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Market Lab Report - Market timing; Liquidity vs markets; Higher rates vs inflation; SEC vs crypto

Market Lab Report

by Dr. Chris Kacher

The Web3 Evolution Will Not Be Centralized™ 

Market timing

While we continue to provide opportunistic longs and shorts in individual stocks, market timing the major indices has been one of the trickiest to time due to one of the most extremely bifurcated markets in history. New bull markets have never started that were led by so few names. The majority of stock market industry groups along with Bitcoin/crypto have decoupled from technology stocks that are involved in AI.

Broader indices such as the NYSE Composite remain in downtrends.

Patiently waiting on the sidelines as concerns the Market Direction Model during such unusual situations is key as the various metrics such as the advance/decline line and number of new lows vs new highs for major indices remains deeply bearish. Capital preservation is paramount. That said, the MDM may soon switch to a buy signal but with tight stops since major indices such as the NASDAQ which are heavily weighted in mega cap tech stocks with exposure to AI may continue to trend higher.  

Outside of market timing the indices, when it comes to stocks and Bitcoin, opportunistic themes come along every so often such as the outperformance in alt-currency, lifeboat stocks in precious metals and Bitcoin earlier this year that was nicely profitable for our members. While this does not impact the MDM which looks to capitalize on broader trends, it illustrates why the trade of a lifetime comes along every several weeks. We remain vigilant as new data presents the next opportunities.

The CME Fed Fund Futures now show a rate hike in July instead of June while US Treasury yields and the dollar fell last Thursday after government data showed lower labor costs. There has also been some ebullience over the debt-ceiling bill having been finalized. But this will cause the TGA to materially rise which will remove an appreciable amount of liquidity from the markets. Liquidity and market direction show strong correlation in this QT environment that started in early 2022:

Just before the debt ceiling was raised, the TGA fell below $25 billion, down from nearly $2 trillion in late 2020. Since then, the first meaningful increase in TGA boosted it by $50 bil. This reduces liquidity as per the equation:

Fed balance sheet - TGA (treasury general account) - RR (reverse repo) = Liquidity

The Treasury General Account (TGA) will fill to $550 billion by the end of June. This should act as a temporary headwind for both stocks and Bitcoin. The last time a debt ceiling hike was signed into law was Dec 16, 2021. Back then, it was about 2 weeks before liquidity materially moved lower, bringing stock market indices such as the S&P 500 with it.

Meanwhile, foreign countries have preferred to buy gold over US Treasurys, while US banks are gun shy about Treasurys given that this normally low risk investment is the reason why banks have suffered large losses. The Fed will therefore have to buy its own debt. This means M2 will eventually start to rise again as it always does over the long run, but in the meantime, the Fed will continue to tighten. With these cross currents affecting liquidity, we will continue to track these metrics closely.

As a number of Fed members have pointed out, inflation could remain stubbornly high due to supply chain issues and prices at the services level. Sticky inflation, more rate hikes, and tight money do not create new bull markets.

On a risk/reward basis, the MDM has strongly outperformed overall over the last few years due to the material change made in Feb-2019. Patience during historically unusual periods remains a prudent course and brings to light a simple and extraordinary passage from Jesse Livermore’s 1940 book, "How To Trade Stocks":

“Many years ago I heard of a remarkably successful speculator who lived in the California mountains and received quotations three days old. Two or three times a year he would call his San Francisco broker and begin writing out orders to buy or sell, depending on his market position. A friend of mine, who spent time in the broker’s office, became curious and made inquiries.”

“His astonishment mounted when he learned of the man’s extreme detachment from market facilities, his rare visits, and on occasions, his tremendous volume of trade. Finally he was introduced, and in the course of conversation inquired of this man from the mountains how he could keep track of the stock market at such an isolated price.”

“‘Well…I make speculations a business. I would be a failure if I were in the confusion of things and let myself be distracted by minor changes. I like to be away where I can think. You see, I keep a record of what has happened, after it has happened, and it gives me a rather clear picture of what markets are doing. Real movements do not end the day they start. It takes time to complete the end of a genuine movement. By being up in the mountains I am in a position to give these movements all the time they need. But a day comes when I get some prices out of the paper and put them down in my records. I notice the prices I record are not conforming to the same pattern of movements that has been apparent for some time. Right then I make up my mind. I go to town and get busy.”

“That happened many years ago. Consistently, the man from the mountains, over a long period of time, drew funds abundantly from the stock market. He was something of an inspiration to me.”

Global inflation

With inflation at higher levels in the UK and EU than in the US, the Bank of England and European Central Bank are both planning on hiking rates at least a few more times. Food inflation in the UK remained close to its highest level in 45 years at 19.1% in April, down just a touch from 19.2% in March. Core inflation which strips out energy, food, alcohol, and tobacco, rose to 6.8% in April from 6.2% in March, marking the highest rate since 1992, or 31 years. That said, German CPI (YOY) came in at 6.1% vs 6.5% est and CPI (MOM) at -0.1% vs 0.2% est. If the trend among EU-member countries continues to come in under estimates, this could reduce the number of times the ECB has to hike.

On the SEC

On the regulatory front, the SEC is now suing Binance and Coinbase. But let's remember, Gensler’s SEC failed to catch FTX which resulted in $8 bil in fraud & bankruptcies, failed to protect Grayscale investors which resulted in an $8 bil impairment, and failed to protect Voyager, Genesis, and BlockFi borrowers which resulted in $4 bil in bankruptcies.

All SEC enforcement actions are civil, not criminal. They can get fines much as they did with EOS who could easily afford it. Binance has minimal presence in the US as it mostly operates outside the US so is unaffected by court rulings. Some have said the worst outcome is that the SEC "wins" and there is a court-approved template for applying securities laws to crypto. But if the Department of Justice gets involved, this would escalate enforcement to a criminal level.

The Binance lawsuit filed by the SEC is an extensive document that highlights the potential introduction of "Chokepoint 2.0" in the US. This agenda seems to aim for a centralized digital currency in partnership with large banks that would grant them total control over individuals' financial lives, indicating an attempt to suppress the ideology of cryptocurrencies and their implications.

At its core, this event signifies a political and philosophical divide between those who support freedom and self-determination versus those who advocate for a more authoritative grip on individuals' economic rights. The fact that a handful of unelected representatives are making these judgements on behalf of millions is worryingly alarming.

Nevertheless, this presents a chance for the industry to come together and cooperate towards a shared objective. It's time for all stakeholders to collaborate and construct reasonable regulations and guidelines that can thwart the United States from sliding into a dystopian state where personal freedoms are eliminated.

Despite challenges, the cryptocurrency field continues to gain momentum. There may be stumbling blocks ahead, but the industry will overcome them and emerge more robust and resilient than ever before.

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