Macro Update (November 15, 2022)

Nov 15, 2022

The FED, Interest Rates, and an upcoming Recession
- CPI, Recession Indicators
The Labor Market and Big-Tech Layoffs
China
- Ease of zero-Covid Policy
- Tech Earnings
The US Midterms
The FTX Bankruptcy
- Timeline of what happened (in a nutshell)
- Consequences for Crypto

The FED and Interest Rates:

On November 2nd, the FED announced the already expected 75 bps rate hike that marks the fourth consecutive 75 bps rate hike. This makes the current rate hikes the fastest of all time.

Never in history has there been a faster rate of change in the FED Funds Rate.

Stocks performed accordingly in the latest months. This week, however, also showed how fast the sentiment can change. Weaker-than-expected CPI data caused the biggest rally in American markets since the Covid rebound. The S&P’s rally was the biggest since February 2020 (5,5%), and the NASDAQ rally (7,5%) since March 2020.

Once again, this shows how important time in the market is instead of timing the market. The extreme rally also started because market participants expected surprises on the upside of inflation rather than on the downside. The euphoria was all the greater when inflation came in at 7.7% instead of ~8%.

Although inflation remains high, the broken uptrend is what investors focus on. However, investors should remain cautious since this is no sure sign that inflation will go lower consistently from now on. And if the FED made one thing clear over the previous months, it’s that they won’t stop hiking rates prematurely.

The downside potential for stocks might be even higher now since investors seem to price in slowing inflation. The market’s expectation for the next rate hike is 50 bps.

Remember, this remains a bear market, and a recession is still a threat for the next earnings season.

Talking about a possible recession, let’s look at some indicators.

The three indicators above are the 10-Year Treasury - 2-Year Treasury, 10-Year Treasury - 3-Month Treasury, and the 10-Year Treasury - Federal Funds Rate.

The first two of these indicators are already inverted, which, historically, was an excellent indicator of a recession. The 10Y-3M is the indicator the FED takes the closest look at.

At the moment, these indicators paint a pretty compelling picture. The 10Y-2Y indicator is typically lagging by 7 to 9 months. The 10Y-3M by 3 to 4 months and the 10Y-FED Funds Rate is the most recent of these indicators, meaning there’s a high chance of inversion in the next couple of weeks.

Note, however, that not all of these indicators have to point to a recession. The 10Y-2Y and 10Y-3M are already convincing, especially considering the last earnings season and the weakening labor market.

But my Macro Updates are not supposed to be macro forecasts. I’m not trying to guess whether we will head into a recession or when that will happen. I’m focusing on how things are right now and where we are in the cycle, as Howard Marks would say.

And in a market like this, I think investors must have a rough idea of what’s going on. How are you supposed to invest for the long term and keep calm when you see price movements of 6-8% in major indices like the S&P and the NASDAQ without any idea of what’s going on?

And if we do head into a recession and you understand why and what that means, you have a huge psychological advantage over investors who freak out and panic sell.

Now, let’s talk about the above-mentioned weakening labor market.

The Labor Market and Big-Tech Layoffs:

In the last Semi-Weekly Update, I talked about the still strong labor market and the FED, which wants to see the Labor market weaken. And the labor market did weaken.

Meta announced a 13% layoff and was rewarded with a 13% rally. Other tech and non-tech firms followed and started laying off employees. Here are some of the most extensive layoffs in 2022.

Twitter: 50%
Intel: 20%
Snapchat: 20%
Coinbase: 18%
Stripe: 14%
Meta: 13%
Lyft: 13%
Redfin: 13%
Credit Suisse: 5%
Goldman Sachs: 3%
Amazon: 3% of corporate employees, 1% of overall employees
Microsoft: 1%
Apple: hiring Freeze

The latest ISM reports also show contracting employment in the Services sector, reinforcing the narrative that the entire job market, including outside of tech, is starting to weaken.

Yet, the unemployment rate remains low, with only slight growth from 3.5 to 3.7 from September to October. Thus, it’s no surprise that the FED is still speaking of a strong labor market and is not yet considering pivoting based on the current data.

China’s zero-Covid Policy and upcoming Tech Earnings:

China’s zero-Covid policy was and still is a massive problem for Chinese stocks. Now, the Chinese government is taking first steps in easing the strict rules. According to the South China Morning Post, control measures should become more “targeted and precise.”

These are some of the changes:

Relaxation of international travel rules, including reducing mandatory quarantine requirements and loosening testing measures
Easing of domestic travel rules and removal of flags on digital-travel passes for past visits to hot spots
A targeted campaign to increase inoculation rates among the elderly
Possibility of broader availability of domestic Covid treatment pills by year-end
Updated pandemic guidelines for containment and surveillance to ease overly aggressive local restrictions

According to Kinger Lau, Goldman Sachs' chief China equity strategist in macro research, Chinese stocks have an upside potential of 20% when Covid policies further ease and eventually end.

Despite that, China will remain a very volatile market, and investors will pay close attention to whether the CCP will continue to regulate big-tech firms in the coming months and years.

Speaking about Chinese tech, Tencent (Wednesday), Alibaba (Thursday), and JD (Friday) will report earnings this week. Alibaba already announced that its Global Shopping Festival was a success, with revenues reaching last year's levels despite current conditions. JD’s Singles Shopping Day, which took place on the same date, was an even greater success, with record revenues.

The US Midterms:

Historically, the ruling party gets “punished” in the midterms. Accordingly, a “red wave,” meaning the takeover of the House and Senate by the Republicans, was also expected this year.

But the election turned out differently and strengthened the democrats. Though they lost the House, they held onto a close majority in the Senate.

Trump-supported candidates did significantly worse than expected, while Trump's inner-party rival Ron DeSantis achieved a clear victory, bringing up debates about who will be the Republican presidential candidate in 2024.

For the markets, these midterms have produced no groundbreaking changes. However, the divided congress will make it difficult for Biden to pass additional bills concerning fiscal policy, government spending, and recession-fighting packages.

The FTX Bankruptcy (in a Nutshell):

First of all, I’m far from being a crypto expert. So I can give you a summary of what happened and a personal, relatively uneducated assessment of the consequences for crypto as a whole. Spoiler: I don’t believe the long-term impact will be as severe as many expect. Mainly for two reasons that I’ll discuss later on, but let’s start with what happened first.

FTX was the 4th largest crypto exchange with a market cap of $32 billion. Founder and CEO Sam Bankman Fried (SBF) had a personal net worth of $16 billion. The market cap, as well as the personal net worth of SBF, are now at $0.

It all started on Nov. 2 when a leaked balance sheet of the hedge fund Alameda Research revealed that a significant amount of their reserves actually were FTT tokens. A token made by FTS. Ohh, and the hedge fund, Alameda Research, is no random hedge fund. It’s SBF’s hedge fund.

Yes, SBF, founder and CEO of FTX, which creates the FTT token, also has a hedge fund whose reserves consist of the token FTX can create out of thin air. And the amount of FTT tokens the hedge fund held was far greater than the amount of FTT tokens traded. This means that liquidating these tokens to market prices is close to impossible.

But this wasn’t a problem until …

On Nov. 6, Changpeng Zhao (CZ), the founder and CEO of Binance, announced that Binance would sell all of its FTT holdings. Due to an earlier position Binance had in FTX that was partly paid out in FTT tokens, the share of Binance was pretty significant. To be precise, Binance planned on selling more than $500 million worth of FTT.

CZ also compared FTX to the previously collapsed Luna token, which made investors nervous, and the price of FTT started to get lower and more volatile.

On Nov. 7, SBF tweeted that FTX assets were fine, but that didn’t help with the “bank run” that started. Investors continued to pull their money out. At least they tried… A day later, on Nov. 8, FTX stopped paying back customers, and it became apparent that FTX had severe liquidity problems. CZ then tweeted that he wanted to help and signed an LOI (letter of intent) to take over FTX. Since then, the price of the FTT token has tanked a staggering 75%.

But the hopes that investors put into a finance takeover remained unfilled when CZ announced on Nov. 9 that finance wouldn’t buy FTX due to more severe issues with the financial structure of FTX.

Simultaneously, the suspicion that SBF’s hedge fund Alameda Research misgoverned customer funds grew. The SEC and the Commodity Futures Trading Commission started an investigation.

Nov. 10 marks the end of Alameda Research. In an attempt to save some liquidity, SBF announced the hedge fund would close. He also tried to raise cash from investors like Sequoia or other crypto exchanges.

On Nov. 11, the whole fiasco came to an inglorious end, and FTX filed for bankruptcy. SBF steps down as CEO, and John J. Ray takes over. John J. Ray is a lawyer who also fought for the Enron scandal victims.

But it wasn’t entirely over yet… a day after filing for bankruptcy on Nov. 12, $1 billion of FTX customer funds disappeared in “suspicious circumstances.”

All in all, it seems like the customer funds are gone, and there’s little hope that victims of this crime will receive payments at any point.

But what does this incident mean for crypto as a whole?

Many people compared the FTX collapse to the Lehman crisis in 2008. I believe the impact of this collapse is not even close to 2008, and the effect is very concentrated in the crypto space. But even for crypto, I don’t believe this will have a significant, long-lasting impact on the industry. At least not in a way that makes people stop wanting to invest in the space.

Not only retail investors but also institutional investors will keep investing. But I can imagine that regulation will change the pace and way crypto exchanges and brokers come up. In fact, I believe this whole scenario is an opportunity for traditional banks to catch up.

Many were hesitant to get into the space initially. However, more and more banks have started projects surrounding crypto and blockchain. And who has more expertise in handling regulation than big traditional banks like Goldman Sachs, J.P. Morgan, or Morgan Stanley?

This might not be what crypto investors want, but I don’t rule out the possibility of this being the result of what we’ve seen in the last couple of days.

But as I said, I’m no crypto expert, and I could be totally wrong about this.

Okay! That’s it for today’s Post and the second Semi-Weekly Macro Update. Any Feedback? Please tell me in the comments.

Also, after many people asked, I’ll post my latest Twitter thread here on Substack tomorrow and add a PDF with the three Financial Statements.