Making sense of the markets this week: May 22

All that glitters is not crypto

“It’s going to replace the world’s currency for day-to-day transactions.” they said.

“The fees are lower, and it’s way better than banks,” they said.

“It’s digital gold,” they said.

“Worst-case scenario, it’s a great addition to a portfolio because it will fight inflation and diversify your returns due to non-correlation with stocks,” they said.

Whomever “they” are….

I admit, that when it comes to cryptocurrencies, I’m not at all impartial. 

For the last three years, I’ve tried really hard to wrap my head around bitcoin, ethereum and the rest of the crypto world. I’ve watched the documentaries and I read everything from books to blog posts. I know what blockchains and cold wallets are. I’ve even interviewed several people about the pros and cons of investing in cryptocurrency.

Yet, I still don’t know why anyone wants to own cryptocurrency, other than for conducting illegal transactions or speculating on “the horse race.”

Crypto isn’t used for day-to-day transactions—and it won’t be any time soon.

The fees associated with crypto currency are actually considerably higher than fiat currencies—government-issued cash.

The recent inflation spike has clearly revealed that bitcoin is not digital gold. In the chart below, gold is shown in yellow and bitcoin in black.

And, it doesn’t actually help to diversify a portfolio.

From what I can tell at this stage, cryptocurrency (not the underlying blockchain technology) is basically:

• One part cult-like devotion to anti-government principles
• One part horse race
• One part greater fool theory
• One part hyper-volatile leveraged Nasdaq exchange-traded fund (ETF)—returns correlation

I’m quite happy to say that I’m not alone with this take. OG investment manager Warren Buffett recently stated:

“If you owned all of the bitcoin in the world and you offered it to me for $25, I wouldn’t take it. Because what would I do with it? I’ll have to sell it back to you one way or another. It isn’t going to do anything.”

The Oracle of Omaha went on to add, in that same article: 

“Whether it goes up or down in the next year or five years or 10 years, I don’t know. But one thing I’m sure of is that it doesn’t multiply, it doesn’t produce anything. It’s got a magic to it, and people have attached magic to lots of things.”

Like Buffett, I have no idea whether the world’s various cryptocurrencies will continue to plummet or if people currently wanting to #buythedip will look brilliant as speculators push prices to new all-time highs.

All I know is that cryptocurrencies don’t have earnings. They don’t pay dividends. They don’t announce stock buybacks. They don’t pay interest. 

Neither does gold—but that’s why I don’t own gold either. (Note: Many gold stocks, like Barrick (ABX), do pay dividends.

While this debate appeared to be theoretical for much of the past few years, it has become quite relevant on a practical level over the last couple weeks, as bitcoin and other cryptocurrencies have seen their value crash.

Much of this negative momentum has been attributed to the blowup of the terra stablecoin. Who would have guessed that a “currency” based on the idea of pegging itself to the very asset (fiat cash) that it was trying to replace would be a bad idea? 

Check out this podcast with Kevin Zhou, the founder of the crypto hedge fund Galois Capital, for details on why this stablecoin collapse was predictable, and why massive fraud in the cryptocurrency space is almost inevitable.

After losing 98% of its value in a 24-hour span, terra holders were left with crushed dreams, and not much else.

This collapse has understandably shaken the faith of the crypto believers, and led people to question not only other stablecoins like tether, but the whole concept of decentralized finance (“DeFi” to converts).

There is no real way to make sense out of a market based on “magic,” as Buffett calls it.

Bitcoin, ethereum, et al, might go up. And… they might go down. The roulette wheel might spin red or black. Tabasco Cat (real racehorse name, btw) might win the next big race. 

Just understand that when you buy cryptocurrency for the sole purpose of hoping someone will pay more for it later, that is not in fact investing. And when things start to go bad, there are no underlying fundamentals to look at (such as earnings or dividend payments) that would provide asset holders with a solid grounding, thus preventing a complete collapse of the asset price. There are no buildings, no physical assets, no customers, no bond holders, no cash flows, no credit history, nothing quantifiable that could help predict where the bottom of a market for cryptocurrency actually is.

Gambling or speculating can be a lot of fun—but let’s not confuse crypto with allocating capital to when it is most efficient.

I thought Walmart was safe

In an investing climate, where risk-on assets are getting clobbered, the conventional wisdom has been that the consumer staples sector would be the place to weather the storm—when it came to calling stock prices. (All numbers below are in U.S. dollars.)

It turns out that our ideas about safety may have been displaced.

On Tuesday Walmart announced, that while revenue for the first quarter had come in at $141.57 billion (considerably higher than the $139 billion expected by analysts), adjusted earnings per share were down to $1.30. It doesn’t take a stock-picking genius to understand that when “The Street” predicts you’ll make $1.48 yer share, and you come in at $1.30, things aren’t going so well, even if revenues are up year-over-year by more than 6%.

What followed was Walmart’s worst day since October 1987, as the stock closed the day down 11.4%. Wednesday didn’t stop the bleeding, as the retail giant fell another 7%.

But the collapse of Team Blue was quickly overshadowed when Target’s earnings report had the market seeing red.

Like Walmart, Target’s revenues were actually pretty solid, coming in at $25.17 billion when only $24.47 billion was expected. The problem was that earnings per share were predicted to be $3.07, and finished the quarter at only $2.19. Target shares then proceeded to fall nearly 25%—the stock’s worst day in 35 years.

The tale behind the numbers was one of supply chain issues and increased costs. When you consider Walmart made headlines earlier this year by offering truck drivers up to USD$110,000 per year, it makes sense that increased costs have led to compressed profit margins.

Target CEO Brian Cornell confirmed when he told Yahoo Finance: “We never expected the kind of cost increases in freight and transportation that we’re seeing right now.”

Notably, fellow retailers Lowe’s and Home Depot fared much better on their respective earnings calls this week, essentially meeting sales and revenue expectations. Most analysts chalked this up to home builder/contractor consumers being more stable than the pure retail clients that Target and Walmart depend on.

Of course even the homebuilding stocks got caught up in the general market sell off this week that saw the NASDAQ take another major hit, the S&P 500 flirt with “bear market” territory, and even the commodity-blessed TSX join in the fall (albeit to a lesser degree).

Can we self-talk our way into a recession?

A couple of weeks ago, I wrote about how the term “recession” (defined as two consecutive economic quarters of negative economic growth) was not all that relevant to long-term investors.

The interesting paradox of using the term “recession,” over and over again in headlines and on 24-hour news channels, is that it has come to mean so much more than its actual definition. 

When people hear the word “recession,” they probably don’t think about the gross domestic product and say: “Oh, our overall GDP shrank by a relatively small amount, mostly because we imported a lot more goods than we exported. But our unemployment is still really low, and this is probably the logical result of easing back on the unprecedented monetary and fiscal stimulus that we just poured into the global market.”

From what I can tell, when people hear or read about recessions, their internal dialogue is more like, “Oh no, our country is in real trouble. I’m in real trouble. Everyone is saying we are, so it must be true. I might lose my job like I did back in 2009, or watch my savings evaporate due to inflation. What’s this about the stock market collapsing? I better be safe and get my investments out so that they aren’t crushed. I can’t afford to have my retirement nest egg go up in flames. We have that one big trip planned for this summer, but after that, it’s time to tighten up the budget a bit because there is clearly a rainy day fast approaching.”

Until fairly recently, economists didn’t like to admit there was a whole lot about market movements that couldn’t be quantified by formulas, graphs and math. Economics majors are a sensitive bunch, and they often have a chip on their shoulders about being considered one of those loosey-goosey social sciences, as opposed to one of those smart, precise, math-based sciences. 

Then folks like behavioural economists Daniel Kahneman and Richard Thaler came along to basically say (I’m paraphrasing here), “We just realized, that as a group, human beings are generally really bad about being rational when it comes to numbers and money stuff. We should probably start to look at economics through the lens of how humans actually make decisions, as opposed to how we think they should make decisions if they were human/computer hybrids.”

This behavioural research is probably at the root of why the world’s central banks and governments stood side-by-side in early 2020 and made huge sweeping announcements. Policy makers knew that as much as the actual dollars and cents were going to make a difference in avoiding a complete economic collapse, an unmeasurable aspect of the pandemic financial response was going to be how people felt about the announcements themselves. If people felt the government was really working hard to find solutions, and that everything possible was being done to help them, then they would be a lot more likely to keep spending money, making investments, taking out loans and keeping the economy on its feet.

The truth is we’ll never know just how big a role psychology/behavioural decision-making played in producing the short-lived bear market in early 2020, and the subsequent unprecedented bull market that followed. What we do know is that we did things a lot differently than we did in the past, and that the economy responded far better than most predicted at the beginning of the pandemic.

The potential problem is that the same behavioural principles now apply when things aren’t looking so hot. An influential study on market sentiment by the University of Michigan recently found that consumer sentiment in the USA was the lowest it had been since 2011. In 2011, the overall economy was in massive trouble as people struggled with high unemployment, a cratered housing market, and investor fear around every corner. Contrast that with today’s “help wanted” signs, and you see just what a problem irrationality can be. 

People are worried about the economy more now than they were in 2020, when no one could even go to work!

If consumer sentiment remains so low, and news/social media algorithms continue to give people the extreme fear-mongering headlines they crave, we could quickly see a spiral start to develop where fear leads to decreased economic activity, which leads to more fear, which leads to … the original collapse that never really had to happen.

Canadian housing prices are down—but are homes more affordable?

First-time home buyers finally got the headlines they were waiting for, when it was announced that housing prices were down 6% in April. The average house now costs CAD$746,000. (All remaining numbers in Canadian currency.) 

Canada’s scorching real estate sector also reported that home sales were down 12% month-over-month despite April usually being a brisk month for housing moves.

While many young Canadians are no doubt hoping for a sustained market pullback that would aid in their quest to get onto the housing ladder, I’m not sure that affordability is actually increasing.

Let’s take a look at the math behind a home purchase back in February (when the market peaked at a record price of $816,000 for the average home in Canada) versus today’s new lower prices.

If we assume that a buyer was able to save 20% for a down payment and amortized the mortgage over 25 years, here’s how the math shakes out when considering the average five-year conventional mortgage rate at the time.

Despite the sticker price of the average home falling $70,000 over the last couple of months, the interest rate increase has meant that the affordability needle hasn’t moved much. With interest rates looking to increase again over the coming months, this affordability math will be front and centre for many home buyers.

It will be interesting to see what market forces prevail when the unstoppable momentum of rising interest rates meets the immovable resistance of Canadians’ obsession with buying a house at any cost.

Kyle Prevost is a financial educator, author and speaker. When he’s not on a basketball court or in a boxing ring trying to recapture his youth, you can find him helping Canadians with their finances over at MillionDollarJourney.com and the Canadian Financial Summit.

About Kyle Prevost

Kyle Prevost is a financial educator, author and speaker. He is also the creator of 4 Steps to a Worry-Free Retirement, Canada’s DIY retirement planning course.

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