The Fed follows Biden on inflation with Chair Jay Powell articulating a faster taper this week. There has not been any new material inflation data since the Fed announced gradual taper plans, but the Biden administration has pivoted to an inflation focus. However, with rising inflation, high valuations and policy rates near zero, we are staring at peak uncertainty in 2022. With this outlook, we prefer to focus on sectors with both valuation support and underinvestment. On the latter theme, Exxon this week announced curtailed capital spending through 2027. From a longer-term perspective, digital assets remain undervalued as they roll out new decentralized services that weren’t thought of a few months back. This is what drives exponential adoption and value accretion.
And what of Omicron? Viruses have historically become less deadly is about all we can say with some conviction. Even the vaccine companies are sending mixed messages on vaccine efficacy. In the meantime, global society will now push back far more strongly against government-imposed lockdowns. Pushback is rational since lockdowns didn’t work with the Alpha or Delta variant, so why try it a third time? Let’s leave it to Australia to prove the lockdown case and run unopposed for the Darwin award!
The full list of discussion subjects of The Dispatch #39, completed on December 3rd, 2021, follows. The Dispatch will not publish next week as it’ll be away for client meetings.
- Inflation is denting consumer confidence
- Capital allocation to energy continues to dwindle
- Goldman and Fidelity to offer loans collateralized by bitcoin
- Fidelity launches spot bitcoin ETF in Canada
- ConstitutionDAO exposes Ethereum gas fee problem & speculation
- BadgerDAO exploited for $120m
Fed follows Biden on inflation as prices dent consumer confidence
Although the anecdotal evidence points to strong economic growth, there are some troubling signs underneath. Flagging consumer confidence is the most worrying, and likely due to high inflation.
Markets have been happy to cheer strong retail sales, ignoring that higher prices boost nominal activity. Retail sales are reported in nominal terms. Used cars offer a good example of the dampening effects of higher prices. The most widely followed used car price index hit a new high in November.
Used car price up again in November
Although this surge is clearly transitory, that doesn’t prevent negative feedback. Buying sentiment for large durable goods, under which autos fall, has reached a decade low. This is one of the contributors to the soft consumer confidence index.
With consumers suffering, it’s no surprise the Biden administration has quickly pivoted the inflation narrative to blame higher prices on oil companies and other bogeymen. It’s too early to call if Omicron will prove a lasting price dampener (energy) or if it worsens supply bottlenecks (autos).
Fed follows Biden on Inflation as Chair Powell signals faster taper
Furthermore, with inflation high the Fed is already committed to reducing stimulus. During the Senate Banking Committee hearing this week, Fed Chair Powell said a faster taper was under consideration. Two days later, Atlanta Fed Chair Bostic voiced support for faster taper and rate hikes. Bond markets for the moment seem to ignore inflation/negative real yields as the yield curve has flattened sharply.
Source: St. Louis Fed
The traditional interpretation of a flatter yield curve is that future growth will slow. However, bond volatility has increased notably of late, indicating a wide future rate outcome.
MOVE index is elevated
With Fed still purchasing $80bn of treasuries a month, we prefer to wait for them to end the taper (June 2022 on current guidance but likely to announce faster pace) before deciding the true bond market signals.
There’s a lot that we don’t know about the latest mutation. What do we know? We know that historically viruses have evolved to become less deadly. Even the vaccine companies aren’t on the same page. On Tuesday the BioNTech founder said that vaccines should make illness less severe, but the Modern CEO’s spin was that vaccine will likely see a material drop in efficacy.
The unifying underlying message, though, from both the BioNTech and Modern leaders was to get a booster shot, and that they’ll have a new formulation for Omicron in the future. They are in the business of selling vaccines! We already get an annual flu shot. An annual covid shot may well be in our future too. In the early going (like now) politicians and their healthcare bureaucracies are likely to recommend quarterly booster shots. The UK has already done so as this short video from The Guardian shows. When you are a hammer, everything looks like a nail!
Covid breakthrough case severity – other risks factors dominate
There’s good original data analysis in this WSJ article. The headline data shows 1.89m breakthrough cases, 72,000 hospitalization and 20,000 deaths among fully vaccinated people. In one of the datasets analyzed by the WSJ, 1.2% of vaccinated people had a breakthrough infection.
It should come as no surprise that hospitalization due to covid is worse with age and when other risk factors are present. The chart below illustrates the relative age risks, which we knew existed. There is no chart illustrating relative risk from underlying risks, but the article explains bulk of the more severe cases are among people with other health risks.
Capital allocation to traditional energy continues to shrink
Exxon to keep spending low through 2027
Here is further evidence of falling capital allocation in traditional energy: Exxon says it will keep annual capital spending in the $20-25bn range through 2027. This is a 17% to 33% decrease from pre-pandemic spending. This follows Chevron reiterating a conservative capital budget of $15bn a year in 2022 and beyond. The chart below from the print version this WSJ article illustrates Exxon’s spending trend. The CEO talks of future uncertainty driving the capex decisions. However, The Dispatch sees the imprint of the three board seats gained in 2021 by activist investor Engine No. 1. The fund’s goal is the push energy companies to pivot away from carbon energy.
As public markets investors divest from the energy sector, private capital is moving in to extract the attractive returns on offer. This is confirmed by the first energy privatization in the current cycle, and The Dispatch would not be surprised by more announcements like this. M&A could well close the valuation gap in the sector, especially in the small-mid cap space. This is still an under-the-radar trend. There’s no WSJ reporting on this $480m take-out deal.
Sustained divestment pressure
Similarly, in the thermal coal patch, most of the major miners like Rio Tinto and BHP have already divested assets or have committed to do so. Only Glencore has stayed with coal exposure and they are now facing pressure to divest. This activism is taking place as coal prices hit decade highs as inventories dwindle. Here again, expect private capital to step in and capture the high returns. Overall, the size of private funds dwarfs capital from public markets, and this trend will drive shrinking capital allocation to the energy sector.
Government shame and blame game
Just to be clear, The Dispatch would love to see zero coal usage. We call out politicians putting pressure on companies to shut or cut product and then blaming those same companies when commodity prices spike. There’s no better example of this behavior than Senator Elizabeth Warren. In this interview two weeks ago, she blames high energy prices on oil companies’ greed and desire to double profits.
Chevron Corp. Operating Profit from 2006 – October 2021
The chart of Chevron’s annual operating profit from 2005 to 2020 shows that the truth is far from Warren’s words. Warren’s interview was fully choreographed as the Washington Post front page article carried the Biden administration inflation strategy: blame corporations for higher prices.
The recent energy price softness will allow the administration to ease off on the blame game. However, if prices rise again, expect them to dust off the playbook to blame energy firms for higher prices.
26% of hedge funds aim to increase crypto exposure according to EY survey
EY Global Alternative Fund Survey shows hedge funds are likely to raise digital asset exposure. This Decrypt article puts a positive spin on the survey. The survey is focused on traditional funds, not just on crypto. Crypto gets three pages out of the 55-page survey PDF, and beat SPACs by one page! The punchline is this chart showing investment intention. The survey can be accessed directly from E&Y.
EY is the latest to confirm rising institutional interest in digital assets. Earlier this year, 86% of traditional hedge funds surveyed by PwC said they were aiming to raise digital asset exposure. The 39 funds in the PwC survey managed $180bn.
The most eye-opening survey result was from Fidelity’s September survey highlighted in Dispatch #30, which showed 52% of the sample already had crypto exposure. Given the calendar nature of fund performance benchmarks, we would not be surprised by additional allocations in the new year.
ConstitutionDAO exposes real world issues of high Ethereum gas fees
The ConstitutionDAO was established and raised roughly $40m over two weeks to bid on a rare copy of the US constitution. You can read more about it here. However, Ken Griffin, the founder of hedge fund Citadel, won the Sotheby’s auction with a $43.2m bid. As a result, the DAO decided to disband and return contributions to the 17,437 participants, which highlights the issue of Ethereum gas fees. With a $217 median contribution and gas fees of ~ $50 for each leg, transactions costs account for nearly 50% of the value transferred. These articles by The Verge and The Defiant explain further. More than $1m was spent on gas fees for the contributions and refunds could cost the same amount.
However, if there was ever any doubt about the current speculative fervor in crypto markets, the surge of the PEOPLE token issued by the ConstitutionDAO is a good example. The PEOPLE token should be worth about the same as the dollar value backing the DAO. Instead PEOPLE rallied wildly as this tweet illustrates.
The gas fee issues should ease over time as Ethereum upgrades improve transaction processing capacity and side chains (think of Visa payment vs. bank wires) gain traction. For the moment, though, Ethereum remains unusable for regular transactions as we discussed last week in Dispatch #38. It is a sign of froth in crypto assets, which is not to say prices couldn’t double or triple from here. This is crypto after all.
Goldman and Fidelity to offer institutional clients bitcoin collateralized loans
This article details the discussion at Investment Banks and this story says that Fidelity is working with blockfi on the lending product. Both of these target institutional clients, but retail clients already have several options to borrow against their bitcoin holdings. Blockfi is one of the pioneers of the loan product. These institutional efforts are a sign of bitcoin, and other large crypto assets, gaining ground as high quality collateral.
Fidelity launched a bitcoin ETF in Canada
It’s quite sad that US fund giant Fidelity has to go to Canada to offer a spot bitcoin ETF. In the meantime, US regulators are quite happy pushing costly futures ETFs on the consumers in the name of “consumer protection”. Bloomberg ETF analyst Eric Balchunas’ tweet on the Fidelity ETF launch matches our sentiment.
BadgerDAO exploited for $120m
This Decrypt article runs through this most recent exploit of bitcoin Defi entity BadgerDAO. The hackers utilized a bug in the front-end system rather than the protocol code itself. What’s equally interesting, and worrying, is that centralized crypto yield/lending platform Celsius has confirmed that it lost bitcoin in the BadgerDAO exploit. Celsius claims no client funds were lost, but that may well be because Celsius shareholders funds are covering client losses. Fortunately for Celsius and clients, the company raised $750m in a Series B round in October 2021, which makes Celsius a well-capitalized crypto company.
The lesson here is the connection between higher return and higher risk. Celsius offers some of the higher crypto yields available from centralized entities. This begs the question if the higher yield offered to clients led to Celsius using BadgerDAO? We are unlikely to find out the answer, but always question how one entity could offer higher returns than others.
Stay safe, get excited for the holidays and do reach out if you have any questions or comments about the material in this Dispatch.
|This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.|