Market Commentary 11th November 2022

For those that don’t know, I head the investment team at IPS Capital. Each week I highlight a few things that have come across my desk that I think are interesting and investment related. We always welcome dialogue so if you have any questions we’ll be happy to answer them here too.

 

Your 3 things this week are:

  1. A private company last valued at $32bn went bust on Monday leaving customers with $8bn stranded in it
  2. The US Senate and congress elections were held on Tuesday and – very surprisingly – both are still too close to call as I write Friday morning
  3. A benign US inflation report on Thursday sent US equities up 5.5% on the day (and the technology focussed Nasdaq market was up over 7%)

 

In any other year this would all be dramatic front-page news. But this is 2022 and, meh, just another week in markets.

 

Let’s start with yesterday’s US CPI report. While monthly numbers are inevitably noisy and volatile, the previous two inflation reports had come in higher than expected and the pressure remained on the US Federal Reserve to keep the interest rate rises coming. I wrote last week, however, about rising inventories at companies like Peloton and falling shipping costs. Housing (the sector most directly affected by rising rates) is also clearly slowing down here and in the US. You could see inflation starting to fall everywhere except the official data. Yesterday, it showed up in the data and the relief in markets was palpable. Bond markets and equity markets rose in unison.

 

US Consumer Price Inflation

Source: Jason Furman

 

You can also see (on the far right of the chart) the work that needs to be done. Goods inflation was in fact negative for the month and we expect this to remain low going forward. Services inflation (6% or so annualised) is still high and above target. This is mainly wage driven. We need to see wage growth fall back to closer to 3% to 4% before we can declare the inflation problem over. How much will unemployment have to rise to tame wage inflation? This remains unknowable but yesterday’s report was a step in the right direction.

 

We cut our equity exposure early in the year but since then we have kept our allocation more or less unchanged. We have also been adding to our bond exposures recently. It is always difficult to stay invested in a year like 2022 when the fundamentals keep getting worse. Part of the reason is that we want to make sure we have enough “skin in the game” to capture the recovery when it comes. This may yet be a false dawn but one way or another there will be a new dawn. We plan on being there to see it. We are glad we were there for this one.

 

FTX

That said, doing this job week in week out can be pretty humbling. Sometimes you are wrong, sometimes everyone else seems to be having fun and making money apart from you. We had a few moments like that in 2020 and 2021 looking at the bubblier parts of technology markets and crypto currencies (the most famous of which is Bitcoin). I remember explaining to clients on more than one occasion why we were not getting involved.

 

Well, it turns out we were right. One advantage of traditional assets is that they produce cashflows. As prices go down the cashflows you receive get cheaper and cheaper to buy. This naturally puts a floor on valuations. Bitcoin (and other unproductive assets) just do not have that floor. This means when they start to fall they can then fall very quickly. FTX is an exchange that lets people buy and sell these crypto assets. Prices fell quickly and (because there was leverage involved) FTX was not able to meet client’s redemption requests. We have seen estimates that around $8bn of client cash is tied up in FTX and at risk.

 

We have a couple of things to say on this. First, we feel a lot of sympathy for the people who have lost money here. Part of the appeal was, of course, to escape the old economy with all its restrictions and FCA and SEC style regulations. Crypto investors are starting to understand why these regulations are needed. They exist to protect exactly the sort of smaller, non-professional investors now stuck in FTX.

 

The second point is that the impact on broader markets has been, more or less, zero. Professional, large ticket-size investors are just not involved in this part of the market. At the margin the number of crypto “millionaires” will have collapsed. I would be bearish Lamborghini sales and the price of tables at swankier nightclubs in Miami, but I think both will be able to survive the hit.

 

US Elections

The fact that I can’t concretely tell you the result of either the house or the senate is in itself a big surprise. On Monday, Republicans were expected to take Congress easily (80%+ chance) and had around a 60% chance of taking the senate. From a market perspective this was deemed to be no bad thing. A Republican blocking vote would probably mean, at the margin, less regulation and lower taxes than an all Democrat majority. This is pretty market friendly. Markets also like certainty and, for better or worse, it would be harder for a deadlocked US government to spring any big surprises.

 

At the risk of venturing into political analysis (very much not my thing) this may also clip the wings of the Trump-style, election-was-rigged wing of the party. Crazier Republican candidates on average under-performed. If you hope for the future of American democracy (as you should do) then Tuesday was probably a pretty good day.

Chris Brown
CIO
IPS Capital
cbrown@ipscap.com

 

The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.