Calming in the Bond Market, Investors Reduce Risks and Drive Markets Lower
Chart of the week
The chart shows into the interest rate development for 5-year U.S. government bonds (black line) and investors' inflation expectations (red background). The two rates have diverged massively since May 2020. Now, inflation expectations are declining and converging to current interest rate levels.
Why this is important
Bond investors in the U.S. have suffered the biggest drop in value since the Marshall Plan in 1948. The fact that inflation expectations are now declining should lead to a calming on the interest rate front. It is not to be expected that interest rates will continue to rise so sharply, but will remain at their current level and could even fall back somewhat.
This should also lead to a small recovery in technology stocks. In the medium and long term, however, interest rates are likely to remain high, which should be bad for growth stocks (Growth) and good for substance stocks (Value).
The chart shows the return of value stocks over the last 16 post-recession economic recoveries since 1927. During economic recoveries and when interest rates rise, value stocks tend to gain strongly. The rally from value to growth we've already seen this year is just the beginning of a longer and larger movement.
Investors reduce risk and drive markets lower
The aftermath of the Covid pandemic, the turnaround in U.S. interest rates and the war in Ukraine have led investors to change their investment policies and reduce risk.
The chart shows that after two years of constant inflows, this is the first time there have been major outflows from equity markets.
The chart gives an indication of what investors have been buying with the cash from equity sales. In times of uncertainty, U.S. government bonds tend to gain. The turmoil in the Bitcoin market, described below, caused an additional flight to safety and especially to the USD. Many investors panicked and sold all USD stablecoins and sought refuge in the real USD.
The chart shows the performance of the USD 25 weeks before and after the first rate hike in a new cycle since 1984. Compared to the last 5 recoveries, the USD gained more than usual and mostly started to lose value around week 10-15. We therefore tend to expect a weak USD in the coming weeks. Unless the war in Ukraine would escalate massively again.
We also see that many hedge funds are reducing their risks. They often take out large loans and invest them in the financial markets. They often have a leverage of 1:20 or even 1:100. To reduce the risks, they have to sell the good stocks they hold and believe in for the long term to buy back the stocks they are short in.
This usually leads to a situation for a few weeks where the good quality stocks lose value and stocks that no one believes in gain value. Such phases occur every 2-3 years. For long-term investors, however, usually a good opportunity to buy.
Netflix, for example, can be bought now at the same price as in 2017, when the company had 80 million subscribers, and now it has over 220 million. The company currently has its problems, but will not perish from them.
Another example is Beyond Meat. A supplier that is known worldwide with meat substitutes and whose products can be found in almost every major supermarket. The stock was listed in 2019 at a price of USD 25 and was already trading 84% higher, at USD 46, on its first day of trading. Currently, it would be available to buy again for USD 31. In 2019, the company had a turnover of USD 90 million, now it is USD 460 million.
These are just two examples of good quality companies that are market leaders and are currently very cheap to buy.
Is bitcoin about to end?
You have to distinguish between two things here. The cryptocurrency such as Bitcoin and the future of blockchain technology on which cryptocurrencies are based.
The chart shows the adoption curve, or the time until a new technology was available to everyone. Every new product category and technology has an adoption curve, which is the cumulative rate at which a population adopts a product, service or technology over time.
In the case of the invention of steel or concrete, it takes almost 100 years for the technology to become fully adopted. With globalization and technologization, the time to adoption is getting shorter. The chart shows that Bitcoin and Ether have only a small part of the adoption behind them and what potential the technology still has. Further adoption would result in massive price increases, as the amount of Bitcoin and Ether is fixed and cannot be increased to meet additional demand.
What is a stablecoin?
In order to trade cryptocurrencies, you need an account on one of the major crypto trading sites like Coinbase. Various banks do offer trading or products directly, but then the bank has to take the step of opening an account with Coinbase or another provider. Traditional cash in USD or EUR currencies is quite difficult to transfer. Therefore, as soon as you leave the "real" world and dive into the crypto world, the cash is changed into crypto-USD or EUR. These are called Stabelcoins. The Stabelcoins are pegged 1:1 to the USD or EUR and backed by collateral. At least that's what they thought.
Collapse of Stabelcoins.
Some were not backed by collateral, but algorithms and for some the collateral was not enough. When bitcoin collapsed massively in the last two weeks, some of the stabelcoins such as TerraUSD crumbled. Terra (or traded as an acronym in crypto exchanges LUNA) dropped from 100% to 16%. Due to the very illiquid markets, the algorithm was unable to trade. Investors who held their money as cash on Terra crypto exchanges lost 84% of its value. This led to massive uncertainty and waves of panic selling and transfers into real USD and EUR. This in turn brought smaller exchanges and providers to the brink of the abyss.
Currently, it looks like the deadly downward spiral has been stopped and the market is not collapsing completely. The collapse of TerraUSD can be compared to the collapse of the investment bank Lehmann Brothers, which triggered the financial crisis. Theoretically, it is possible that the entire crypto market will now collapse, but it is very unlikely.
We have pointed out in previous market reports that 80% of Bitcoins have been created but never traded. It all depends now on how these investors react. If they panic and start selling, it would be the end of bitcoin. However, the investors hold the Bitcoins in cold wallets. This means that in order to sell them, they have to transfer the Bitcoins to an exchange. Currently, you can see such movements sporadically, but it seems that most early investors remain calm.
The chart shows the current fear index and below in historical comparison. Since this index was measured, a lower value had been measured only once before in the fall of 2019. The index is considered a contra indicator. If all are negative and no longer hold Bitcoins, even small purchases can turn the market upwards.
Various analysts have been pointing out for months that there are still too many fortune seekers invested in Bitcoin. This refers to investors who became cryptotraders during the Covid crisis and hoped to be able to increase their capital tenfold without risk. These are now capitulating and liquidating all holdings. But this would then be the basis for a good and solid recovery.
We believe in a great future of blockchain technology. Which cryptocurrency based on this technology will be the winner and survive the current crisis is currently difficult to predict. The only thing that can be clearly predicted is that volatility will remain high.
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