IN THIS PUBLICATION:

1. Higher Rates and US Dollar Strength

2. Equities Update

3. BTC Momentum Continues

4. Gold to New All-Time Highs

1. Higher Rates and US Dollar Strength

Going into 2024, there was a significant divergence between the number of rate cuts that the market had priced in (seven) and what the Fed expected they’d actually cut (three). In just over two months, that divergence has almost completely collapsed. The last time we expected September Fed Funds to be around the current level (which implies two rate cuts until then, starting in June), the S&P 500 was 15% lower.

This repricing of rates higher has helped fuel the dollar index towards the higher end of the range it has been trading in for the better part of the last year.

We’ve said it many times – the US Dollar is one of the most important financial assets in the world, with its direction having broader implications across a plethora of markets. Any breakout of the range will be a headwind for EM and commodities. (To fully understand the US Dollar, why it’s so important, and how the mechanics work, we’ve covered extensively the Eurodollar Market in a primer here.)

 2. Equities Update

Going into February we were worried about seasonality, which in the second half of the month tends to be horrible, but that has failed to make any serious dent in performance. The S&P 500 has now closed higher in almost 90% of the weeks since the October lows, something that has not happened since the 1970s.

Additionally, the expectation of higher rates for longer has not deterred the market from making new all-time highs in February, but (without being overly repetitive) that’s mostly thanks to the Mag 7 (but really only the Fantastic 4 (yes a new market super team) as only Nvidia, Meta, Amazon, and Microsoft are positive on the year (and only the first three are beating the S&P).

• Google, Apple, and Tesla are all battling their demons at the moment – Google’s Gemini is proving a little too DEI friendly for most people, Apple is feeling the pressure on both top-line growth and geopolitical posturing from being overly exposed to China, and Tesla investors are finally realizing it’s a car company and not a high growth AI startup.  

As we mentioned in the last Markets Update, the dispersion of return within the Mag 7 has continued to increase. In fact, the return divergence between the best-performing name of the group (NVIDIA) and the worst one (TSLA) has never been this wide. Also, there is now only $500 billion separating NVIDIA’s market cap from Apple’s…

The broadening of dispersion of performance between the Mag 7 and the continued leadership of NVIDIA means that investors are being increasingly more selective on the kind of “bull narrative” they want to be exposed to – i.e. this has not been a broad bull market rally, but rather a Mag 7 that has narrowed to AI and that is further narrowing to Nvidia and Meta.

This also means that market performance is increasingly dependent on fewer companies and fewer narratives – that’s why market concentration, as you can see below, is the highest since the early 1970s. Financial analysts will tell you that high levels of market concentration have historically coincided with, or preceded, recessions and that you should take some risk off the table.

We think that one of the likely reasons we hear so much about the “problems of a concentrated” market is because active managers tend to underweight the largest stocks (one of the key reasons why most have underperformed their benchmark in 2022). These kinds of arguments serve financial analysts on the sell side, whose clients are active managers, quite well: tell your clients what they want to hear (“You’ve been underperforming but a recession is coming and market leaders will start to underperform soon enough”) and they’ll continue paying your fees.

In fact, if we compare the US with other markets across the globe, what we would note is that it’s not really that concentrated (of other major markets, only Japan is more diversified than the US).

Additionally, since the end of WWI, the US has consistently been the largest stock market in the world. This mattered throughout the last century but matters even more in a post-2008 world where flows have become the single most important driver of equity performance (thanks to central bank activity and the rise of passive vehicles).

This all means that historical comparisons of performance given levels of concentration should be taken with a pinch of salt mainly because market structure nowadays is completely different than that of two decades ago. We live in a world where big companies (and large equity markets) get bigger because they capture a greater share of liquidity flows, and the only thing that is going to stop that (or at least slow it down) is anti-trust legislation (which is probably the most significant potential headwind for a few members of the Mag 7).

In any case, as we argued many times over the last couple of months, the Global Liquidity Cycle is all that matters now, and most global liquidity continues to go to the US. In a world where the relationship between the index level of the S&P 500 (y-axis) and Global liquidity (x-axis) is as tight as displayed below, it’s hard to find a catalyst that justifies being tactically bearish right now.

In the words of the key person behind the Global Liquidity Cycle model, Michael Howell: “The S&P 500 looks extended in absolute terms when measured by US domestic liquidity flows, but it looks far more comfortably placed when Global Liquidity is the benchmark. Plainly, US equities have got much further to run if we can reassure ourselves that Wall Street has become the ‘World market’ for stocks. Indeed, this might be plausible given the dominance of US firms in tech and AI applications?”

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 3. BTC Momentum Continues

As always seems to be the case with Bitcoin, recent interest has surged as the dominant crypto asset continues to perform extremely well in 2024 (and temporarily hit all-time highs, overtaking silver’s market cap), following on from 2023 when it returned a healthy 156%.

We’ve written about the importance of the ETF approval last month. Most sales teams at the large financial institutions that are sponsoring the Bitcoin ETFs are just about to finish their crash course on the asset so they are fully prepared to go out and educate prospective investors about it – and we think that there should be significant adoption as a result of this over the coming months and years.

More importantly, those sales teams will come to market just before one of the most important events in Bitcoin (known as the halving) takes place, which is when the rewards for miners (in other terms, the rate of new supply of Bitcoin that comes to market) halves.

Pantera has done a good summary and analysis of what to expect from the halving. Whilst we think that this forecasting exercise is more likely than not to be wrong (most models are, not just in the crypto world), we still find it helpful to frame what kind of upside we could see if history around halvings were to repeat. We quote:

“The next halving is projected to occur on April 20, 2024. The mining reward will decrease from 6.25 BTC per block to 3.125 BTC per block. In our view, it’s relatively straightforward: if the demand for new bitcoins stays constant or increases and the supply of new bitcoins is cut in half, this will force the price up.

Efficient Markets Theory would hold that if we all know it’s going to happen, then it has to be priced in. Paraphrasing a line attributed to Warren Buffet on the dogma, “The markets are almost always efficient, but the difference between almost and always is $80 billion to me.” Thus, even if we believe everybody knows something, it doesn’t mean there isn’t a still huge upside to be had.

Over the years we have stressed that the halving is a big event – but it takes years to play out. 

In our November 2022 blockchain letter, we published an analysis on halvings impact on price by studying the change in the stock-to-flow ratio across each halving. Below is the chart that we included in that analysis, which also forecast what could happen next.

Bitcoin was at $17,000 when we made this forecast. The model forecast that bitcoin would be just over $35,000 at the next halving in April 2024. At the peak of the post-halving rally, which would be in August 2025 based on the average duration of previous rallies, it could hit $148,000.

 The current price of bitcoin is currently outpacing our projection of $35,500/BTC at the halving date, now 60% above that forecast.”

 4. Gold to New All-Time Highs

The significance of the Bitcoin rally is, in our opinion, enhanced by the fact that gold has been rallying as well and just recently broke a technical level that has not been breached in a sustained manner before. As Charlie Morris said: “Dr. Copper has a PhD in economics, and is an expert on the business cycle, then gold is a professor with a Nobel Prize in monetary debasement.”

This recent price action is an indication that market participants are indeed starting to focus on “monetary debasement” alternatives with greater interest. Consider this:

• The confidence level around the Fed is at the lowest level ever.

• BRICS + have been steadily increasing their ownership of gold since 2009 (a trend that has accelerated as a result of the sanctions against Russia, which the BRICS interpreted, and rightfully so, as militarization of money).

• This matters quite a bit in a world where the largest share of global GDP starts to tilt in favor of the BRICS block.

• It has also been widely covered that Central Banks (i.e. the operators of the printing press) have been buying up gold at the fastest pace ever.

• Lastly, geopolitics is playing a key role in pushing the asset higher as gold is both a reserve asset in a de-dollarizing world as well as it’s being used as a settlement medium for interstate capital flows between the Middle East and China (which, in the long term, undermines the petrodollar system).

Gold is hardly a speculative asset, so do not expect these trends to be reflected in price in the short term. But the breaking out of such an important technical resistance that has lasted for four years merits our attention as it could signal a sustained bull market in the bullion.

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