Crypto Contagion Spreads

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Genesis Global Trading halts customer withdrawals … 11 months of homebuilder sentiment declines … the Fed’s housing tightrope … don’t forget QT

Yesterday brought the first sign of crypto contagion spreading beyond FTX and BlockFi.Genesis Global Capital, which had $2.8 billion in active loans at the end of Q3, has frozen customer assets.From CNBC:

In the latest fallout from FTX’s rapid collapse last week, the lending arm of the crypto investment bank Genesis Global Trading is pausing new loan originations and redemptions…The cryptocurrency lender had already halted withdrawals of customer deposits and admitted that it has “significant exposure” to the now-bankrupt crypto exchange FTX and its sister trading house, Alameda Research.

In a company tweet explaining the freeze, Genesis wrote:

FTX has created unprecedented market turmoil, resulting in abnormal withdrawal requests which have exceeded our current liquidity…

Providing comfort to exactly no one, Genesis went on to tweet:

Our #1 priority is to serve our clients and preserve their assets.

This is a big deal because a failure at Genesis could have a massive impact on the many crypto platforms that offer customers yield by going through Genesis, which lends cryptocurrency to funds.There are many lending platforms and the majority of them use Genesis. So, if Genesis can’t shore up its liquidity problems, there will be other dominoes to tip before this is over.We hope we’re wrong.If you own crypto, it’s imperative you find out if your exchange and/or service provider has exposure to FTX and Alameda – and now, Genesis.

Meanwhile, homebuilders continue to suffer under the weight of inflation-fueled labor costs and lower demand from homebuyers

Yesterday, we learned that homebuilder sentiment in the single-family housing market hit its lowest level in a decade.November’s monthly sentiment index from the National Association of Home Builders fell five points from October. This is the 11th straight monthly decline, putting the index at its lowest point since June of 2012.For greater context, one year ago, builder sentiment clocked in at 83. Yesterday’s reading stood at 33.Homebuilders are getting nailed on two fronts…On the cost side, their margins are being eroded by higher prices for labor and materials thanks to inflation.On the demand side, mortgage rates that have exploded higher in recent months are destroying homebuyer interest. As a result, homebuilders have to slash prices for new homes, which further eats away at margins.Here are more details from CNBC:

In the face of mortgage rates that are more than twice what they were at the start of this year, builders are having to offer potential buyers better deals.The NAHB said 59% of builders reported using incentives, a significant increase from September to November.In November, 25% of builders reported paying points for buyers, up from 13% in September. Mortgage rate buydowns rose to 27% from 19% during that same time.In addition, 37% of builders cut prices in November, up from 26% in September, with an average price of reduction of 6%.

Back in our April 20 Digest, we suggested that aggressive investors could jump into an ITB trade, which is the iShares Home Construction ETF. That call was due to the potential for major, multi-year gains we see coming after the market turns from today’s basement prices.Since then, ITB sold off, then rallied. Today’s price is even with its price at the time of our April call.Bigger picture, looking at ITB’s two-year chart below, you can see it’s trying to carve out a base.

A 2-year chart of ITB, showing the ETF trying to carve out a base here in late 2022
Source: StockCharts.com

To be clear, the volatility isn’t over, and we can’t be certain the bottom is in. But ITB is going to be a big winner in the years to come when mortgage rates recede and the homebuilding sector finds its footing.

In related housing news, a recent study suggests the Fed needs to weigh the pain in the housing sector carefully as it seeks to curb inflation

Tomorrow, we’ll get the latest Existing-Home Sales report from the National Association of Realtors. The September data showed that home sales have declined for eight straight months.From Lawrence Yun, NAR’s Chief Economist:

The housing sector continues to undergo an adjustment due to the continuous rise in interest rates, which eclipsed 6% for 30-year fixed mortgages in September and are now approaching 7%. (The average 30-year mortgage rate now stands at 7.32%.)Expensive regions of the country are especially feeling the pinch and seeing larger declines in sales.

Now, for would-be homeowners sidelined by exorbitant mortgage rates, this is great news. It’s also great news for the Fed, which wants to see the housing bubble pricked to help in the inflation fight.But according to new research from the Federal Reserve Bank of Dallas, the Fed has a tightrope to walk.From Bloomberg:

A “pessimistic” scenario where prices now retreat by 15% to 20% could subtract 0.5% to 0.7% from inflation-adjusted consumer spending, [Dallas Fed economist Enrique Martinez-Garcia] wrote in a blog post Tuesday.A hit of that order to consumption would in turn weigh on Fed policymakers’ ability to avoid a recession as they rapidly raise interest rates to bring inflation under control, Martinez-Garcia wrote. “Such a negative wealth effect on aggregate demand would further restrain housing demand, deepening the price correction and setting in motion a negative feedback loop,” Martinez-Garcia wrote.

Yet another challenge for a Fed already stuck in a proverbial “rock and a hard place” economic situation.By the way, as a crazy stat for your entertainment, the National Association of Realtors looked at prices for single-family homes in 185 U.S. cities.The median income needed to buy a typical home has risen to $88,300. That’s almost $40,000 more – nearly double – what it was before the start of the pandemic.

Finally, a reminder for caution in today’s market

The growing expectation is that the Fed will slow its rate hikes to 50 basis points in December.While that’s potentially good news, remember, there’s another massive variable influencing inflation and our economy. And we must be humble about how little we know of its coming effect on the economy and your portfolio.I’m taking about Quantitative Tightening (QT) – the opposite of Quantitative Easing (QE), which Wall Street adores.As of June 1, the Fed began shrinking its $8.9 trillion balance sheet as a pace of $47.5 billion per month. When September hit, that amount doubled to a combined $95 billion.Is this a big deal?Yes. Although, to be fair, no one is certain of exactly how big of a deal.But to try to ballpark it, history does offer a precedent.From Financial Times:

The Fed staged a dress rehearsal for QT beginning in 2017, gradually shrinking its balance sheets in a process then Fed chair Janet Yellen said would be so predictable it would be like “watching paint dry”.In fact, it ended up having to be abandoned after September 2019 when the plumbing of the financial system gummed up and overnight borrowing costs skyrocketed.

More directly relevant to your portfolio, that 2017 roll-off campaign, combined with rate hikes from the Fed, resulted in the Christmas 2018 stock market meltdown.

Chart showing the S&P crashing 20% from Oct into Xmas Eve 2018
Source: StockCharts.com

From October through Christmas, it was a peak-to-trough collapse of 20% in the S&P, punctuated by a drop of nearly 3% on Christmas Eve.Now, consider that the peak bond runoff amount from the Fed at that time was $50 billion a month.

Today, the Fed is basically doubling that amount…with elevated interest rates…that are headed higher…during a period of high inflation

But even today’s faster pace of QT might not get the job done.Here’s more from Barron’s:

Markets are on two counts oblivious to the significance of QT, says Solomon Tadesse, head of quantitative equities strategies North America at Société Générale.His model says that if the Fed is to bring inflation back to its 2% target, then some $3.9 trillion in balance-sheet shrinkage must accompany a policy rate of at least 4.5%.That amount of QT, he says, is equivalent to an additional 4.5 percentage points of tightening.Tadesse’s math suggests that the U.S. central bank’s QT plans are both insufficient and vastly underestimated.

Tadesse’s concern is that the longer the Fed’s balance sheet remains elevated, the more likely it is that the Fed’s former quantitative easing actions become irreversible. What that means, practically, is a higher level of baseline inflation.Tadesse goes on to suggest that quantitative tightening is essential because not doing it basically accepts this higher “new normal” inflation level.Before you write him off, Kansas City Fed President Esther George is equally concerned about today’s inflation becoming entrenched – despite the latest inflation data that Wall Street has rejoiced over.Here’s The Wall Street Journal:

Inflation is at risk of growing entrenched in the economy due to an overheated job market, and that will make it increasingly difficult for the Federal Reserve to bring inflation down without a recession, a central bank official said in an interview.“I’m looking at a labor market that is so tight, I don’t know how you continue to bring this level of inflation down without having some real slowing, and maybe we even have contraction in the economy to get there,” said Kansas City Fed President Esther George, who is set to retire in January.

So, what happens if inflation becomes entrenched?

Let’s return to Barron’s:

Tadesse doubts that the Fed will get anywhere near the $3.9 trillion in balance-sheet shrinkage he estimates is necessary.The upshot: It might have to lift its inflation target to about 4%.

I can assure you, Wall Street is not prepared for a “new normal” of 4% inflation.Now, I’m not saying Tadesse and George are 100% correct in their fears about entrenched inflation while more dovish analysts and Fed members are wrong.But that’s the point…No one really knows how this grand QT experiment will play out because it’s never been done before. The Fed has never embarked on a QT program to this degree – ever. But the smaller QT program didn’t end well.Meanwhile, growing optimism on Wall Street doesn’t seem to be factoring this massive gray area into its expectations.It’s just a reminder to maintain a balanced perspective as hopeful market narratives become more pervasive.We’ll keep you updated.Have a good evening,Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2022/11/crypto-contagion-spreads/.

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