Friday 21st May, 2021
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We are coming to the end of a highly interesting, if somewhat unsettling, two-week period for markets as various forces – from economic data to celebrity tweets – have pulled risk assets in just about every direction. It all kicked off with a massive data miss on Friday 7th May as the US non-farm pay-roll figure for April came in at 266k, well below expectations of over 1mn, and the unemployment rate crept up to 6.1%. On initial reading, this print suggested that the much-anticipated hiring boom, a manifestation of a robust domestic recovery, had simply failed to materialise. However, the reality is that companies are desperately looking to bring on new staff to keep pace with the increased demand for their services, yet no-one is taking them up on the offer. The NFIB’s April jobs report showed that a record 44% of small companies (a record spanning 40+ years of data) are struggling to fill job openings as many workers, currently on generous government unemployment benefits, have proved reluctant to return to the workplace. This points to an interesting dynamic where the unprecedented fiscal support, widely lauded as playing a major role in the US’ resilience through the pandemic, may now be overstaying its welcome and could actually be hindering economic growth. Whether this is the case or not, the difficulty in hiring is certainly real and points to further inflationary pressure as employers are forced to hike wages in order to staff their businesses. Just last week, McDonalds announced a plan to lift hourly wages by ~10% for US employees, while Amazon is offering sign-on bonuses of up to $1,000 as part of its drive to add 75,000 jobs in North America.
Inflationary fears then peaked on Wednesday last week as the April CPI print showed it rising +0.8% MoM (vs 0.2% expected) and +4.2% YoY (vs 3.6% expected). This could not even be pinned on a surge in energy prices as core CPI was up +3.0% YoY, its fastest pace since the 90s. Of course, a high reading was expected given the strong economic backdrop and a low-price base from the peak of the pandemic, but the scale of the beat took markets by surprise. Inflation expectations had been creeping up in advance of the reading, but they then surged shortly afterwards with 5Y inflation breakevens crossing 2.8% for the first time in over 15 years, suggesting that there might be more to this than a one-off freak reading (or at least that is what the market thinks). Interest rates were dragged up in turn due to concerns about the impact this could have on the pace of monetary tightening and the 10Y US treasury yield crossed 1.7%. None of this was good news for equity markets, with the rate sensitive high growth tech sectors suffering most acutely, and we saw the Nasdaq and the S&P 500 fall by -5.2% and -4.0% respectively over the first three days of last week. After the print, Fed officials reiterated their dovish stance, highlighting that the reading was within expectations and they would need to see a sustained rise in inflation (i.e., several months of similar readings) before considering the tapering process. This was really nothing new – indeed, the Fed’s verbal commitment to letting inflation run hot in the short term has been one of the few constants this year – but was still sufficient to soothe markets, which rallied into the week’s close. We have seen a remarkably similar pattern evolve this week, albeit on less clear drivers, with a draw down in equities over the first three days and then prices picking up from Thursday. Nonetheless, the shock of the CPI print seems to have faded and most assets now find themselves not far from their levels two weeks ago – both the S&P 500 and the NASDAQ are down a modest -1.5% (and futures indicate the former will open up on Friday), while the US 10Y yield is back down to 1.62%.
While equity markets may be nearly flat over the last 12 days, the same cannot be said for cryptocurrencies. They took a beating last week as Elon Musk – who seems to have readily adopted Trump’s mantle as the market’s pet celebrity – tweeted that Tesla would no longer be accepting Bitcoin as payment for its cars, citing concerns about its environmental impact and directly rowing back from a tweet made earlier in the year. Unconfirmed reports that Tesla had sold its Bitcoin holdings only added fuel to the fire and Bitcoin finished the week down -14%. However, there was an even more brutal second-leg to the sell-off this week driven by a regulatory crackdown in China. On Wednesday, the PBoC doubled down on its stance against digital currencies by announcing a new ban that prohibits financial institutions from accepting digital currencies as a means of payment and from offering a very broad array of related services (e.g., no exchange services, account openings, issuing crypto-related products, etc.). This caused Bitcoin to tank and it fell to $30,000 at one point, which represented an intraday drop of more than 30% and a decline of over 50% from the all-time high touched in April! Other cryptocurrencies followed suit and the Bloomberg Galaxy Crypto Index (a market-cap weighted index of the largest digital assets) is currently down -30% for the week, despite losses being pared back over the last two days. Cryptocurrencies have never been an asset for the faint-of-heart – Bitcoin alone has seen three 80%+ drawdowns over its lifetime – but the swings seen this month have been quite something even by their standards and have served to highlight some of the difficulties inherent in investing in this asset class. We are not going to comment on the “fair” valuation of any of these currencies, nor the viability or potential of the underlying technology, but when the price falls 30% because a nation known for its tight-fisted oversight decides to impose restrictions on a highly popular, volatile, and largely unregulated asset, it is hard to argue that a good deal of wishful thinking and speculation is not involved. With more and more regulators taking notice of the space, we expect that the ready adoption of this still very novel asset will suffer more setbacks and the mettle of crypto proponents will be tested further.
As such, when it comes to an asset that can act as a store of value and hedge portfolios against currency debasement, we will continue to stick with gold. The yellow metal has been on an excellent run recently and is now closing in on $1900, having benefitted from the general market turmoil (including the sell-off in cryptos), a weakening of the USD, escalating geopolitical tensions in the Middle-East, and rising inflation expectations. We consider it a core holding in a market that is likely to continue to be dominated by inflation concerns and episodic bouts of volatility. We have also said for some time that we would not be surprised to see a 10%+ correction to equities and this has not changed. Markets may have been largely flat for the last two weeks, but they are also looking increasingly skittish and we do not think it will take much to tip the balance. Given the level of good news being priced in, even a moderate disappointment on any of the upcoming data readings could prove to be a catalyst for this and the CPIs through the summer will be crucial to watch. We will stay vigilant.
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