Market Pulse
Sunday, August 18, 2024
Welcome to this week's Market Pulse, your 5-minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.
Our three stories this week:
It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.
Headline U.S. inflation data came back slightly cooler than expected on Wednesday. While forecasters anticipated a repeat of June’s 3% reading, the consumer price index rose just 2.9% in July. [1] That data came on the heels of Tuesday’s producer price index release, which fell to 2.2% in its largest decline in more than a year. [2]
In addition to bolstering the Federal Reserve’s resolve to cut rates in September, falling CPI and PPI data has widely been interpreted as a signal that the Fed has emerged victorious in the battle with inflation. Yet there is some reason to be sceptical about the extent of the Fed’s inflation impact and the durability of their victory.
Although we often speak about inflation as a unitary item, a more granular look at the data shows that not all prices react equally to the same factors. In particular, “cyclical” components of inflation are more sensitive to macroeconomic conditions, while “acyclical” components are more sensitive to industry-specific and supply-side factors. [3]
This distinction matters because the Fed, like all central banks, can only influence inflation by attempting to change macroeconomic conditions. They have no power to influence industry-specific factors. As a result, we should expect to see a bulk of the Fed’s influence on inflation through price changes in cyclical categories, not acyclical ones.
As data breaking down inflation components shows, the sharp price increases we saw in 2022 were largely driven by a jump in acyclical inflation. [4] Similarly, the steady price moderation we’ve seen over the past year and a half appears to mostly be the result of acyclical inflation returning to historically normal levels. In comparison, cyclical inflation both rose and fell slower and more modestly.
How should investors interpret this data? There is no denying the hard reality that inflation figures have fallen. Digging deeper, though, both the inflation run-up and eventual decline seem to be largely attributable to price changes that the Fed has surprisingly little influence over.
In other words, the Fed may be less responsible for cooling inflation than many presume. Correspondingly, the Fed may also be less capable of keeping an inflation resurgence under control than many expect. If industry-specific disruptions result in acyclical inflation rising again, there may not be much the Fed can do to help - especially when growing evidence of a weakening U.S. economy will constrain their ability to tighten monetary conditions.
On the back of retail investor demand, ETFs promising income generation have been a hot commodity over the past few years. One variant of these funds, known as “covered call ETFs,” have seen net assets grow to nearly $75 billion as of this year. [5] In exchange for that income generation, though, investors in covered call ETFs might be sacrificing more than they expect.
Covered call ETFs deliver extra income to investors by selling call options against an underlying portfolio of stocks. As you might guess, a detailed explanation of what that means can get highly technical. Put simply, though, selling covered calls involves capping your potential upside in a stock in exchange for earning a fixed premium today.
If the underlying stock stays flat, selling covered calls can be a fine strategy. Since the potential upside in the stock didn’t materialise, you earn a premium without really sacrificing anything. And while it’s true that you still have full exposure to losses if stock prices decline, the premium income earned can help mitigate at least some of those losses. The essential question, then, is whether the income you earn is worth the upside you sacrifice in the event that the stock rises.
By and large, the answer appears to be no. Despite the stock market’s recent travails, the S&P 500’s total return is still about 14% year-to-date. [6] The Cboe S&P 500 BuyWrite Index, meanwhile, which tracks the performance of a basic covered call strategy on the S&P 500, is only up about 8.5%. [7] That’s roughly in line with the performance of popular covered call ETFs from asset managers like JPMorgan and Global X. [8]
If the market is mispricing future volatility, it’s certainly possible for covered call income generation to be worth sacrificing some upside in a stock. To generate consistent income, though, covered call ETFs need to employ an indiscriminate call writing strategy. As a result, this consistent income is being purchased at a hefty price.
During his presidency, Donald Trump repeatedly dismissed cryptocurrencies, stating that the value of Bitcoin and other tokens is “based on thin air.” [9] In 2021, Trump even denounced Bitcoin as a competitor to the U.S. dollar. [10] In a surprising about-face, however, Trump has now embraced crypto, making looser regulatory restrictions and government support for the industry a key part of his 2024 campaign.
Speaking at a Bitcoin conference in late July, Trump vowed to make the U.S. the “crypto capital of the planet,” calling for the creation of a strategic Bitcoin stockpile. [11] Trump also promised to fire SEC chairman Gary Gensler, under whose leadership the agency has taken a harsh stance towards crypto.
Whatever the motivations for this reversal, markets have embraced the notion that a second Trump presidency would be extraordinarily beneficial for Bitcoin and other crypto tokens. In the wake of Trump’s speech, Bitcoin climbed to nearly $70,000, just off of all-time highs. [12] Other tokens, including Solana and Ether, also pushed higher. [13]
There are a few reasons to suspect, however, that Trump’s crypto plans might do more harm than good for the industry. If the U.S. government becomes a substantial long-term holder of Bitcoin, it could dramatically undermine the vision of a decentralised libertarian currency that initially helped make the token so popular. Moreover, since Trump’s plan for a Bitcoin reserve relies in part on holding tokens the government has already seized in criminal cases, establishing such a reserve may not add much demand to the market. [14]
For crypto more broadly, looser regulatory restrictions could also introduce greater risk to the industry’s future. Although relaxed enforcement could boost token prices in the short term, poor oversight would be detrimental to user trust and safety, as the FTX episode clearly demonstrated. [6] While few would argue that crypto’s current regulatory framework is optimal, what is needed is not necessarily fewer rules, but clearer ones.
It's tempting to think that a U.S. presidential candidate embracing crypto is necessarily positive for the industry. Ultimately, though, Trump’s plans to introduce more government interference in certain areas and less in others might be the exact opposite of what crypto needs.
[1] The FT
[2] Reuters
[5] InvestmentNews
[6] S&P Global
[7] Cboe
[10] BBC
[11] Bloomberg
[12] Bloomberg
[13] Associated Press
[14] Associated Press
Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.
