Market Commentary
Bitcoin
“There are decades where nothing happens; and there are weeks where decades happen”
The weeks we just lived through will be written about for years to come. Just consider the BBC headline below: “Bank of England steps in to calm markets”.
In today’s special “Canadian Thanksgiving” dispatch we are going to look beyond the week ahead and break down 3 key events on tap for the next 30 days: (1) U.S. corporate earnings, (2) the upcoming Fed meeting, and (3) the U.S. midterm elections.
First, some context: The meltdown in U.K. bonds and the British pound forced the U.K. government to do a complete 180 turn on its planned tax policy, within mere hours of being announced.
It also forced the Bank of England to have to start buying its own government’s debt to stop it from spiraling downwards as buyers disappeared. The precipitous drop in sovereign bond prices almost put the U.K. pension industry into bankruptcy.
It appears that Britain was the first country to start bumping into a political wall while tightening policy - and it sent an ominous message to investors and regulators worldwide. Britain is the first, not the last, to experience these problems - the same will occur to other countries in a matter of time.
Governments have limits as to how much pain they can inflict in a society via employment and crushing asset prices before that society starts turning against them. And if and when “they” turn - the outcome is not generally kind to those in power.
Within hours of the U.K. crisis unfolding, several interesting things happened:
1. The U.N. calls for the Fed & others to stop hiking rates
These three statements say the same thing: Central Banks are tightening too much, too soon - and there will be severe consequences if they continue the current course.
To say it bluntly, economic instability can very quickly turn to political instability. If people are angry or hungry they become exponentially more susceptible to populist rhetoric - generally fueling extreme views in one end of the political spectrum or the other.
According to Fed Fed President, Raphael Bostic, his “base case” remains for a 75 BPS rate hike in the November meeting and 50 BPS for the December meeting. According to the CME FedWatch tool, investors still see 65%+ probability of this being the case.
It appears that the fiscal room that central banks had - the ability to change rates without disrupting the political equilibrium, is becoming very small, very fast. Public opinion is starting to reach a limit - and the U.S. is headed to the polls in weeks. We’ll discuss how the upcoming midterm elections could impact markets in our What’s Ahead section.
S&P 500
Yes, the Fed sets the price of money, and sets the amount of money available in the system, which greatly affects investor sentiment and asset prices overall. However, outside of its influence, private and public companies control their fate by controlling their ability to generate profits and run a sustainable business. Beyond the Fed, corporate earnings results drive a company’s valuation, and the third quarter results for 2022 will be published in the coming weeks. In today’s issue we’ll break down what investors could expect from the upcoming earnings season.
Broadly speaking, there are some sectors that have benefited from economic conditions in the third quarter more than others. Good examples of this would be the energy sector - which has benefited from soaring oil and natural gas prices:
And banks, which typically benefit from a higher interest rate environment.
Outside of those 2 industries, the rest have been impacted in one way or another by soaring inflation and supply chain disruptions.
While analysts have been revising earnings targets and projections leading up to the reporting season, the results could still move the markets.
One element that could put downward pressure on markets is the difficulty in forecasting future quarters.
Typically, stocks react to the picture of the future that corporate management paints. However, in the current scenario, it is very difficult to forecast sales or economic activity with so many moving pieces.
It will be interesting to see how companies address their future guidance. Some might restrain from providing forecasts or present them with large caveats. This upcoming earnings season poses more of a risk of being a headwind than a tailwind to equity and asset prices.
Gold
Gold closed at $1,693/oz after 2 strong weeks, but it is still below the important $1,700 mark. A note of interest is that Bitcoin's 30-day correlation to gold is currently north of 30% - the highest level in the last 12 months.
In the chart below, you can see the DXY on the right axis and XAU/USD futures on the left.
With all the turmoil in sovereign currencies, it’s not surprising to see “digital gold” start trading more like its analogue counterpart. We’ll keep an eye on this correlation for the remainder of the year.
DeFi
It was a quiet week in DeFi land and assets in the space overall underperformed relative BTC. Ethereum has been flat in Bitcoin terms over the last 3 weeks - and the DeFi index has also remained relatively muted.
Beyond price, Ethereum fundamentals continue to improve after the Merge:
As of last week, almost 12% of the entire ETH circulating supply was being staked to validate the network. That’s more than 14M ETH, and the number keeps climbing.
There’s also been some interesting investor activity around the space, with Defiance capital looking to raise $100 M to purchase crypto tokens, Golden Tree Asset Management disclosing a position on the SushiSwap protocol tokens, and a few other small venture rounds for DeFi startups.
Uniswap Labs, the group behind the Uniswap decentralized exchange, is also said to be seeking to raise an additional $100 Million.
Reports say that one of the focuses for this new raise is to bring more NFTs and DeFi tools to its platform.
Lots of activity behind the scenes in DeFi, though it is not yet being reflected on prices.
Mining
Miners are getting squeezed, and the “squeeze” is about to intensify. Every major Bitcoin mining pool has increased its hashrate over the last epoch, meaning mining is about to get even harder.
The next difficulty adjustment is estimated to increase network difficulty by 11.5%.
With current bitcoin prices, bitcoin miner revenue per TeraHash is on the brink of reaching all-time lows.
Hashrate today is hovering around 297 EH/s, when BTC has been trading between $19k and $20k for months now. In contrast, when Bitcoin hit $69k last year, hashrate was standing at 161 EH/s. Basically, despite a 72% drop in price, hashrate still moved up 84% within a single year.
What's ahead for the week
The week ahead will deliver inflation data for the month of September, and the FOMC meeting minutes. Looking beyond the week ahead, there are 3 major market catalysts in the next 35 days:
- Start of Q3 Earnings Reports for U.S. Equities: Monday October 17th
- Federal Reserve FOMC Meeting: November 2nd, 2022
- U.S. Midterm elections: November 8th, 2022
We’ve tackled the first 2 in the previous sections, and in this section we’ll discuss the third.
Sometimes charts do a better job of explaining a concept than words. I think this one does just that:
Growing up, I remember listening to my father during lunch time talk about how he had never seen a recession during an election year. Keep in mind that this was in Venezuela in the late 90s, different place, different times now - but I always thought that it made a lot of sense conceptually. Campaigning incumbent politicians will crank up the spending as they try to rally their constituents, and newly elected politicians will want to “show quick results”. Sudden increases in spending tend to achieve both.
As the chart above shows, there isn’t “more economic growth” per se during midterm election years vs. all other years, however, investor behaviour patterns are clear and seem to be consistent in midterm election years. Investors seem to start bidding up the market once clarity starts forming around the election results and are able to assess the potential implications.
The chart above may also explain why some investors seem to have started jumping back in on the long side, albeit expressing caution and that it could be short-lived.
While it still feels too soon to be talking about a sustained rally in the current rate environment, a slight change of posture from the Fed and other Central Banks could very swiftly shift investor moods.
However, a very likely scenario still is that the midterm tailwind clashes with the Fed’s hammer and markets nets out in sideways trading to end the year.
Here’s what you can expect for the week ahead:
Wednesday
02.00 PM EST - Federal Reserve Open Market Committee meeting minutes
Thursday
08.30 AM EST - September Consumer Price Index. Expectations are for a 0.4% month-over-month increase in core CPI, and an annualized inflation of 6.5%, slightly higher than 6.3% in August. Look for markets to sell off if the numbers come in higher than expected, and bounce higher if the number comes in significantly lower than expected.
It's a big week coming up, and as always, we'll keep you posted on any relevant news throughout the week right here and from our Twitter account.
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