Week of Aug 8, 2022

Opening Remarks:

We’re starting this week as optimism continues to hold and there is no sign of softening in the market. The prevailing view is that too much pessimism was priced in the valuations in June when the prices plummeted, and now that the outlook is less ominous (evidenced by earnings reports and economic indicators), the valuation should reflect less amount of negativity.
Also, more activity in the market can be partially attributed to the network effect. Currently, the US is the safest and best place to invest (comparatively), and the flow of more capital creates demand and price appreciation.
The US dollar is expected to strengthen as the Fed’s rate hikes are expected to outpace the rest of the major economies.

After a series of disappointing news from China, including housing market slump and weak manufacturing results due to COVID lockdowns, the latest data show signs of stabilization. It appears China tries to devise its public policies such that it avoids igniting inflation. In other words, instead of firing up the economy followed by a forced recession (what is happening now in the rest of the world), China has chosen a path of restraint.
Geopolitical tensions pose a threat but it is expected to wind down soon enough and has not had any significant market impact, mostly because everyone was certain that China will not do anything that threatens the global economy. We will monitor the data that is coming out of China next week.

On Sunday, Aug 7, 2022, the Senate narrowly passed “Climate, Healthcare, and Tax Bill”. This bill provides relief for prescription drugs, incentives for climate preservation, and raises taxes on large corporations. In our view, this is a positive development, and despite what the opponents believe, it will help the middle class and take away from the wealthy, exactly as it is intended.

There will be 1,370 earning reports this week. On Wednesday, Thursday, and Friday, CPI, PPI, and Michigan Uni Consumer Sentiments will be released, respectively. China’s July CPI will be published on Tuesday, Aug 9.

Source: Yahoo! Finance
CBOE Volatility Index.

Monday, Aug 8, 2022

Inflation expectation: The Federal Reserve Bank of New York’s Center for Microeconomic Data released the July 2022 Survey of Consumer Expectation, which shows substantial declines in short-, medium-, and long-term inflation expectations. Median one- and three-year-ahead inflation expectations both declined sharply in July, to 6.2% and 3.2% from 6.8% and 3.6% in June respectively.
Implication: This is positive news for the Fed as one of their main concerns with regard to inflation is that the inflation expectation becomes deeply entrenched and impacts the Individual’s purchasing decisions (in other words, you buy today rather than tomorrow because you think the prices will be higher tomorrow).
Note: Another impact that inflation has is something called wage spiral. That is, faced with higher prices, workers ask for higher wages, which in turn increases the cost of production for companies who increase the prices (hence inflation) even more.
As you can recognize, both of these condistions are self-perpetuating.

Tuesday, Aug 9, 2022

Bet on volatility:
As we’re getting closer to the announcement of the CPI for the month of July, one metric that we have our eyes on is the CBOE Volatility Index (or VIX). There are different scenarios that can play out. The VIX is currently at 20. We’re watching this metic specifically if it approaches 15 and below, at which point we are going to make a bet on it.
That being said, tomorrow the CPI data will be released, which gives us an opportunity to bet on the outcome, using this ETF: UVIX (2x Long Vix Futures ETF).
Basically, our bet is based on the market’s reaction to what economists are predicting, which is that the Headline CPI will be slightly lower and Core CPI slightly higher than the prior month. We expect that the markets act rationally and that the prices would decline (S&P500 be lower and VIX be higher). The reason is that the current market prices still reflect the expectation that everything will go back to normal by the beginning of 2023 (inflation will be curbed and the Fed will reduce rates again). We don’t believe that will be the case. We believe that the Fed will continue to hike rates and keep them elevated even if we had a mild recession. A no change from prior month is not an improvement. It’s just status quo and the inflation as it is now is high. One extra note about the headline inflation: we expect the headline inflation to be lower because the energy prices were reduced, as everyone could feel it at the pump.
Ex-Ante Note: Our bet did not work and we had to exit our position before the opening bell of the next day. Basically, we monitored pre-market activity and the response to CPI print was surprisingly positive. Given that our position was just opportunistic (and didn’t work), we took a small loss and quit our position.
See the portfolio section for the records of the trades.

Coinbase released its quarterly data today after the closing bell. The earnings per share and total trading volume (on Coinbase’s platform) were below analysts’ estimates. The revenue was slightly short of expectation.
The prices were down 10% during the day and sank another 5% after hours. According to the company’s CIO, the poor performance is attributable to a combination of macro trends, crypto-specific trends, and the composition of Coinbase’s users (geographical and transactional focus). Some analysts believe that the impact of the macro is less significant than the fact that we’re entering the so-called ‘crypto winter’. Coinbase is an exchange and it makes money on transactions and not necessarily higher coin prices. Subsequent to the significant drop in crypto prices earlier this year, many individual investors stopped trading which resulted in lower revenue. In addition, whereas other exchanges have a strong presence internationally, Coinbase has been heavy in the US market only.
In terms of technological limitation, one of the reasons for the decline in crypto transactions was the higher ‘gas fees’ charged for ETH (Ethereum). After a surge in demand for ETH, the transfer prices increased dramatically, so basically, the individual investors were losing money for simple transfers. This was mentioned as a reason for the drop in ETH transactions and it will be a hurdle to mass adoption unless the technological limitations are resolved.
Last week, Coinbase announced its partnership with Blackrock that would allow Blackrock’s institutional clients to buy bitcoin, resulting in a jump in Coinbase’s share prices.
Ex-post note: After a few ups and downs in the price of Coinbase, it closed at $90.49 on Friday. This is 80% increase from the beginning of July. See the chart below,.

China’s CPI reading for July was 2.7%, slightly lower than estimated. China is grappling with issues in its real estate market.To avoid any surprises down the road, the government ordered the audit of Trusts (AUM of $3 trillion) which have excessive exposure to this sector.

The PHLX Semiconductor Sector Index (SOX) dropped today by 4.57%. This comes after semiconductor companies (for example NVIDIA) indicated less demand for their products in their forward guidance. The drop in the semiconductor share prices continued in Asian markets.

Wednesday, Aug 10, 2022

CPI (INFLATION): On Wednesday, the Bureau of Labor Statistics published July CPI. See GGC’s post on Inflation and CPI. As per the release, the July overall CPI increased by 8.5% annually (June was 9.1%). This figure includes food and energy which tend to be more volatile. When excluding those two categories, then we get a ‘core CPI’, which increase 5.9% in July 2022 compared to a year ago (the same 5.9% in June 2022 compared with a year ago). Prior to the release, the estimate for core inflation was 6.1% and the fact that it came lower by 0.2% stirred up the markets and caused a rally.
The following are month-over-month changes, seasonally adjusted:
Gasoline decreased by 7.7%, fuel oil decreased 11%, food increased by 1.1%, and all items less food and energy increased by 0.3%.
Why does this matter?
In the past few decades, the Fed provided forward-looking guidance and then stick to it in order to keep its credibility (as part of discharging its responsibilities). In the last meeting, however, the Fed departed from this tradition and indicated that they are data dependent and will decide based on the economic data as they are published. Given that Fed is determined to fight inflation makes the CPI, which is the measure of inflation, more critical.
So, when the market saw that the inflation did not increase compared to the prior month, it was relieved and immediately interpreted this as a sign that the Fed will be less hawkish. The S&P500 jumped as a result.

Our bet on volatility
Yesterday, we bought 50 shares of UVIX (an ETF tracking volatility). Our bet did not work, and the market responded exactly the opposite. We track the transactions in the Portfolio section.
We still hold the belief that the stock market is overpriced. The market is rallying and will probably continue for a while.
It seems that the only way to slow down the markets before the next FOMC meeting (in September) is for the Fed Chair to unequivocally say that they will raise rates and keep the rates relatively elevated during the recession (if one happens).

Thursday, Aug 11, 2022

PPI: the highlight of today was the release of PPI which comes on the heels of the CPI that caused markets to rally. See GGC’s post on PPI.
Given the market’s reaction to CPI yesterday, it wasn’t a surprise to expect a positive reaction to this release as well. Below are the highlights of the release:

“the monthly PPI for final demand fell 0.5% in July, following an increase of 1% in June and 0.8% in May. On an annual basis, Final Demand PPI increased by 9.8%, and PPI in Final Demand Less Food, Energy, and Trade increased by 5.8%. Although the pressure from energy has cooled down during last month, but as indicated by the numbers above it still has a significant impact on the annual PPI increase. See below the image from BLS’s website. You can find the full report in here.

Another noteworthy event today was the pressure on pharmaceuticals. We will follow this in the coming days. There are two specific stocks that we have identified as good opportunities for investment: GILD and ME. We will provide a separate post for these stocks.

Friday, Aug 12, 2022

Today, the preliminary August 2022 Michigan Univerisity Consumer Sentiment Index was released. Below is the summay, which is a good news for those participating in the current market rally.

As evident above, the Index for Consumer Sentiment and Consumer Expectations are up slightly, and the expectation for Current Economic Conditions is down slightly. Overall not much change and slight improvement.

Below are a few highlights from the Michigan Uni website that we found noteworthy:
“All components of the expectations index improved this month, particularly among low and middle income consumers for whom inflation is particularly salient.”
“At the same time, high income consumers, who generate a disproportionate share of spending, registered large declines in both their current personal finances as well as buying conditions for durables.”
“With continued declines in energy prices, the median expected year-ahead inflation rate fell to 5.0%, its lowest reading since February but still well above the 4.6% reading from a year ago.”
Below is the chart published by Michigan University plotting the Index back to 1997 (please note that this is a 3-month moving average, so you still don’t see the small uptick in the chart).