This commentary was posted recently by fund managers, research firms and market newsletter writers and was edited by Barron’s.
2 key digital asset reports
Washington Policy Update Weekly
October 8: Two upcoming reports are expected to provide an overview of the regulatory policy landscape for digital assets: 1) The Federal Reserve’s digital payments paper in October, which is expected to provide an update on its digital currency efforts from the central bank (CBDC), and 2) a stablecoin report from the PWG [President’s Working Group] by early November. As for the Fed report, we expect it to be a largely academic press release that describes both the promise and the peril of a Fed-backed CBDC without explicitly committing to it. on the design or on a plan of action for the future. When it comes to the PWG stablecoin paper, we would expect a fair framing of the benefits (e.g. faster / cheaper payments, financial inclusion) with potential drawbacks (e.g. risk of rushes leading to untimely sales of reserve assets), as well as a number of policy recommendations.
Our feeling is that the Fed’s digital payments / CBDC paper will likely be released first, and press reports suggest that release is imminent. In the end, we think the Fed will continue its work on CBDCs, but we are reluctant to make the effort and do not expect tangible progress in the short term. We offer the following points in support of this view: 1) there are questions regarding the need for a CBDC given that the Fed is expected to launch its real-time payments system, FedNOW, in 2023; 2) a CBDC would result in the transfer of a large amount of bank cash deposits, which would have negative implications on banks’ funding bases, loan growth and costs to borrowers; 3) BPI, one of the major banking trading groups, warned that the CBDCs could limit the Fed’s ability to effectively advance monetary policy; and 4) any effort to advance a Fed-backed CBDC would likely require congressional approval, which is unlikely in the near term. We will continue to monitor relevant CBDC developments given the potential market implications, but we do not expect any tangible short-term action on this front.
Implications of the natural gas crisis
October 7: There are three things we think the energy world (as well as industrial and retail consumers) are learning firsthand with the current gas crisis. First, the world will need a lot more natural gas / liquefied natural gas (oil and natural gas liquids as well). Second, renewable energy sources need a larger reserve margin than they currently provide, otherwise the fragility and volatility of prices will only increase. Third, planned base power reductions / retreats (coal, gas, oil, nuclear) are expected to be moderate compared to the aggressive “by date” plans that have dominated power grid transformations. If these three elements are not addressed, an unintended consequence is likely to manifest itself in a decline in support for the energy transition (ET).
ET is not the only factor to blame / credit for what is happening in global gas markets. Wider growth in demand and the effects of the Covid lockdown / takeover also play key roles. However, ET is important and is the sustainable factor in our opinion. Energy systems have historically been built and operated so that sufficient reserve margin exists to handle both routine and unforeseen extreme events. The historical view was, better pay a reserve and avoid breakdowns. Could it be that one of the reasons that many renewable energy sources are described as cheaper than traditional fossil fuels is that they do not include an implicit backup / avoidance fee (much less explicit? )?
—Roger D. Read, Lauren Hendrix Walker
Food price inflation is skyrocketing
National bank of Canada
October 6: The risks of a stagflation scenario increase. Global supply chain constraints are currently exacerbated by energy shortages and the skyrocketing cost of carbon permits in many OECD economies. And this at a time when China is recalibrating its industrial policies. This confluence of factors increasingly resembles a supply shock reminiscent of the early 1970s, when soaring production costs slowed industrial capacity and reduced potential GDP for many quarters.
As if that wasn’t bad news for inflation already, we now have to deal with soaring food prices. Earlier this week, the United Nations reported that its Food Price Index (FFPI), which tracks the international price of a basket of food items, is already up 30% in 2021 from its annual average of 2020, the biggest increase in 47 years. The inflation-adjusted FFPI is currently at its highest level since the early 1970s. This is a development of particular concern for emerging markets, where food represents a large share of the market basket. Remember that emerging markets now account for around 60% of global GDP. Clouds are forming over global economic growth forecast for 2022.
Investor optimism is sagging
Phases and cycles
October 6: One of the best ways to determine where we are [in shifting markets] is by examining the level of optimism or pessimism of the editors of the North American investment newsletter. Investors Intelligence has been producing this data for over 50 years. It has proven to be a very useful indicator of investor sentiment.
As of October 5, 40.4% of freelance newsletter writers were optimistic (up from 46.5% the week before) and 22.5% were pessimistic (relatively unchanged). This is the lowest level of optimism since May 2020. It was two months after markets started to rebound from Covid lows on March 23, 2020. Currently, optimism is lower than it was not under normal market conditions.
Optimism is at its lowest when the markets are at its lowest. Optimism plummeted on the 20% sale in December 2019 and the 35% sale of Covid in March 2020.
Value investment opportunities
October 6: One of the components of our investment strategy is relative value, i.e. the valuation of a company against companies in the same industry. What is the market undervaluing that makes a stock attractive to its peer group? This concept may have been lost on many investors in the early months of 2021, when we saw the emphasis on cheapness over quality. This tends to happen with a recovery trade at the start of a new cycle. The enthusiasm for an economic rebound leads investors to turn to the cheapest stocks, often without considering the fundamentals of the company. Notably, this “cheap rally” left behind higher quality companies that became undervalued and presented some timely entry points.
This reinforces our belief in the importance of defining value on a daily basis. Once a year, the Russell 1000 Value Index is reconstructed, identifying a universe of companies with lower price-to-book ratios and low growth rates. However, the fundamentals of the business can change dramatically over the course of the 12 months; 2020 was a classic example. During the rebalancing of the Russell Indices in June 2020, for example, healthcare stocks moved up to the Growth Index after outperforming in the previous 12 months. During the next index rebalancing last June, the drop in performance sent healthcare stocks back into the benchmark. Much more frequent — we suggest daily — analysis of the value universe is needed to uncover the most interesting stocks, many of which may not currently be part of a value index.
—Shep Perkins, Darren A. Jaroch, Lauren B. DeMore
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