It is truly difficult to explain the stock market's behaviour over the last year or so, including the parallel cryptocurrency craze and the tremendous rally of Bitcoin. The coronavirus pandemic devastated the global economy's weak links, prompting widespread ripples across emerging and developed economies alike. This unprecedented crisis forced every major central bank to action, resulting in massive levels of liquidity being pumped within the global economy in order to cushion the coronavirus fallout and foster recovery.
While uncertainty loomed large over the tentative global recovery for the better part of 2020, the stock market and the crypto market seemed to be having the best possible time. This apparent dichotomy between reality and underlying market behaviour was due to central banks' massively accommodative monetary policies, but mainly to the U.S. Federal Reserve's stance.
Since the beginning of the coronavirus crisis, the FED has pumped over $3.5 trillion dollars into the economy, increasing the aggregate money supply drastically. Essentially, such a dovish MP stance is intended to serve as a gas pedal to an economy that was abruptly brought to a screeching halt, and investors took advantage of this boost.
In that same period, Tesla shares, the stock market's darling, had risen by over 220 per cent at one point, while Bitcoin had climbed by more than 240 per cent. These massive rallies do not reflect the economy's underlying conditions but are rather the result of Wall Street getting high on FED's bolstered money supply.
If FED's QE programs are to a struggling economy what antibiotics are to a sick person, then hyperinflation symbolises the damages to the immune system caused by overuse of antibiotics. In short, the FED will eventually need to step off the gas pedal, lest it overheats the economy. In order to prevent headline inflation from shooting way above the symmetric 2.0 per cent target level, the FED will have to lift the Federal Funds Rate, making investing in the secondary market much less appealing.
And it is in relation to such concerns regarding inflation getting out of hand that the commotion that was brought about over the last couple of weeks comes to mind. Namely, investors are getting worried that the FED now has more reasons to weigh in on a possible rate hike sooner than initially thought. Such fears are not entirely without merit, given last week's robust employment data and the expectations for another jump in headline inflation this week. Nevertheless, it should be mentioned that the FED is unlikely to lift the Federal Funds Rate before the end of 2022.
Even still, it is quite telling when investors and traders, who have taken advantage of the happy times on the stock market during the most tumultuous times for the global economy in over a decade, are getting fearful when the underlying economic sentiment is improving.
The yield of the 10-year Government Bond has been steadily rising since Q2 of 2020, which is demonstrative of this changing market climate. The bond market represents the last refuge for scared investors, and the fact that the yields of the mid-term Treasury Note are rising implies lessening general fear. This is a peculiar situation, however, because at the same time that investors were flying to these low-risk securities, the demand for the high-risk shares and cryptocurrencies was rising commensurately.
This apparent polarisation can only be explained in one way. The market was hedging against the potential coronavirus ramifications using bonds while at the same time taking advantage of FED's accommodative MP stance in the secondary markets. But now, the tables seem to be turning for the speculators. As the underlying economic conditions are improving, the risks posed by the pandemic fallout seem to be waning. In turn, this is causing the demand for bonds to subside, which represents yet another possible reason for the FED to tighten its QE programs eventually.
As shown on the chart above, the stock market was the first to register this changing sentiment. The latest ripples in the VIX (S&P 500 volatility index), which were prompted in part by the recent developments in the bond market, exacerbated Tesla's woes. Meanwhile, Bitcoin continues to cling on above the 50000-barrier for the time being. However, it remains to be seen whether the cryptocurrencies' flagship will manage to weather the brewing speculative storm.
Two crucially important conclusions can be drawn from all of this. Firstly, this is only the latest confirmation that whenever the "happy times" on the stock market seem almost destined to go on indefinitely, that is usually when traders get restless, inadvertently bringing the happy times to an abrupt end.
Secondly, it proves that Bitcoin cannot be regarded as "the new gold", in the sense that the cryptocurrency does not truly serve the role of a safe-haven asset. Instead, it represents a classic speculative tool. The considerable boost in demand at times of uncertainty manifests only an illusionary connection to gold's hedging qualities. Instead of the intention to mitigate risks, this demand is prompted by the desire to take advantage of an underlying opportunity.