Bitcoin Futures Overshadow Record Day For Stocks

Monday saw the Dow reach its 66th all-time high this year which is 3 shy of tying the record. The S&P 500 was up 0.32% and the VIX was down 2.51% to 9.34. Even with the market putting an explanation point on its great year, Bitcoin stole the headlines its futures trading launched. Bitcoin futures were up 19% in the first day of trading as the cryptocurrency is now at $16,600. The total market cap of all the cryptocurrencies has reached $456 billion. There are reports that people are taking out mortgages to buy bitcoin as it reaches the mania stage. It’s an unusual bubble because everyone who owns it knows it will go down quickly. After it goes down, speculators don’t panic; they buy more. I’m wondering what correction size would cause people to sell, ending the hype train. As you can see from the chart below, bitcoin futures trading is much smaller than the Nasdaq 100 futures or copper futures. It will never grow that large because most traders don’t want to touch bitcoin. With futures trading beginning, I expect the calls for a bitcoin ETF to grow again. That would provide a final catalyst to get as many retail investors in the space as possible. The crash could come in tune with a recession if the speculation in bitcoin keeps going for a couple more years. It’s tough to have a forecast for how the price will look at the end of this week, let alone 2020.

(Click on image to enlarge)

Downtrend In Yields To Continue?

In a previous post, I discussed how the Fed might be bound by the downtrend in rates, preventing further hikes. As you can see, the resistance line is a little bit over 2% which means the Fed only can hike rates 3 or 4 more times this cycle. That implies 2018 or 2019 will be the end of the hike cycle as the Fed will raise rates 2 or 3 times next year. As I said, the multi-decade trend won’t necessarily continue. The ending of this bull market in stocks would cause much uncertainty, but that’s nothing compared to what would happen if the bond bull ended. The other point this chart shows clearly is the length of this hike cycle. As you can see, rates haven’t been raised much, but the cycle length is already longer than the two hike periods in the 1990s. Given how slow the Fed has hiked rates, this cycle should outlast the one in the 2000s.

(Click on image to enlarge)

2018 The End Of Goldilocks

As I mentioned, the possibility of accelerated rate hikes and the ending of central bank stimulus means the Goldilocks scenario for stocks will be ending. That doesn’t mean stocks will fall in 2018, but it does mean volatility will rise and the next recession will get closer. As you can see, the economy is leaving the liquidity pump stage and moving to the excess demand stage. The Fed started a fire and now it’s trying to control it. As you can see, if the cycle follows this model, in the next couple of years growth will peak, inflation will beat expectations, the Fed will tighten financial conditions by raising rates and shrinking its balance sheet, bonds will sell off, and the credit spread will tighten. The tax cuts put a wrench into this analysis because they can stimulate the economy. That could push a recession off another year or two, allowing the Fed to raise rates more. Alternatively, the Fed can work in tune with fiscal policy and take its foot slightly off the break, encouraging a strong economy for a few more years. The Fed’s ability to keep rates steady depends on inflation. The Fed does have discretion because like Neel Kashkari said, inflation has been low for a while. Averaging it out, inflation can be near 3% for a couple years before the Fed needs to hike quickly.

(Click on image to enlarge)

Industrial Production Growth Examined

Industrial production fell into a recession in 2015 and exited it in late 2016. As you can see, just like manufacturing, it has accelerated in 2017, nearly reaching the heights last seen in 2014. The chart below breaks down the individual factors driving the overall index. The mining industry was the biggest drain on the sector in the depths of the recession. It has recovered in 2017. The recent rally in commodities has caused 68% of the year to date growth in the industrial production index even though it only has a 23% weighting. This shows how the global reflation trade seen in the Goldilocks scenario above has led to a rebound in industrial production. Getting even more in detail, the mining industry makes up 46% of the year to date growth in industrial production even though it only has a 13% weighting. Mining was the industry behind the decline in recovery rates in the junk bond index in 2015 and 2016.

(Click on image to enlarge)

Yield Curve

While industrial production accelerates, the yield curve shows the same story as the graphic above which shows tougher times are ahead in 2018. Morgan Stanley created that graphic, so it’s not surprising to hear that the firm is also predicting the yield curve will completely flatten in 2018. It is predicting a 1.95% 10 year bond yield and a 30 year bond yield of 2%. I don’t think the yield curve will flatten because economic growth will be strong because of the tax cut. However, it’s interesting to see one of the major investment banks predicting potential doom in the next 2 years.

(Click on image to enlarge)

Conclusion

Any doom in the economy and the stock market will pale in comparison to the weakness in bitcoin when it crashes. The decline will mirror the speed of the increase. Calling it a bubble does not imply it will crash in the next few days. It’s silly when speculators claim the people calling it a bubble were wrong because the price has increased. Exponential increases without a catalyst never end well.