Friday, Dec 16, 2022

“I'd take the awe of understanding over the awe of ignorance any day.” – Douglas Adams ||

Hi everyone! I cannot believe another Friday has ricocheted around so fast. I bet you’re all looking forward to a breather over the holiday season – I hope you take advantage of it, because it looks like January will be full of macro and possibly more crypto drama. Each piece of bad news brings us closer to the end of the bottom part of the current cycle, and we will soon start to see the green shoots of spring, both figuratively and literally.  

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MARKETS

Earnings expectations

The strong start to the week supported by the pleasant CPI surprise quickly unwound as the stock market digested Powell’s hawkish comments, falling to its lowest point since early November. This may feel like investors are finally getting the message that Powell needs a weaker economy, but a month ago the Fed’s determination and just how far it is willing to go were not as clear as they are today. The S&P 500 is more than 8% higher than its level two months ago, when the official projection for 2023 rates was 50bp lower than it is today. So, shouldn’t the stock market be lower still?

(chart via TradingView)

Yesterday we touched on how the market does not seem to be taking Powell’s hawkish stance seriously enough, and earlier this week I laid out the main reasons I believe inflation is not getting down to 2% any time soon, which will impact the timing of rate cuts. Another indicator of the suspension of economic reality in market pricing is the forward S&P 500 price/earnings ratio, which is now at pre-pandemic levels.

(chart via the FT)

Effectively, the market is telling us that we will have the same level of earnings growth next year as was expected before Covid, before the war, before the vulnerability of global energy supplies became obvious, and before interest rates started rising. In 2019, the 10-year yield was 1.7% (vs 3.5% now), the DXY was at 97 (vs 104 now) and GDP growth was clocking in at around 2.3% (vs 0.5% expected for 2023 by the generally over-optimistic Fed). Does that make sense to you?

It’s possible that economic growth next year will be even stronger than expected – the labour market is still tight, in spite of the layoffs you see announced in your feeds. Inflation seems to have peaked in many key areas. International conflicts may ease, investment is eager to get going again, and new technologies continue to bring new efficiencies. But, current equity market valuations in aggregate feel like they are not yet fully accepting that the headwinds appear to be stronger than the tailwinds, at least for the short-term.

This suggests that there will be sell pressure on equities as investors recalibrate their models and positions.

Selling pressure

In contrast, where will BTC sell pressure come from? There may be some ugly contagion news yet to drop (the market is not yet confident about the fates of Binance, DCG, Tether), and we could see more miners switching off machines and selling their holdings (I’ll talk more next week about why I think this is increasingly unlikely). But most investors who were going to sell have done so.