Transcription
Hello my friends,
Today is November 23rd, and this is Markets Weekly.
So, this past week was a pretty good weekend in markets. We had a nice rally in the S&P 500, which is trading just a little bit below all-time highs. I think we'll find out pretty soon if we make new all-time highs. But today, let's talk about three things. First, this past week the FED released their latest Financial Stability Report, which is always a wealth of quote charts and information. Let's talk about some highlights.
Secondly, what caught my eye in markets the past week was, of course, Bitcoin basically surging every single day and just knocking at that 100K key threshold. Let's talk about what's driving this rally.
Lastly, the other price action that caught my eye was the euro, which looks like it's absolutely imploding, trading below 1.05. Let's talk about some of the headwinds the euro is facing.
Okay, starting with the Financial Stability Report. Now, as many of you know, the FED releases this report semiannually, and it's basically their assessment of various corners in the financial system.
So, let's start with equities. Now, when you look at equities, there are various valuation metrics. Some of the traditional ones are, say, looking at it from a fundamental perspective, PE and stuff like that, and others are looking at it from a relative perspective, comparing, say, the earnings yield to treasury yields, something like the equity risk premium. Now, the FED staff does calculations using these metrics and suggests that equity valuations are historically elevated.
But also, when you look at this chart, you'll notice that sometimes things can get expensive, can become even more expensive, and stay expensive for many years; and things that are cheap can become even cheaper and stay very, very cheap for many years. So, when I look at these valuation metrics, it seems to me obviously not very helpful.
But what I did think was super interesting in their equity section was this chart about equity market liquidity. Now, they seem to be focusing on S&P 500 mini futures, but they're suggesting that equity market liquidity is pretty poor. Again, this is a sign of fragility in the markets. Where, let's see, if we have a negative event, markets could go down quite a bit simply because when liquidity is poor, small amounts of volume can have outsized price actions.
But, of course, you can also look at this from another perspective: smaller amounts of buying could also have outsized upward movements in price. So, things like crash up, which I would say that we've been seeing over the past several months—the equity market is up significantly this past year—could also play out as well. Something to keep in mind as we move into the historically quite positive December month.
Now, moving to credit. Now, as we all know, credit spreads have been very, very tight. Now, one interesting way that the FED is looking at this is something they call the excess bond premium, which is to say they are decomposing credit spreads into more, I guess, more components.
So, for example, when you look at high-yield credit spreads—high yield being anything that trades below investment grade—that could be double B, that could be single B, that could be single B minus and so forth. So, even within these categories of investment grade or high yield, there are finer distinctions that you can make.
Now, the FED staff is trying to control for all these different distinctions and these characteristics, and they come out with a measure called the excess bond premium, which is a bit more refined than credit spreads. According to this, the excess bond premium is just, you know, around where it is historically. So maybe that tightness we see in credit spreads can be simply about the composition of the underlying borrowers, rather than, say, financial market exuberance, which, of course, could be—I'm sure both play some role.
One other thing that I thought was pretty interesting about credit markets was the interest coverage ratio. Now, the market has been taking out more and more cuts, so interest rates have been rising the past few weeks. Now, according to this chart, companies, even though interest rates remain elevated, are easily able to afford these higher interest rates, right? That's what the interest coverage ratio measures.
Again, although interest rates are historically high, nominal GDP growth continues to be strong and there doesn't seem to be a recession at the moment.
Moving on to real estate, the report suggests that, as we all know, residential real estate seems to be very, very overvalued. Now, residential real estate prices continue to rise, but according to this valuation metric where the FED is looking at rental yields, comparing them to interest rates, that residential real estate appears to be historically elevated in valuations.
But, of course, this does not mean that we're going to crash or anything like that. There are also many structural forces, as we all know, that are involved. For example, if you look at homeowner equity in the residential real estate market, basically everyone is sitting on tons of equity. Prices have gone straight up for the past few years, especially during the high inflation times.
So, when everyone has positive equity, and many people have mortgages that are, say, below 4%, then there's really no need for anyone to be a forced seller, and so that takes out a lot of tail risk.
There are many arguments that say that the US has underbuilt housing and so forth, which there are two sides to this, of course. But the bottom line is that home prices continue to increase even though mortgage rates are around 7%.
One other thing that I'll mention in the report is about auto loan and credit card delinquencies. So, even though, as we know, unemployment rates remain relatively low and GDP growth remains above trend, there have been increases in delinquencies in certain consumer loans.
Now, auto loan delinquencies and credit delinquencies have ticked up. They are, I guess, relatively elevated compared to the past 10 years. They have plateaued over the past couple of months, and the reports suggest that this is really driven by a narrow segment of consumers that are really struggling.
The report suggests that most people are actually totally fine, but there is this segment that is not, and seems to confirm the K-shaped recovery that many people talk about, whereas I guess people who own assets have been riding the wave higher, but people who don't have assets have been really struggling.
So, let's see if this improves as the FED potentially cuts rates in the coming months.
Okay, the second thing that I want to talk about is, of course, Bitcoin. Now, just looking at that Bitcoin chart, that momentum is undeniable. It looks like a rocket ship going to the moon.
Now, what is driving this?
So, I think there are three interesting developments that happened recently that are driving this upward surge in Bitcoin. One, of course, is the launch of options for Bitcoin ETFs. Now, not too long ago, it was permitted to have cash Bitcoin ETFs; that is to say, you put money into an ETF and the ETF goes and buys Bitcoin in the spot market.
Previously, the ETFs were buying Bitcoin futures. Now, that we have these spot Bitcoin ETFs, the SEC is also allowing people to trade options on them. As you guys know, when you have options, you can often have these frenzies where everyone goes and buys a whole bunch of call options and maybe squeezes the asset higher.
Now, looking at the options that are trading on these Bitcoin ETFs, it does seem to be largely call options, so that could be, of course, squeezing up the price of ETFs and maybe forcing the ETFs to buy Bitcoin, which, of course, increases sentiment further. Looking at the inflows into these Bitcoin ETFs, they have been very positive over the past couple of weeks.
Now, another interesting development is SEC chair Gensler saying that he's going to step down and allowing Trump to appoint a new chair to the SEC. Now, many people in the crypto community perceive chair Gensler as someone who was unfriendly to crypto.
On day one, I will fire Gary Gensler and appoint a new SEC chairman. I didn't know he was that unpopular. Let me say it again: on day one, I will fire Gary Gensler.
Whoa, Gensler has described crypto as basically rife with all sorts of fraud and grifters, which to be clear, given what we know about things like FTX, has truth to it.
But in any case, the perception is that with a new Trump-appointed SEC person there, the SEC will probably become more friendly towards crypto as an asset class, and that could, of course, prompt new inflows.
In addition, there is discussion that there could be a role in the White House that is some kind of senior-level crypto advisor, a crypto czar or something like that, that could further have a link between the crypto community and the White House, potentially having more positive encouraging policy.
Again, fundamentally, any asset class is about supply and demand. If you make the regulations more friendly, you're going to make it so people can more easily pour money into the asset class, and that is bullish for prices.
You can actually see this in an interesting announcement by Charles Schwab. Schwab, of course, is a very large retail-oriented broker in the US. Now, Schwab is suggesting that once the regulations are changed, they will allow people in Schwab to trade spot Bitcoin on the Schwab platform. That is to say that anyone on the Schwab platform can log in and just click trade to buy Bitcoin, again making it easier for the public to buy Bitcoin.
They don't have to go and, I suppose, create all these wallets and stuff like that. With Schwab being a big brokerage doing this, it's likely that other big brokerages would also follow.
So, all in all, this whole past week, there's been a lot of bullish news on the regulatory front for crypto, so seeing that surge in prices is not surprising.
To be perfectly clear, I must emphasize that crypto assets, Bitcoin, these things are very, very high risk and I personally am a nocoiner.
Okay, the last thing that I want to talk about is the euro. Now, the euro has just had a really, really bad week. Looking at that chart, it looks like it's melting straight down, and many people in the market expect the euro to reach parity with the dollar.
Now, the most recent bout of weakness has been driven by weaker than expected PMI data. PMIs are basically a survey where the surveyor asks a whole bunch of businesses in Euroland if business is getting better or worse. So, it's really a diffusion survey. It just measures direction—are things getting better, staying the same, or getting worse?
Now, the PMIs for Euroland were unexpectedly poor this past week, suggesting contraction, and that really hit the euro hard because if the economy is doing poorly, then that suggests that the ECB is probably going to cut rates. And if the ECB is going to cut rates, obviously that's downward pressure on the currency.
Now, if you look at the interest rate differentials between the US 2-year yield and the German 2-year bond, you notice a pretty notable divergence. As the US economy has been stronger than expected and optimism overtakes US businesses, we have fewer and fewer cuts priced in, so the US 2-year yield has actually been rising.
At the same time, the market is increasingly bidding on a jumbo 50 basis point cut by the ECB in December, and so the German 2-year yields have been declining. So that divergence in interest rates is really putting a lot of downward pressure on the euro.
But in addition to these poor economic news, you have two other things that have really been weighing on the euro as well, and that is gas prices. Now, gas prices in Euroland have been rising. Now, they're not at emergency levels that we saw a couple of years ago, but when you look at the gas reserves in Europe, you'll notice that they're actually depleting at a faster than historic pace.
Now, Europe seems to be pretty cold right now, and so that's adding demand for heating. Now, if we have an even colder winter, that can, of course, suggest even more demand for gas, and gas prices could go even higher, which raises costs for businesses and consumers. Again, that's all money that is basically being sucked out of the euro economy and sent to whoever is selling them gas. Again, that is a dampener on European growth.
Now, the third thing that seems to be weighing on the euro is geopolitical risk. So, the past couple of weeks, we've seen some escalation in the war in Ukraine. President Biden, or someone in the White House, seems to have authorized that Ukraine can use certain US munitions to strike within Russia.
Recently, the UK has also authorized Ukraine to use certain British missiles to strike within Russia as well. Now, Russia has been very clear that they perceive this to be a war—not so much between Ukraine and Russia, but a war between NATO and Russia.
Of course, in order for Ukraine to use any of these missiles, they need the active cooperation and intelligence of NATO allies, like the US. So, for Russia to perceive that way is not unreasonable.
Now, this past week, Russia did something new—they launched an experimental missile into Ukraine. There's a very interesting discussion between Lieutenant Colonel Daniel Davis, former Colonel Daniel Davis, and Professor Postel of MIT, who is an expert on these ballistic missiles. The professor notes that this is kind of a new weapon that cannot be intercepted by anti-missile defenses.
It seems to be at very high speed, and what it does is it's a big missile that basically launches several other smaller missiles—kind of like a missile that shoots out other smaller missiles. So, it's basically impossible to intercept and it's also capable of having nuclear payloads.
So, what Russia is doing is basically suggesting to NATO that they have this weapon that could strike, you know, strike Berlin, strike Paris, strike London, and warning them not to further escalate the conflict.
Again, this is a new development on the Ukraine warfront and suggests heightened geopolitical risk. So, I think it's no surprise that, let's say you have a lot of money in Euroland and there is some possibility of war, you would want to move some money out of, say, Europe and maybe into a safer jurisdiction like the US.
So, you have all these really heavy risks weighing down on the euro, and it looks like they are in a lot of trouble.
So hopefully, things will improve in the coming weeks as we get some new political direction.
Okay, so that's all I prepared for this week. Thanks so much for tuning in. Remember to like and subscribe, and if you're interested in hearing more thoughts on markets, check out my blog, fedguy.com, or my online courses on centralbanking101.com.
Talk to you all!
Actually, next week is a holiday week in the US, it's usually very quiet, so we may not have an episode next week unless something happens.
But in any case, talk to you all soon!