The Sandbox Daily (9.27.2022)
The Sandbox Daily (9.27.2022)
Treasury Inflation-Protected Securities (TIPS), retesting the June lows, dollar strength, lumber prices
Welcome, Sandbox friends.
Today’s Daily discusses the mystifying performance of Treasury Inflation-Protected Securities in 2022, markets retesting the June lows, dollar strength weighing on digital assets, and lumber prices falling back to pre-Covid 19 levels.
Let’s dig in.
Markets in review
EQUITIES: Russell 2000 +0.40% | Nasdaq 100 +0.16% | S&P 500 -0.21% | Dow -0.43%
FIXED INCOME: Barclays Agg Bond -0.44% | High Yield -0.21% | 2yr UST 4.287% | 10yr UST 3.949%
COMMODITIES: Brent Crude +1.94% to $85.69/barrel. Gold +0.17% to $1,636.2/oz.
BITCOIN: -0.71% to $18,975
US DOLLAR INDEX: +0.04% to 114.149
CBOE EQUITY PUT/CALL RATIO: 0.80
VIX: +1.05% to 32.60
Inflation-protected bonds are suffering?
The U.S. Consumer Price Index (CPI) is currently at multi decade highs, +8.26% YoY, which is significantly above the Fed’s desired target of 2.00% and also well above the 2.44% average for the last thirty years. So naturally, it seems like the opportune time for investors to add inflation protection to their portfolio via Treasury Inflation-Protected Securities (TIPS), right? The unfortunate reality is that TIPS bonds are unperforming the broader market, as measured by the proxy iShares Core U.S. Aggregate Bond ETF (AGG). So what gives?
TIPS help protect investors from unexpected inflation. Expected inflation is already priced into the yield relative to normal treasury bonds. So you would expect TIPS to outperform when unexpected inflation rears its ugly head (as it did in 2021). Unfortunately for 2022 inflation-protected seeking investors, the market began pricing higher inflation into these bonds in 2021 so the outperformance we saw in 2021 did not carry over into 2022.
The other major headwind for TIPS? Rising interest rates. The 10-year U.S. Treasury note has more than doubled; we started the year at 1.63% and in just 9 short months it’s at 3.88%! When rates rise this much in a such a brief period of time, TIPS will act more like bonds than an inflation hedge. This is especially true for longer-duration TIPS. For example, the TIP BlackRock ETF has a duration of 6.9 years. In efforts to simplify bond math, a duration of nearly 7 implies that for every 1% move in interest rates, the bond fund should move up or down by 7% in price. Since yields and prices are inversely related with bonds, the increase in yields has dwarfed the increase in inflation.
Simply stated, the poor performance for TIPS in 2022 is that interest rates are up (alarmingly so!) and inflation was already baked into the pie for more than a year.
Source: Sandbox Financial Partners
Markets retest the June lows
A successful retest requires fewer stocks, sectors, and indexes making new lows.
Less volume, especially downside volume, is a critical sign that selling pressure is less pronounced on the retest than on the initial low. Thus far, we are seeing only one major breadth of these metrics more extreme now than the June lows: the 21-day new lows. Most other metrics are approaching or still a ways off the June readings.
So much emphasis is placed on whether indices are above or below previous lows that their importance cannot be understated from a market positioning and sentiment perspective. Right now, we are seeing most of the major U.S. indices undercutting the June lows.
When looking at sectors, 5 of the 11 S&P 500 sectors have broken below their first half lows. Four of the five are value-oriented sectors. Communication Services, which is a mix of growth-tilted media stocks and value-tilted telecom stocks, is the fifth sector.
When reviewing these metrics altogether, the retest has not failed yet, but the persistent selling pressure of the past few weeks, which is gaining momentum, suggest it is a distinct possibility. As more indicators undercut the June lows, the more likely we reset the bottoming process and look for the next leg lower.
Source: Ned Davis Research
Dollar strength weighs on digital asset space
One of the many headwinds facing the digital asset space in 2022 has been extraordinary dollar strength. This year’s dollar strength is a reflection of 1) a relatively strong economy versus the rest of the world, 2) a faster hiking cycle and thus attractive interest rate differentials, and 3) the dollar’s safe-haven status in times of economic and political uncertainty. Year-to-date, the Dollar Index is up +18.3% versus Bitcoin down -59.2%.
Given that the dollar is the base pair for bitcoin investors and the flight to quality has shifted investor interest from speculative assets to traditional safe-havens, the strong dollar continues to be a major headwind for digital asset investors and cannot be ignored as the U.S. dollar and digital assets are moving in opposite directions.
As a friendly reminder, the U.S. Dollar Index is a measure of the market’s indication (or value) of the U.S. dollar relative to a basket of six foreign currencies (European Union euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona).
Source: Eaglebrook Advisors
Lumber prices fall back to pre-Covid 19 levels
Lumber prices have fallen to their lowest level in more than two years, bringing the commodity back to what they cost before the pandemic building boom and perhaps pointing to a sharp slowdown in the housing market.
Lumber futures ended Tuesday at $429.30 per thousand board feet, down ~1/3 from a year ago and more than 70% from their peak in March, when the Federal Reserve began raising interest rates to fight inflation.
Source: Wall Street Journal
That’s all for today.
Blake
Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily.