Week 4: Rates, Innovation & Stablecoins
Briefing: The Fed continues with its plan to raise rates and end asset purchases. | Innovation and growth trends will continue. | Stablecoins have marched on unfazed by Fed actions.
Rates: At the top of everyone’s mind
For broader context, the Fed Funds rate has been in a persistent downward trend since the 1980s, and it finally hit 0% following the Great Financial Crisis in ‘09, where it stayed for nearly ten years. When the Fed wants to stimulate the economy, they can cut rates to entice businesses to borrow at more profitable rates. One problem with 0% interest rates is it leaves no room for further cuts. From 2016 to 2019, we raised rates to 2.5% slowly.
In response to Covid in March 2020, the Fed cut rates from 1.5% to 0%, increased its bond purchasing program, and set aside roughly $12 trillion in financial support for markets and individuals.
Today the Fed is focused on raising rates in 2022 somewhere between 3-5 times, at roughly .25% for each rate hike, with the first occurring in March. Rising rates increase borrowing costs for all parties: businesses and people. This means mortgage rates may be going up, which could cause home prices to fall. However, the persistent housing shortage will likely keep housing prices stubbornly high.
Most importantly, prices in “long duration equities” or technology-focused businesses have fallen sharply over the past two months. In our view, this is an exceptional buying opportunity as many of these valuation multiples are now lower than pre-pandemic levels. Prices overshoot to the upside and the downside, and we are in an “overshoot to the downside” phase right now. Everyone wants to wait until prices come down to buy, but when prices actually fall, it can suddenly seem too intimidating. If you’re looking for the bottom in prices, a good proxy is to watch for a few weeks of sideways prices on ARKK, which has been hit the hardest. ARKK has been Wall Street’s punching bag for the past year.
Going forward, equity markets can perform as rates rise, as they have in the past (see table below.) The reason for raising rates, according to Powell, is the economy is strong and no longer needs any accommodative support.
Innovation and growth
In this market, it’s tempting to focus on recent strong performers like oil and banking instead of Innovation-oriented investments. Recently we went through a period of peak-inflated expectations with very high multiples. Innovation investing (growth investing) falls on a scale from wildly profitable and growing tech monopolies like Microsoft, Apple, and Google to the much younger, unprofitable, but fast-growing next-gen leaders like Datadog, Cloudflare, Atlassian, Affirm, and so on. Profitability and size have helped with price stability in this most recent market route.
The next generation of leading companies is focused on the trends we’ve been writing about: digital health, digital finance, cloud computing, semiconductors and AI, digital advertising and e-commerce. These trends will continue to produce results over time via individual company holdings, thematic funds and index funds.
Despite crypto prices falling +50% over the past two months, adoption has continued without skipping a beat. Stablecoins allow dollars to flow freely within blockchain ecosystems. Some are backed 1:1 with real currency, and some are based on clever algorithmic strategies like Luna.
Total assets in stablecoins have continued to increase over the past two months by approximately 16%, from $ 139 billion to $ 162 billion. Speaking of rates, stablecoins have staking yields between 8%-20% depending, and these are close to risk-free rates of return. I call this a “teaser rate” because it’s a promotion to entice assets onto the various stablecoin platforms. These rates are unsustainably high as the rest of the world has rates near zero, and after a few years, these stablecoin rates will have to fall in line because they won’t be able to afford that high rate. The bottom line is the growth in stablecoin adoption in the face of the Fed meeting shows an impressive commitment within the crypto community.