Some investors see bitcoin’s price plunge as an omen for global sharemarkets, but others are hopeful that this week’s Fed meeting can restore the market’s mojo.
A sharp divide has opened up among investors after global stockmarkets last week suffered their heaviest falls in more than a year.
One camp believes that cryptocurrencies are now acting as the canaries in the financial coal mine. And they warn that the vicious drop in the value of digital currencies, which has wiped out more than $US1 trillion ($1.4 trillion) from their aggregate market value, is a bleak warning for global sharemarkets.
Bitcoin, which was trading at around $US35,000 on Sunday afternoon, has now fallen to its lowest level since July 2021. The digital currency has shed close to half of its value since it hit a peak of $US67,582.60 last November.
Bearish investors warn that the precipitous decline in the value of bitcoin and other digital currencies is a foretaste of the pain that lies in wait for the prices of other assets, particularly for the formerly high-flying technology stocks.
Already, the Nasdaq Composite Index is in correction territory, having fallen by 14 per cent from its November peak.
According to legendary investor Jeremy Grantham, who last week warned that the US is now in the fourth superbubble of the last hundred years, it is common for more speculative assets to lead the way when markets deflate.
“The final feature of the great superbubbles has been a sustained narrowing of the market and unique underperformance of speculative stocks, many of which fall as the blue-chip market rises. This occurred in 1929, in 2000, and it is occurring now”, he wrote in an investor note.
Dancing off a cliff
“A plausible reason for this effect would be that experienced professionals who know that the market is dangerously overpriced – yet feel for commercial reasons they must keep dancing – prefer at least to dance off the cliff with safer stocks.
“This is why at the end of the great bubbles it seems as if the confidence termites attack the most speculative and vulnerable first and work their way up, sometimes quite slowly, to the blue chips.”
Other analysts point out there could be another factor that explains the growing correlation between the performance of cryptocurrencies and tech shares.
They point out that the growing popularity of digital currencies has meant that more investors hold these assets in their investment portfolios.
However, it also means that investors could be tempted to sell off their crypto assets when tech stocks fall, and they face pressure from brokers to post extra cash to cover possible losses on trades made with borrowed money.
But not all investors are convinced that the prices of global shares and bonds will suffer the same brutal decline as the cryptocurrencies.
Instead, they argue that two events this week will be pivotal in deciding the fate of markets in coming months.
The first is this week’s meeting of the US Federal Reserve.
Now, senior Fed officials openly concede that the United States has an inflation problem. At their December meeting, US central bank officials decided to scale back their monetary stimulus more quickly, by ending their bond purchases by March.
Many commentators now expect the Fed will go even further at this week’s meeting and end the bond buying program in February.
That would clear the way for the Fed to start raising interest rates at their March meeting (financial markets are expecting at least three, and possibly four, US interest rate hikes this year).
Already, futures markets have fully priced in a 25 basis point rise in the US central bank’s key interest rate in March.
The Fed’s challenge
But this leaves the Fed with a difficult balancing act: Can it find a way to tighten monetary policy and combat inflation, without triggering a rout in financial markets?
The Fed’s challenge is exacerbated by the growing anxiety over US inflation, which has pushed the yield on benchmark US 10-year bonds as high as 1.88 per cent last week, before it dipped back to 1.76 per cent. (At the beginning of the year, US 10-year bonds were trading on a yield of 1.63 per cent.)
Higher yields on ultra-safe assets such as US government bonds means that investors have less incentive to pay high prices for tech companies that are expected to deliver strong earnings in the distant future.
Still, long-term US bond yields could inch lower if the Fed manages to convince investors that it is acting promptly to tame inflationary pressures. The risk, however, is that markets start to fear that the Fed will use overly-aggressive tactics to stamp out rising price pressures.
What’s more, some analysts argue that the tech stocks could be vulnerable to a major correction as the Fed and other major central banks move towards reining in their bond purchases.
The prices of the big US tech stocks such as Meta Platforms (formerly known as Facebook), Amazon, Apple and Google parent Alphabet, have soared in tandem with the growth in the size of the balance sheets of the world’s major central banks.
As a result, their share prices could come under pressure as the Fed not only ends its bond purchases, but starts to work out plans for shrinking its nearly $US9 trillion balance sheet by allowing bonds to mature without replacing them.
Still, the Fed is still some time away from any decision to start shrinking its balance sheet.
And some investors are hopeful that US tech stocks – Microsoft, Apple and Tesla are all due to report this week – will get a boost from stronger than expected fourth-quarter earnings.
The big US tech giants were huge beneficiaries from the pandemic, as companies and individuals shifted their activities online. As both work and school went virtual, people spent more on iPads and Macs, while companies invested in upgrading their software.
What’s more, the tech giants enhanced their earnings by cutting spending on items such as travel and entertaining, while investing in areas to cement their market dominance.
As a result, the share prices of companies such as Microsoft, Apple and Amazon have soared over the past two years.
But investors enthusiasm for the seemingly invincible tech giants has faltered this year, as rising bond yields have forced investors to apply a higher discount rate to their future cash flows.
Investors, however, could rediscover their enthusiasm if the tech giants unveil stronger than expected sales and earnings for the holiday quarter.
An impressive financial performance in the quarter will reassure jittery investors, and help to insulate tech stocks from rising bond yields.
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