The long-awaited recession and resulting bear market restart in 2022 has so far failed to materialize in 2023. In fact, most assets were bought, with the Nasdaq hitting a new 52-week high on July 12.
how so? Will the rally continue?
michael bury big short In January, news that the U.S. could be in recession by the end of 2023, low consumer price index (CPI), and Fed rate cuts (note last week’s CPI numbers were well below expectations further fueled the recent rally). In his view, this will lead to another inflation spike.
Most recently, independent macro and cryptocurrency analyst Lyn Alden explored the topic in a newsletter released this month.
In the report, Alden examines today’s inflation environment by contrasting it with two similar but different periods, the 1940s and 1970s. From this, she concluded that the U.S. economy is likely to stagnate or experience a mild recession while experiencing some degree of persistent inflation. This could mean that the market will continue its upward trend until it officially enters a recession.
My July 2023 newsletter is out:https://t.co/gTH0nUyrU8
The theme focuses on fiscal dominance and how large debts and deficits undercut the impact of high interest rates as a policy tool. pic.twitter.com/qmuzInyYjK
— Lynn Alden (@LynAldenContact) July 2, 2023
The Fed’s Inflation Fight Continues
The important difference between the two periods is the rapid bank lending and large monetized fiscal deficits, which Alden believes are the underlying factors driving inflation. The former happened in the 1970s, when baby boomers started buying homes, while the latter happened during World War II, as the war was being financed.
The 2020s are more like the 1940s than the 1970s, but the Fed is executing the monetary policy playbook of the 1970s. This can backfire. As Alden explained:
“So as the Fed raises rates, federal interest payments rise, and the federal deficit, ironically, widens at a time when it was initially the main cause of inflation. Its risk is akin to trying to put out the oil in the kitchen with water Fire, which makes intuitive sense, but doesn’t work as expected.”
In other words, inflation today is largely driven by the creation of new federal debt, or what some call government money printing.
It is possible to raise interest rates to calm inflation, but it means that the source of the inflation lies in the expansion of credit associated with bank lending. While higher interest rates curb inflation by raising the cost of borrowing and thereby reducing the creation of loans by the private sector, they make fiscal deficits worse by increasing the interest owed on these debts. Today’s federal debt is more than 100 percent of gross domestic product (GDP), up from just 30 percent in the 1970s.
While the Federal Reserve has raised interest rates by 500 basis points for over a year to cool parts of the economy, the underlying causes of the current inflationary environment remain unaddressed. With America’s debt-to-GDP ratio much higher than it was 50 years ago, things will only get worse at a faster rate. But markets remain resilient, including tech stocks and cryptocurrencies, even though the correlation between the two has broken down.
As a result, the Fed may use tools that are not appropriate for the current situation, but this has not stopped the market, at least for now.
Big Tech Defies Recession Expectations and Drives Stocks Rally
Even as the Federal Reserve battles inflation and market participants expect a recession to be inevitable, the first half of 2023 remains fairly upbeat for stocks, with gains extending into July. While bonds have sold off again, with yields rising near 2022 highs, risky assets such as technology stocks have been surging.
It’s worth noting that this rally was led by seven stocks, including companies like Nvidia, Apple, Amazon and Google. These stocks are disproportionately represented in the Nasdaq:
Just 7 stocks make up 55% of the Nasdaq 100 and 27% of the S&P 500
The distribution has become so unbalanced that Nasdaq will rebalance to reduce the weight of these megacaps.
source: @goldman sachs pic.twitter.com/k1xM1wmL2S
— Markets and Chaos (@Mayhem4Markets) July 13, 2023
related: Bitcoin Mining Stocks Outperform BTC in 2023, But On-Chain Data Suggests May Stall
Bonds fall, cryptocurrencies and tech stocks rise
Much of the rise in technology stocks has been attributed to the artificial intelligence-driven hype, while a handful of large-cap stocks have also been boosted by easy liquidity in the bond market.
Alden noted how it all started late last year:
But then some things start to change at the beginning of the fourth quarter of 2022. The U.S. dollar index fell as the U.S. Treasury began dumping liquidity into the market, offsetting the Fed’s quantitative tightening policy. The S&P 500 bottomed out and started to stabilize. Liquidity in the sovereign bond market has started to loosen. Various liquidity-driven assets such as Bitcoin have rallied. “
A July 11 report from Pantera Capital made a similar point, noting that real interest rates also tell a very different story compared to the 1970s.
“Traditional markets may struggle, while blockchain may be a safe haven,” the report said, in part because “the Fed needs to keep raising rates,” as real interest rates remain at negative 0.35%. The report also concluded from this: “bonds remain subject to substantial risks.”
The report also noted that while most other asset classes are sensitive to interest rates, cryptocurrencies are not. Bitcoin’s correlation with stocks in 2022 is driven by the collapse of “overleveraged centralized entities.” Today, this correlation has reached near-zero levels:
One of the key takeaways may be that risk assets appear to have a bid right now. However, this trend could easily reverse before the end of the year.
Dan Morehead of Pantera Capital put it well:
“After 35 years of trading market cycles, I understand that market declines can be long. Investors can only take so much pain. (…) It’s been a full year since TerraLUNA/SBF/etc. Time Enough is enough. We can rally now.”
With the halving looming and the prospect of a spot bitcoin exchange-traded fund looming, the cryptocurrency’s catalyst seems poised to break out in almost any scenario.
This article does not contain investment advice or recommendations. Every investment and transaction involves risk, and readers should do their own research when making a decision.
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