What to Make of the Crypto Crash

Bonds Rebound, Crypto Crashes

Berkshire Hathaway investing legend Charlie Munger famously quipped: “The first rule of a happy life is low expectations.”

Pondering that mantra would have helped market-watchers’ spirits as they followed the just-ended third-quarter earnings reporting season as well as the ongoing battle to slay inflation while avoiding recession.

Over the last month, inflation continued to clock a fast pace (albeit a bit slower than in prior periods), Federal Reserve policymakers have signaled they will continue to hike the fed funds rate (possibly also a bit slower) and corporate earnings growth was the lightest since the pandemic.

Still, it’s been a happy month for stock and bond investors. Why?

Well, inflation remains high but not as high as feared. The Fed is (most likely) going to raise interest rates at the next several meetings, but by less than previously anticipated. And while earnings aren’t growing as quickly as before, some 70% of companies in the S&P 500 still reported better results than analysts expected.

When your expectations are low, it doesn’t take much to be pleasantly surprised. The news doesn’t even need to be that good, just better than the alternative.

Here’s what else we’re watching this week and why it matters:

  • Shop till you drop? Retail sales rose 1.3% in October compared to September—despite inflation’s pinch. Shoppers spent more on gas, food and even big-ticket items like cars and furniture. Holiday shoppers are expected to spend between 6% and 8% more this season than in 2021.
  • Mixed results from the country’s leading retailers suggest that there’s a shift in how and where consumers are spending:
    • Target’s third-quarter profits fell shy of expectations and the retail giant lowered estimates for holiday spending, noting that customers have become more discerning about discretionary items while spending more on food and household essentials. This suggests consumer budgets may be coming under strain.
    • Discounter Walmart’s sales rose 8.2% in the third quarter compared to the previous year as consumers hunt for bargains. The question is whether that means holiday shopping got an early start and the traditional fourth-quarter season will disappoint.
    • Amazon announced plans to lay off about 10,000 of its corporate employees even as it ramps up to the holiday shipping maelstrom. (The company hired some 800,000 workers during the pandemic to meet increased demand from quarantined consumers.) This latest move in the e-tail Goliath’s cost-cutting campaign repositions it for a potential recession.
  • Speaking of shopping, companies in the S&P 500 are on pace to set a quarterly record for spending—about 20% more than in the fourth quarter last year. While the expenditures have run the gamut, “reshoring” (bringing operations back to the U.S. from overseas) has been one recurring theme on earnings calls. Meanwhile, energy companies have been bolstering their capabilities to keep up with demand.

The Bond Rally’s Mixed Message

Over the past week, the yield on the 10-year Treasury bond hit a high of 4.16% before dropping to Wednesday’s low of 3.67%. (Remember, yields fall as prices rise.) Meanwhile, the 3-month Treasury’s yield has moved in the opposite direction—rising to 4.24%. The result: The inversion between the 3-month and the 10-year passed a historically significant 0.50% gap (actually 0.57%, but who’s counting?).

The Federal Reserve has often cited this difference in yield between 10-year and 3-month Treasurys as a signal of incipient recession—though there has been a tendency by various Fed officials in recent years to downplay its importance. As you can see in the chart below, there have only been a handful of periods in the last 60 years where the yield curve inverted by 50 bps or more (a rather small dataset). A recession followed each occurrence.

 

Yields spread is a recession indicator
Note: Chart shows daily difference in basis points between the 10-year Treasury and 3-month Treasury yield from 1/2/1962 through 11/16/2022.
Source: U.S. Department of the Treasury.

The yield curve inversion tells us that bond investors’ moods have clearly changed. As the Fed has fought inflation with aggressive fed funds rate hikes, fixed-income traders have been pricing in an eventual economic slowdown. Stronger-than-expected retail sales will keep interest-rate hikes on the front burner.

So as longer-term bonds rose in price, bringing some reprieve to that segment of the bond market, the cause is not necessarily one based upon optimism for the economy—the lingering fear is that Fed activity will catalyze recession and investors are seeking safety. 

Chart of the Week: Crypto Chaos, Not Contagion

Portfolio Manager Jeff DeMaso 

The noise from the cryptocurrency space this past week has been deafening as FTX, the second-largest exchange, melted down and declared bankruptcy. FTX was led by Sam Bankman-Fried, an unlikely media star who made headlines just months ago by bailing out some failing crypto-related firms while bashing politicians and their suggestions that the crypto industry would benefit from regulatory oversight. The tables turned quickly for Bankman-Fried, FTX and his crypto-trading firm Alameda as well as a host of other crypto companies.

It sounds bad, but for investors who didn’t go overboard or simply ignored the crypto hype, the impact is minimal and self-contained. Cryptocurrencies do not pose the same systemic risk to the traditional banking or financial system as did, say, subprime mortgages in 2007. Less than 2% of the big banks’ “tier one capital” (core assets that fund business activities and are part of the calculation of their overall financial strength) is in cryptocurrencies.

We estimate that the total value of all cryptocurrencies is equal to just 2% of the U.S. stock market’s value. If all those coins went to zero overnight, it would be a bad day in the market, but nothing close to a financial disaster for a diversified investor.

As our chart this week comparing bitcoin (a proxy for the crypto market) to past market bubbles makes clear, bitcoin is a gamble, not an investment. It could be a home run. It could be a zero. It could be both depending on your timing!

But it’s a speculative asset class, at best, and you should size the position accordingly—which means don’t buy more of it than you are willing (and able) to lose. And remember Munger’s insights on expectations.

Crypto chaos, not contagion
Note: Chart shows weekly cumulative percentage gain in each asset or index’s price over the period indicated. Data as of November 2022. Sources: Morningstar, Bloomberg, Adviser.

Contagion or not, the FTX ordeal is high drama. Check out Senior Research Analyst Liz Laprade’s analysis for the ins and outs of how it went down.

Podcast: Wrap-Up Your Year Right—With These Smart Money Moves

The past year has been a blur for investors with bonds experiencing their biggest losses in decades. But don’t let the remaining few weeks slip away without taking a close look at your financial plan. There are several steps you can take now that will get you well positioned for the new year. In this episode, Portfolio Manager Jeff DeMaso and Manager of Financial Planning Andrew Busa discuss the important items to update on your end-of-year financial checklist, including:

  • Taking advantage of tax-loss harvesting
  • Updating your portfolio allocation
  • Whether to make a backdoor Roth conversion in 2022
  • Reviewing your medical coverage, and more

When it comes to your financial plan—and the dreams and goals it’s built to help you achieve—a little maintenance goes a long way. Listen now to learn how end-of-year planning can help you stay on track.

Ask Us a Question!

We’re always interested in the topics or concerns you might like us to comment on. As much as we try to cover the financial planning, investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question and one of Adviser’s wealth management or investment specialists will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

Adviser in the Media

Portfolio Manager Adam Johnson stopped by Fox Business this week with his take on the potential long-term impact of the latest crypto crash.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade took a deep dive into the FTX debacle, while Wealth Adviser Diana Linn shared tips for navigating Medicare’s open enrollment period.

Looking Ahead

Next week, markets and Adviser’s offices will be closed all day Thursday as well as on Friday afternoon for the Thanksgiving holiday. You’ll see next week’s email in your inbox on Wednesday afternoon.

In the shortened trading week, we’ll be looking at fresh reads on durable goods, manufacturing and the service sector, consumer sentiment and five-year inflation expectations, new home sales and the minutes from the Federal Reserve’s early November meeting.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser wish you a safe, sound and prosperous investment future, and a safe and happy Thanksgiving.

About Adviser

Adviser is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


Please note: This update was prepared on Thursday, November 17, 2022, prior to the market’s close.

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