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Analysis

What is the Smarter Market Telling us?

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The inverted yield curve in the bond market has a 100% record of predicting recessions since the late 1960s. A recession affects all asset classes. Therefore, it is essential for all the investors to be aware of the developments in the bond market.

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Key observations

  • The bond traders have a very high probability of predicting recessions
  • The yield curve is flattening
  • Do the bond traders sense a trouble
  • Slow economic growth and weak inflation continue to be a worry for the Fed

What are we Focusing on?

We are interested in analyzing the yield curve between the 2-year and the 10-year Treasury. Ideally, the curve should be sloping upwards, because if the short-term yield moves up, the long-term yield should also follow suit. After all, the long-term bond holders should demand a higher yield because, with time, risk and uncertainty increases.

However, at times, the yield curve flattens or even inverts.

When does this happen and why?

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The short-term yield is dependent on the federal funds rate, which is set by the US Federal Reserve to fulfill its mandate of maximizing employment, stabilizing prices, and moderating long-term interest rates. However, the long-term rates are set by the bond traders, based on their expectations of inflation, economy and future interest rates.

Therefore, at times, the bond traders are in conflict with the expectations of the Federal Reserve.

So, who should we listen to? The bond traders or the US Federal Reserve.

Bond Traders have been right Every Time in Predicting Recessions

The above chart showcases the difference between the 10-year and the 2-year Treasury yields. One can see that every time the differential has dipped into the negative i.e. when the yield inverts, the economy has fallen into a recession.

The uncanny ability of the bond markets to correctly predict a recession makes it even more important to study the bond market closely.

As seen in the charts, the differential between the 10-year and the 2-year Treasury is in a declining trend and that has got a number of bond traders worried.

Why is the yield curve flattening now?

A yield curve is termed to be flat when the 2-year and the 10-year both have the same rates. Though we are not there yet, the differential has fallen from about 2.66% on 31 December 2013 to 0.98% on July 7.

The yield curve had recovered post President Donald Trump’s election victory, on hopes of a major tax reform and a large fiscal boost. Those steps would have pushed the US GDP and inflation figures higher. However, as the President’s tenure commenced, hopes for a quick reform began to fade and the price differential collapsed. It touched a low of 0.78% just over a fortnight ago. However, since then, there has been a small rebound.

Where is the Curve Now?

The short-term rates are closely linked to the Fed funds rate. As the Fed made its intent clear to bring an end to the ultra-loose monetary policy, the 2-year Treasury rates began to inch higher. It is up from about 0.25% on 12 July 2012 to the current levels of 1.40%.

However, during the same period, the 10-year has traded in a range of about 1.40% to 3.0%. Currently, it is at 2.39%.

Therefore, as you can see, the 2-year has rallied 460% in the past five-year period, whereas, the 10-year has only risen about 71%. This difference in the speed of ascent has led to the curve flattening.

What is the Reason for Flattening of the Curve?

The US Federal Reserve and a number of other central banks across the developed world maintained an ultra-loose monetary policy to support the economy following “The Great Recession”. The Fed reduced interest rates to near zero in December 2008. It then followed it up by a series of quantitative easing measures, where it purchased bonds in the market to improve the liquidity conditions. The easy monetary situation helped boost asset prices across the board.

As the financial condition improved and the economy showed signs of a recovery, the Fed decided to taper its bond purchase before winding it down completely. Nonetheless, the central bank continued to reinvest the proceeds from the bonds that mature.

With the economy on a strong footing and financial risks having reduced, the Fed finally decided to bring an end to its easy monetary policy.

In December 2015, after months of delay, the Fed finally raised rates for the first time since 2006. The second hike, thereafter, had to wait until December 2016.

However, since then, the Fed has increased the pace of its tightening. It has hiked rates twice already in 2017 and is likely to tighten once more by the end of the year. For 2018, it has hinted at three to four rate hikes.

Economic Growth and Inflation Don’t Support Fed’s Bullishness

In its June policy meeting, the US Federal Reserve outlined a plan to shrink its massive $4.5 trillion balance sheet. Though the unwinding is expected to be gradual, it will affect the markets nonetheless. Clubbed with tightening rates this will affect the economy adversely, especially as growth and inflation are not yet showing considerable strength.

The International Monetary Fund (IMF) has recently cut its 2017 and 2018 US GDP forecast to 2.1% from its earlier prediction of 2.3% and 2.5% respectively. The US GDP growth of about 2% is neither great nor a disaster.

On the other hand, the annual US inflation, which had hit a five-year high of 2.7% in February of this year has already slowed down to 1.9% in May.

What are the Economists and Analysts Forecasting?

“We think that inflation expectations will be stubbornly low over the course of the next 18 months. I wouldn’t be surprised to see last week’s sell-off, where interest rates on the 10-year went to [2.3 percent], actually reverse itself,” Washington Crossing Advisors portfolio manager Chad Morganlander told CNBC last week.

On the other hand, Craig Johnson, chief market technician at Piper Jaffray said: “I feel even stronger about our year-end call of 3, 3.25 [percent] in the 10-year bond yield at this point.”

Michael Pento, the president and founder of Pento Portfolio Strategies and author of the book, “The Coming Bond Market Collapse”, and the producer of weekly podcast, “The Mid-week Reality Check”, wrote in his commentary on CNBC that “the yield curve will invert by the end of this year and an equity market plunge and a recession is sure to follow”.

David Rosenberg, an economist in Toronto points that the trusted financial indicator is giving us a warning of the forthcoming trouble. He advises to keep cash in hand and adjust the portfolios. He said: “I can’t tell you when it is going to happen, but the economic cycle has not been abolished, and the chances of a recession are rising.”

On the other hand, Edward Yardeni, of the Yardeni Research is positive on the stock market. He says that the current low bond yields point to a prolonged period of low inflation. However, he cautions that things will change if the Fed delays in raising the short-term rates, as it will lead to irrational exuberance, which will push the stock prices into extremely overvalued territory.

So, what should the Equity Investors do Now?

The analysts and economists are divided in their opinion as these are unprecedented situations. It is, therefore, difficult to correctly forecast what will happen. We are still some distance away from the inverting of the yield curve.

The current valuations of the S&P 500 are stretched, however, there is nothing stopping it from getting overstretched. Therefore, traders should continue to hold their positions with close stop losses. New investments should be done sparingly. It is better to remain in cash to invest at lower levels, which offer a better risk-reward ratio.

Featured image from Shutterstock

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Analysis

Bitcoin’s Record-Breaking Rally Continues as Prices Cross $8,100

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Bitcoin surged to new highs on Sunday, as the world’s largest crypto by market cap continued to generate bids following the cancellation of Segwit2x.

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BTC/USD Price Levels

The value of a single bitcoin reached a daily high of $8,110.59, its best level on record. At press time, BTC/USD was valued at around $8,002 for a gain of 4%.

With the gain, bitcoin’s market cap now exceeds $133 billion. That’s roughly $100 billion greater than Ethereum, the market’s second most valuable cryptocurrency.

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Bitcoin has added more than $1,100 over the past five sessions. It was down around $5,600 just one week ago.

Bitcoin Cash (BCH), a digital currency alternative that broke away from the original blockchain Aug. 1, was down 5.1% at $1,185. BTC and BCH locked horns earlier this month after the Segwit2x hard fork was abandoned.

$10,000 and Beyond?

Institutional clearing platform LedgerX has initiated its first long-term bitcoin futures option, which is set to expire Dec. 28, 2018. In setting up the option, LedgerX is assuming a price of $10,000 at the time of expiration. That’s a 25% premium on current levels.

Investors who buy the option are essentially saying they believe prices will exceed $10,000 by the time of expiration.

Bitcoin is being helped by growing institutional demand for the digital currency, as hedge funds, day traders and other mainstream investment outfits look to access this burgeoning asset class. CBOE and CME Group have each announced plans to integrate bitcoin into more conventional investment vehicles in the coming months.

The rush of institutional money into bitcoin is a sure sign that the digital asset class is becoming too big to ignore. The value of all cryptocurrencies in circulation has already exceeded $230 billion, with more than a dozen coins valued at $1 billion or more. Nine others have a market cap of $500 million or greater.

Coinbase Responds

The rise of institutional capital has also compelled Coinbase to introduce a custodial service targeted at account holders with more than $10 million in assets. This service targets hedge funds and other institutions that have remained largely on the sidelines of the crypto revolution.

In a recent blog post, Coinbase CEO Brian Armstrong announced that the new service will launch sometime next year.

“When we speak with these institutions, they tell us that the number one thing preventing them from getting started is the existence of a digital asset custodian that they can trust to store client funds securely,” Armstrong wrote.

In addition to maintaining the minimum $10 million asset requirement, institutions must pay a $100,000 setup fee to gain access tot he Custodial program. In response, institutional investors will receive assurance that their assets are secure.

The Coinbase Custody website lists broad support for bitcoin, Ethereum (ETH) and Litecoin (LTC), as well as ERC20 tokens. The ERC20 protocol has emerged as the favorite for startups launching initial coin offerings (ICOs), a controversial crowdfunding model that has already overtaken early stage venture capital.

Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.

Featured image courtesy of Shutterstock. 

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Cryptocurrencies

Is Ethereum Ready to Play Catch Up With Bitcoin?

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In mid-June of this year, the difference between the market capitalization of bitcoin and Ethereum had narrowed down to less than $8 billion. This had many market participants excited. They expected Ethereum to dethrone bitcoin as the leader, a move popularly termed as flippening.

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Key observations

  1. Ethereum has hugely underperformed bitcoin
  2. The chart pattern suggests that Ethereum is likely to play catch up in the next few months
  3. Stay on the long side of Ethereum to benefit from the bullish setup

However, fast forward five months and the difference in the market capitalization of the top two cryptocurrencies has increased to about $96 billion. This shows that while bitcoin has raced ahead in the past few months, Ethereum has hugely lagged behind.

However, is the underperformance about to end?

The chart pattern shows that Ethereum is likely to embark on a rally of its own that can carry it to $645 to $670 levels in the next few months. Let’s see how we arrived at these levels.

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Ethereum opened trading at $8.16 on January 1, 2017. It started its rally in March and by June 12, it reached a high of $420, an astronomical rally of about 5047%. Thereafter, it entered a period of consolidation, digesting the gains.

On the charts, Ethereum has formed a large symmetrical triangle, which usually acts as a continuation pattern. The breakout is generally in the direction of the long-term trend, or the trend that was prevailing before the pattern formed. In this case, the sharp move from January to June confirms that the cryptocurrency was in an uptrend before forming the triangle.

However, this is not a fool proof trade because sometimes the symmetrical triangle acts as a reversal pattern. Therefore, the best way to play this trade is to wait for a breakout of the triangle before initiating any trade.

Where can we take an entry?

Currently, the resistance line of the triangle is at about $378 levels, a level close to today’s intraday highs. The bears are likely to strongly defend this level. However, if the bulls breakout of $378 and manage to close above the resistance line, the trade on the long side will set up.

Different traders use different methods to confirm whether the breakout is valid or not. Some wait until price moves 3% above the breakout level, others wait for three consecutive closes above the resistance level.

However, we have observed that the best breakouts never look back, hence, waiting for three days may lead to a missed opportunity. Therefore, we can wait for a closing above the resistance line of the triangle and initiate the long positions on the following day.

The breakout can face resistance at $400 and $420. However, we expect the virtual currency to scale both these resistances and rally towards its pattern target zone of $645 to $670.

Notwithstanding, even the most reliable patterns can fail. Therefore, our stop loss will be kept at $340. We don’t want to hang on to the trade if it falls back into the triangle. We shall raise our stops to breakeven as soon as Ethereum breaks out to new lifetime highs. From thereon, we shall trail the stops higher to protect our paper profits.

Note

The chart pattern suggests a resumption of the long-term uptrend in Ethereum. However, this will not get confirmed until the cryptocurrency breaks out and sustains above $380. Therefore, please initiate positions only on a breakout and close above the triangle. Entering presumptive trades may result in losses.

Featured image courtesy of Shutterstock. 

 

 

 

 

 

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Analysis

Long-Term Cryptocurrency Analysis: Bitcoin Flirts with $8000 as Altcoin Bull Persists

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Bitcoin’s swift recovery was the main topic of the week, as the most valuable coin not just regained its steep losses, but hit a marginal new high towards the end of the period. The entire segment is experiencing capital inflows as the total value of the coins climbed above $230 billion for the first time ever after finally leaving the vicinity of the $200 billion mark.

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BTC breached the $8000 level before turning slightly lower on Friday, but despite the severely overbought daily chart, it is still trading near its all-time highs. As the long-term picture still suggests a deeper correction, investors should wait with opening new positions and traders should also control position sizes here. Key support levels are found at $7700, $7000, and $6700, while the recent key break-out level at $5000 still hasn’t been re-tested.

BTC/USD, Daily Chart Analysis

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Dash is still the most bullish altcoin from a technical standpoint, despite this week’s short-term correction, as the coin is trading above its prior all-time high, and this weekend, it looks ready to test the break-out high near $500. Support levels are still found at $400, $360, and $330, and as the long-term picture is approaching overbought territory, investors should only hold on to their positions here.

DASH/USD, Daily Chart Analysis

The other major altcoins are also mostly in bullish setups, with some of them already in the latter stages of this cycle, like Monero and IOTA, but elsewhere in the segment, there are still opportunities for both traders and investors. Let’s see the detailed long-term view.

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