Hey!
Sadly, summer is coming to an end. August has flown by, and we are now entering the later months of the year. After ending August with yet another month of positive returns, are the equity markets ready for a pull back, or can we keep the rally going?
The market pursuantly grinded higher throughout the month even as many have become quite skeptical on the sustainability of the rally. Some perceived risk is mounting, and the Federal Reserve is a key player in the direction in which we head.
Let’s talk about the various market factors in play and what you should be thinking about in this environment.
First though, these newsletters are meant to be informational and educational only. They are not financial advice, and I am not a financial advisor. Always do your own research before investing any of your hard-earned money into something!
Monthly Highlights
· Federal Reserve & Perceived Risk to the Market
· Correction Looming or More Gains Ahead?
· Bitcoin & Crypto Ready to Go Parabolic?
Index Year to Date Gains Through End of August
· S&P 500 +21% (+3% mo./mo.)
· Nasdaq +21.5% (+4.85% mo./mo.)
· Dow Jones +15.85% (+1.35% mo./mo.)
· Russel 2000 +15.4% (-4.2% mo./mo.)
· Bitcoin +65% (+15% mo./mo.)
· Ethereum +375% (+40% mo./mo.)
Federal Reserve & Perceived Risk to the Market
As you can see by the figures above, the markets have moved up significantly throughout the year. Despite the gains though, the more surprising metric in my opinion is that we have not seen more than a 4.5% downside monthly move in the S&P500 since September 2020.
Naturally, the more we trend up, the louder the calls for a move downward become. There is definitely a lot of perceived risk in the market right now. Seemingly anything could take the market down if taken the wrong way by the majority of market participants.
I don’t disagree with the calls for a downward move necessarily. Corrections are healthy for markets and are needed to keep things in check. However, in my opinion investors are currently fixated on one thing. That thing is the Federal Reserve’s plan to taper asset purchases and eventually raise interest rates
It’s a lot to unpack, but the Fed’s game plan has the most important potential to drive market direction.
Everything else is just noise.
I always like to focus on big picture ideas akin to “Signal vs. Noise”.
There is a lot of noise in the market. Sometimes that noise will move the markets, but noise is just noise. Anything can happen at any moment to shake up markets and that’s part of the game, but if you can attempt to filter out the noise and focus on the big picture signals in play, you will be able to navigate the market with a clearer sense of vision.
Here’s a few examples of some of that perceived risk along with the biggest risk which is the Federal Reserve’s actions.
Afghanistan Withdrawal & Taliban Takeover
When the story first broke that the Taliban were on the cusp of capturing the capital city of Kabul amid the US withdrawal of Afghanistan earlier this month the media had a field day. Markets were a bit shaken up, but overall stayed in grind mode.
As we saw, Kabul inevitably fell which was followed by a US withdrawal mission of allies in the country. Despite a bombing that killed several US servicemen and Afghan civilians, America continued its effort to withdraw and has since done so completely as we end the month of August.
The perceived risk in this situation was America would be re-entering a war. As poorly as the situation was handled and ended, this was noise.
In reality it was pretty well known that the U.S. had no intentions of continuing a 20-year fight. Evidence was further supported when the Taliban began taking over many areas of the country once the US had begun withdrawal efforts months earlier with no repercussions. As the situation unfolded, the market basically shrugged this off, waiting for a confirmation of that perceived risk to unfold.
The Delta Variant
Ok so I don’t want to underestimate the impact the delta variant and COVID can have as we enter the colder months of the year. This past month we have started to see an uptick in mask mandates. For example, Chicago and greater Illinois have been mandated for indoor mask mandates. A large spike in COVID cases and increased full scale lock downs can definitely impact the market’s appetite for risk.
Yes, this is a risk, but market participants are generally looking at COVID and Delta with a bit of optimism as we have been fighting this pandemic for over a year. Companies and businesses are much more equipped to handle safe work, remote work, or a hybrid of these new working conditions. In addition, vaccines are continuously being pushed and rolled out.
Most importantly though, market participants are learning that COVID is now a part of our lives here to stay. Managing COVID and its impacts are continuing to become more tolerable as most have adapted to the new environment. Market participants realize that regardless of an ebb and flow of restrictions or a delay on some re-opening plans, that overtime things will trend back to a normal way of life. The markets are bracing for this and have started to price this risk in.
The Federal Reserve and Tapering Plans
How the Fed’s tapering plan plays out is currently the most important thing for markets right now. This past month was the infamous Jackson Hole Summit where Federal Reserve members met (virtually) to discuss monetary policy and lay out clues for their future plans.
There was a lot of anticipation leading up to this event. The timeline in which tapering would start has been quite fluid and market participants have been looking for clarity when this tapering may occur.
Last month, Fed Chair Jerome Powell communicated that the Fed would be monitoring the jobs growth and unemployment rate, inflation metrics and the impact the delta variant may have when determining their plan of action.
In his speech on 8/27 at the Jackson Hole summit, Powell stressed that inflationary pressures are cooling and getting closer to the Fed’s 2% target rate. Powell also acknowledged that some inflation is a “cause for concern” and implied that higher prices could be more permanent than he expected.
Jerome Powell Jackson Hole Speech
Keep in mind, the inflation rate based on CPI data is over 5% and has been trending up all year. Funny how NOW inflation may be a cause for concern…
So basically, Powell indicated that the inflation metric was met for tapering. That leaves jobs data and unemployment as a remaining primary factor. Powell did not however give a definitive answer on when tapering would start.
As I believe Powell communicated in July, the Fed would need to see a few more data points on jobs growth before making a call. Well, tomorrow 9/3 we get a jobs report. If this report indicates high job growth, we could see the Fed announce a taper plan later this month at their 9/22 meeting.
Keep an eye out for market pressure following a high jobs report. I could also see a continued run up in the markets if the jobs numbers come in below expectations. Markets have been pricing in tapering starting later this year or even in 2022. An announcement of a taper in October could shake markets a bit.
Albeit I fully expect any taper reducing the Fed eventually announces to be miniscule in comparison to the broader picture. Keep in mind, the Fed is pumping BILLIONS of dollars into the system monthly. A reduction of a few billion here or there is not significant.
Correction Looming or More Gains Ahead
Broader picture though, there are always risks both known and unknown to the market. I could name off an additional ten things that could be a risk to the markets, but it could also just be noise. Anything can happen that drastically alters what’s important or worth paying attention to.
In my opinion the biggest thing to pay attention to right now in the current environment is the Federal Reserve’s monetary policy and the inflationary impacts it brings with it.
We could easily see a 5%+ correction at any time but as long as the Fed liquidity remains extremely elevated, the downswings could remain short.
After seven months of continuous upside, the case for some downside remains strong. September is historically one of the weakest months of the year for equity markets alongside February.
Markets can’t go up forever, but they can continue to grind upward as long as risks remain manageable. Don’t get fooled by the noise.
Bitcoin & Crypto Ready to Go Parabolic
Bitcoin and Ethereum had massive August rallies, up 20% and 45% respectively.
Bitcoin was able to clear some crucial overhead resistance above $41,000 and has been grinding upward, currently meeting some resistance right at $50,000.
Based on on-chain data metrics, the bullish case for Bitcoin could not be stronger. Current data shows a new all-time high in Bitcoin supply held by long term investors. These entities now hold 12,731,020 Bitcoins. As a percentage of circulating supply, these long-term investors now possess 67.7% of supply.
Additional on-chain metrics support data that previously priced BTC above $58k earlier this year when long-term supply levels was much lower.
Furthermore, the number of wallets with non-zero balances continue to trend up. As new users continue to come onto the network, the demand will go up alongside it.
Increased demand coupled with a supply crunch for available BTC inevitably will lead to an upside move. These metrics alongside the ‘stock to flow’ model presented by PlanB support a strong move into the end of the year for Bitcoin.
I am a strong believer in the S2F model and its four-year cycles. From a short-term perspective, things are going to be wild for Bitcoin in the back half of the year.
In a longer-term view, the S2F model makes sense as well. As a matter of fact, investment firm Fidelity just pitched a $100 million per coin Bitcoin by 2035 using the stock to flow model. Check out the article here:
Fidelity Predicts $100m Bitcoin
As I’ve said before when Bitcoin goes so will the broader crypto market. However, Ethereum is really standing out to be a major winner in the crypto space. Ethereum has rallied strong through August and with good reason.
Earlier this month the famous EIP-1559 protocol was implemented which essentially is a step towards ETH-2.0 and puts in place a token burn, decreasing available supply over time.
In addition to this major upgrade, countless layer-2 projects are being built on top of the network. This is a strong indication of growth and adoption ahead. ETH is cementing itself as a smart contract layer-1 solution network, aka the decentralized internet 2.0.
Additionally, ETH is really starting to gain popularity as a means of exchange in the digital world with smart contracts and NFTs.
The NFT space (non-fungible tokens) has begun to explode with digital artwork selling online for thousands and even millions of dollars! These sales are primarily being priced in ETH and on the ETH blockchain. I’ve spoken about NFT’s in the past and believe growth in this market is just beginning. Lots of cool things ahead for NFT’s from artwork to gaming to music as a few examples. With this ecosystem running through the ETH network, this remains an additional bullish factor. Just be careful buying a JPEG for millions of dollars..
Bored Ape Yacht Club’ NFT Could Fetch $12 Million at Sotheby’s
Final Thoughts
Try to look for the signals in the market vs. the noise. In my opinion the biggest signal the market is looking for is going to come from the Federal Reserve and monetary policy. Be patient in your endeavor to put your money to work and stay diligent in your understanding of market sentiment. Inflation is here and should be paid attention to. Expect volatility to increase as we get closer to the back end of the year and clarity on Fed policy becomes better known.
Bitcoin and crypto are non-correlated to equity markets. Regard of equity market direction, the crypto ecosystem is set up to have an outstanding back end of the year. Don’t FOMO in and do your own research. Big investment firms like Fidelity (among many others) are looking at long term massive growth in the space. Dollar cost averaging into any long-term investment is the best strategy for success.
With that said, we live in an age where education and information on anything we want to know is accessible at our fingertips through the internet. You owe it to your future-self to become educated in money management.
By signing up for this newsletter you have already taken steps to accomplish that. Stay consistent on your journey and don’t stop learning.
Thank you for spending the time to read this month’s newsletter!
Bryan Craig
Lefty Group Capital Chief Investment Officer
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