, MGTI, HIVE, ARBK, ISWH, CAN, NCTY, ANY, HSSHF, BBIG, YVR, CSCW, HMBL, DLPN, HOOD, BTCM, CLSK, ETHE, BKKT, CME, BTF --------------------------------------------- About Our Name But how, you will ask, does one decide what [stocks are] "attractive"? Most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth,"...We view that as fuzzy thinking...Growth is always a component of value [and] the very term "value investing" is redundant. -- Warren Buffett, Berkshire Hathaway annual report, 1992 At Valuentum, we take Buffett's thoughts one step further. We think the best opportunities arise from an understanding of a variety of investing disciplines in order to identify the most attractive stocks at any given time. Valuentum therefore analyzes each stock across a wide spectrum of philosophies, from deep value through momentum investing. And a combination of the two approaches found on each side of the spectrum (value/momentum) in a name couldn't be more representative of what our analysts do here; hence, we're called Valuentum. --------------------------------------------- Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE, and RSP. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies. Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free. |
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