The Weekend Edition # 41

Welcome to another issue of the Weekend Edition. 

Thank you to all who’ve read and subscribed to the newsletter this week!

Here’s what we cover this week:

• Market Recap - Crypto & the Markets

• Macro - Where will tightening take rates?

• Earnings of Week - Summary

• The Week Ahead - Economic & Earnings Calendar

• Closing Thoughts

Let’s dive in ⬇️

Market Recap - 09 May to 13 May, 2022

We’re getting closer.

This week was a tough week in the market with all market indices seeing significant decline during the week. Had it not been for the bounce on Friday, the S&P 500 would’ve have been very close to bear market territory.

That’s not to say that it can’t happen next week. But, it would seem that we see some exhaustion and may see a continuation of this bounce into next week.

The big news of the week was obviously everything crypto and coins. I’m not even going to begin to pretend that I understand anything that’s going on there. But, what I do see is the broader implications with regard to the market.

1. Bitcoin / Crypto / Coins have been fueled by easy money, this time around and last time.

2. These “assets” if you want to call them that, are in a typical bubble.

3. Bubbles burst when liquidity starts to disappear from the system

4. There’s some cross-asset correlation with high-beta stocks, which make them even more vulnerable.

5. So, a large contingent of Crypto buyers are also buyers of high-beta tech stocks. And these have taken quite the beating. I won’t be surprised if people are getting margin-called and liquidating crypto to pay that.

6. What’s troubling though, is whether it starts a contagion.

7. There’s always one asset class that starts the domino effect leading to a broad market decline.

8. While we’re seeing a decline across the board already, this could just be the nail in the coffin that starts widespread panic and pushes us into a longer and stronger bear market.

This is perhaps an oversimplified view of what’s going on in the crypto space and there’s probably a few more complex issues at work. But, the bottom line is, we’re living in a period where crypto’s decline can actually have a major impact on the market.

Ask people for a target, and they’ll say Bitcoin is going back down to $10,000-$11,000. Who knows whether that’s the case but, if it does, I think it’s just another sign that we’re headed for a bear market coupled with a recession.

But, crypto isn’t the only asset class that’s seen some pain during the week. Equities, and commodities saw significant declines, particularly precious metals. Bonds however, did get a nice bid during the week.

Macro - Where will Tightening Take Rates?

When the Fed cut rates to zero, it became harder to quantify the effect of QE on the economy. So, a concept called the Shadow Rate was introduced and this rate proposes to stand in for the Fed Funds rate to track the effects of QE. (The rate has stopped being tracked now as the Fed Funds rate has now come off the zero-bound.)

But, what does the shadow rate tell us about tightening?

If you look at the picture above, the last recorded shadow rate is 0.21% in February 2022. The shadow rate in Dec 2021 was -1.15%. So, the change since December is 1.36%. Effectively, rates have now increased by almost 2.11% (0.75% + 1.36%), if we assume the last shadow rate to be at the same level as February. I don’t think it is so, though; I think it would be higher.

But, that’s equivalent to eight 25bps rate hikes!

So what happens when QT starts? Now, that we’re looking at QT, how much of the tightening actually feeds into the rates?

According to Ben Bernanke, every $200B of QE is almost equivalent to a 25bps rate cut. So does that imply that every $200B of QT is equivalent to a 25bps rate hike? And if that’s the case, then $1 trillion of QT will be equivalent to five 25bps rate hikes. I’m keeping this simple but, the consensus is that QT has a much harsher effect on rates hikes vs. QE on rate cuts.

So, in terms of 25bps rate hikes we have within a year

• 8 hikes already in place

• 5 hikes from QT

• 4 hikes from the Fed (2 50-bps hikes)

That’s 17 x 0.25% = 4.25%

… and I’m being conservative.

Earnings of the Week

FactSet Summary for the Week:

The Week Ahead

Not only do we have retail sales reports coming out but, also quite a few retail earnings. It should be an exciting week for retail all around.

Economic Calendar

Earnings Calendar

Closing Thoughts

We’ll see if this bear market rally holds into next week. We do have some relatively major earnings coming up in the retail space and the retail reports may not look too gloomy just yet.

We do however, have some housing data coming up next week and that will be important to watch. While homebuilders have recently seen a bit of a bounce, I doubt this continues and housing data may just tip it over. There’s still plenty of room to the downside for homebuilders ($XHB).

Here’s wishing you a happy weekend, and safe investing.

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers

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None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have no affiliation with any of the companies that are mentioned.