Thursday, April 20, 2023

The Federal Reserves Internal Turmoil, Recent Economic Reports and How To Profit - The Case for NUGT, UGL, AGQ, and Crypto

Hey everybody, my name’s Christian.

Today I wanted to talk about some of the big news that's come out in the past few weeks. Specifically, the recent employment report on April 7th, the CPI data, the Release of the Federal Reserve meeting minutes from March 21 and 22nd on April 12, the earnings report from major US banks on 4/14, and how all of this may affect the Federal Reserve’s decision to raise interest levels at their next meeting on May 3rd. Finally, I want to discuss what we, as investors, can do to profit from this.

Employment Report

On April 7th, the Bureau of Labor Statistics released its Employment Situation Summary for the past month, which generally contained good news, but also did create some doubts (1). The main points from the report were that in the past month, 236,000 new jobs were added, which is historically strong but represents the smallest monthly gain in the past two years. The most significant increase was in the sectors of restaurants, bars, and hospitals, with jobs being lost in construction, manufacturing, and retail. Unemployment dropped to 3.5%, while hourly wages increased 4.2% year over year, representing the most minor level of growth since mid-2021, when inflation was surging.

The results from this release indicate uncertainty in the state of the economy, which may impact the Federal Reserve's decision to raise interest rates at its May 3rd meeting. Regarding the total job numbers and unemployment, the steady hiring growth indicates that the job market and economy continue to grow as new employees are added. This increase in employment may suggest to the Federal Reserve that it’s necessary to raise interest rates to slow the economy and bring inflation down to its 2% target. Conversely, the slower wage gains indicate a slowing or stagnating economy as employers are less desperate to retain and gain employees. This metric may suggest that the Fed’s interest decisions are having the desired effect of slowing the market.

Overall, the report suggests a resilient labor market that is less desperate to hire and retain employees as indicated by wage stagnation but is still clearly growing, implying to the Fed that an interest increase is necessary. This is reflected in the CME Fed Watch Tool (2), which reflected a 49% chance the Fed would increase rates the day before the release on 4/6, but grew to a 72% chance of increased rates the following Monday, 4/10. Thus the Employment report suggests future rate hikes.

Consumer Price Index

Another major release in the past week has the Consumer Price Index (CPI) and Core CPI data posted on April 12th (3). The CPI tracks the changes in prices paid by consumers for goods and services, while the Core CPI aims to do the same but does not include the volatile price of food and fuel prices in its calculations and is consequently considered a more accurate measure of inflation. Before the release, it was expected that the CPI would show a 5.6% year over year, while the actual value was 5%, beating expectations and down from 6% in February and marking the slowest increase in CPI value since May 2021. The Core CPI was expected to be measured at 5.6%, a slight uptick from 5.5% in February and the first acceleration in Core CPI since September 2022.

Since the Russian invasion of Ukraine last year, the price of food and fuel, the key difference between the CPI and Core CPI, has increased dramatically. However, food and fuel prices have dropped in the past few weeks and months, as evidenced by the AAA gas price tracker (4). This drop in food and fuel prices explains why the CPI artificially fell below expectations while the Core CPI didn’t. Additionally, the report demonstrates a significant increase in inflation in air line fares, transportation services, as well as service costs, such as rent, hotel rooms, manicures, insurance, and child care. Thus, the fact that fuel and food prices dropped while other metrics increased further explains why the CPI fell month over month while the Core CPI increased month over month. These results demonstrate to the Federal Reserve that inflation has not been tamed and may suggest that further interest hikes may be necessary.

Federal Reserve 3/21-22 Meeting Minutes

The Federal Reserve’s meeting minutes for the March 21st and 22nd meetings were also released on April 12th (5,6). The primary sentiment from the meeting was that the Federal Reserve sees a mild recession starting later this year, as likely, with an economic recovery over the subsequent two years. This was primarily due to the concern surrounding the banking sector, caused by the stress of banks increasing lending standards and tightening credit requirements, which may cause the economy to slow. In conjunction with the slow increase in CPI over the past few months, the Federal Reserve is concerned that a mild recession is highly likely.

However, there was disagreement among the member of the board on whether a rate hike increase is necessary or beneficial to the economy's long-term health.

John Williams, the president of the Federal Reserve Bank of New York, said the Fed had more work to do and suggested a 0.25 rate increase was a “reasonable starting place.” Austan Goolsbee, the president of the Feder Reserve Bank of Chicago, is concerned about the recent bank failures, suggesting we need to be cautious, and gather more data before raising interest rates too quickly. Additionally, Mary Daly, the president of the Federal Reserve Bank of San Franciso, said that there are good reasons both to keep rates as they are but also to increase them. These quotes demonstrate great uncertainty in the Federal Reserve regarding its next steps.

Additionally, the Federal Reserve isn’t the only central bank with confusion about whether raising interest rates is the right course of action. The Reserve Bank of Australia decided to halt its rate increase at 3.6% after reports of falling inflation in Australia in early April. Conversely, New Zealand is still going full speed ahead with its interest rate hikes, raising rates by 0.5% on April 5th. This disagreement on whether or not to raise interest rates, both in the US and internationally, signals great uncertainty surrounding global and domestic financial and economic health.

Following the CPI and Fed Reserve Minutes reports on 4/12, there was not a massive effect on the stock market. Stocks and bonds showed little change following the release of the CPI, indicating investors found the results of the CPI to be in line with expectations and the current outlook. Additionally, the CME Fed watch tool lowered the probability of a Federal interest increase from 73% to 67%.

Major Bank Earnings on 4/14

The last significant event I want to discuss today is the earnings reports from a few major US banks released on April 14th. Since before the collapse of Silicon Valley Bank, banks have been tightening their lending practices, starting in January. Since January, economic conditions have only worsened, especially concerning the collapse of SVB and other banks, such that these earnings reports were highly anticipated and likely to affect the Fed’s decision regarding interest rates. Specifically, earnings may either create confidence or fear in investors and the Fed, who will adjust their investing strategies and monetary policies accordingly.

The major banks of JP Morgan Chase, Citigroup, and Wells Fargo were the primary focus of the 4/14 earnings, in which they beat expectations and consequently saw upticks in stock price. JP Morgan Chase was up 7.55%, Citigroup climbed 4.8%, and Wells Fargo traded sideways after rallying earlier in the day. Much of the increased earnings in these banks can be traced back to rising interest rates, as increased reserve rates lead to higher returns for banks through their loans, at the comparatively small cut to profitability by paying out depositor interest.

However, it was not all good news for banks regarding the inflow and outflow of their deposits and the implication for the Federal Reserve. JP Morgan Chase did see a 2% increase in total deposits in Q1, but they fell behind 2022 Q1 by 3%. This means that while they saw an increase in deposits, the growth rate is slowing. Following the earning report from the major banks, the CME Federal Reserve watch tool projected a 78% chance of increasing interest rates at the next meeting from 67% the day before earnings to 78% after earnings were released. Ultimately, while the banks reported good profits, the details of the release have not been positive signs for the Federal Reserve to keep rates where they are.

Actionable Advice

***I am not a CFA, nor is this content aimed to be financial advice; it simply serves to provide my opinions on market conditions, opportunities, and strategies that interest me. You should do your own research before making any investment decisions.***

Taking the combined results of the employment report, the CPI and Core CPI report, the Federal Reserves Meeting Minutes, and the bank’s earning reports, what can you do with this information to potentially make money?

The major takeaway from these events is that there is a high degree of uncertainty surrounding the Federal Reserve’s decision to maintain or raise interest rates and the general health of the US economy. The jobs report with high employment numbers contradicts the low rate of wage increases. The CPI increased a smaller amount than expected, but the Core CPI suggests inflation is still very present and growing monthly. The Federal Reserve has internal disagreements on whether to increase or keep rates, as demonstrated by statements from bank presidents and is consistent with the indecision seen in other national central banks. This all culminates with large bank earnings that surpassed expectations, but are still concerning, resulting in a predicted 80% chance of increased interest rates.

In times of financial uncertainty, the type of assets that increase in price are the ones that represent a “safe” and “stable” store of value. The two major sectors in which I believe the current uncertainty benefits are precious metals and cryptocurrencies. Regarding precious metals, the stock tickers I suggest looking into are NUGT, UGL, and AGQ.

NUGT is a 2x leveraged ETF tracking the price of gold-producing companies. Over the past month, NUGT has increased by 20% and 100% in the past six months. As uncertainty continues and possibly grows, companies that produce gold, the standard for safe storage of wealth, will grow in value, resulting in increased stock prices.

UGL is a 2x leveraged ETF that tracks the price of gold itself. Over the past month, UGL has increased by around 2% and 45% in the past six months. For the same reasons as NUGT, UGL will likely continue to grow in price as uncertainty continues, especially if interest rates are raised at the next Federal Reserve meeting.

AGQ is a 2x leveraged ETF that tracks the price of silver. Over the past month, AGQ has increased by 26% and 75% in the past six months. Like gold, silver is a standard value storage and benefits from increased market uncertainty. Additionally, silver is a common component in electric products, especially electric cars, and solar panels. If you believe in the future of EVs and solar technology and that financial uncertainty will continue, AGQ may be a good option for you.

If gold and silver are the standard “boomer” choices for securing value and hedging against inflation, cryptocurrency is their Gen-Z relative. For the same reasons as gold and silver have and may continue to increase in price, cryptocurrency, as a decentralized hold of value, benefits from increased market uncertainty, with the price of Bitcoin and Ethereum clearly demonstrating its value to investors.

Bitcoin has increased in value by 22% in the past month and nearly 50% in the past six months.

Ethereum has increased by 11% in the past month and is up over 51% in the past six months.

All of these assets are posed to continue to increase in value if uncertainty in the market and with the Financial Reserve continues, and will significantly benefit from an increase in interest rates from the Fed, of which there is an 86% chance on the day of posting. Of course, buying leveraged ETFs, as I’ve highlighted, is risky and should only be done by investors who understand the risks associated with the asset and have done their own research. But while not financial advice, all these assets have opportunities to continue to rise in price due to the geopolitical and macroeconomic events at play.

That's all I have for today. I hope this was useful to you, and please let me know what you think about these ideas.

Thanks for reading!

References

  1. https://www.bls.gov/news.release/empsit.nr0.htm
  2. https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
  3. https://www.bls.gov/news.release/cpi.nr0.htm
  4. https://gasprices.aaa.com/
  5. https://www.federalreserve.gov/monetarypolicy/files/monetary20230322a1.pdf
  6. https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20230322.pdf

No comments:

Post a Comment