Is It Time To Bet Against US Assets As Moody’s Downgrades US Credit

Macro volatility is increasing substantially, to the point that even rating agencies felt compelled to act.

On Friday, the 16th, Moody’s Ratings downgraded US sovereign ratings from Aaa to Aa1. The country’s economic outlook also clunked down from ‘stable’ to ‘negative’. Presumably the press release was issued on the last business day of the week to minimise market impact. While the latest credit downgrade is viewed as USD negative, the real market impact is actually harder to predict.

For one, the United States of America is unique in the sense that it doesn’t suffer downgrades that often. The country possesses unrivalled ‘economic and financial strengths’. Moreover, as noted by Moody’s in the press report, “the US dollar’s status as the world’s dominant reserve currency provides significant credit support to the sovereign.” These credit supports have been fuelling America’s swelling federal deficits for years, which, according to Moody’s, will reach a staggering 9.5 percent of US GDP.

Fiscal risks aside, the rating agency stresses this point, which I believe is worth highlighting in its entirety (given recent market turmoil):

Underpinning the rating is our assumption that the US’ institutions and governance will not materially weaken, even if they are tested at times. In particular, we assume that the long-standing checks and balances between the three branches of government and respect for the rule of law will remain broadly unchanged. In addition, we assess that the US has capacity to adjust its fiscal trajectory, even as policy decision-making evolves from one administration to the next.

In other words, if the US were to retain its strong credit rating, the independence of key government institutions, eg the Federal Reserve, must not be compromised. If not, it may hasten a further slide in the US’s ratings.

Given this sovereign rating downgrade, is it time to bet against US assets? Before you do that, let me draw your attention to an earlier US credit downgrade.

History Recap: 2011 US Rating Downgrade and Treasuries…..rallied!

In August 2011, the US lost its triple-A rating. Equities tanked. But Treasuries, due to heightened investor risk aversion, surged. Look at the Treasury price chart (proxied by Bond Fund, ticker TLT) during those tumultuous months. It rallied a significant 20 points within weeks of the sovereign rating downgrade. Bond investors who underweighted Treasuries (eg Bill Gross) severely underperformed the market.

Given the outcome of that episode, can we assume a similar outcome? History repeats. But with a different tempo. Several underlying economic factors have changed markedly since 2011.

The first is the state of the US economy. Broadly speaking, it has been performing reasonably well going into this latest credit downgrade. US unemployment remains stable around 4-4.5 percent; US productivity is amongst the world’s highest. As late as January, large investment groups were anticipating smooth sailing ahead.

The second difference is the enactment of US tariffs. In last week’s macro, I highlighted that US average tariff rates (as of 12 May) are now at their highest level in decades. Tariffs will, over time, increase and anchor inflation in the American economy. Already, Walmart (US:WMT) warned last week that price rises are coming. Instead of deflationary risks, investors are staring at various inflationary scenarios in the next few months. None of them good, or benign. Higher inflation will likely weigh on Treasuries.

Inflation Fears Are Casting Doubt on Treasuries

Look at the same bond fund (TLT) recently. While stock indices have surged in the past month, due to fading tariff fears, US Treasuries resolutely failed to keep up. Even more worryingly, Treasury yields rose on Moody’s rating cut. For example, the US 30-year yield is now flirting with the five percent resistance level going back to 2008. A generational breakout appears imminent.

If we compare the year-to-date performance of key assets (Gold, S&P, Nasdaq, Bitcoin and US Bonds), long bonds are the worst-performing asset. Equities have recovered strongly (over optimistic?); gold is up by more than 20 percent.

Given the growing fiscal problems facing the US government, Treasury yields may have to rise further to entice investors. Compounding the problem are those tariff negotiations. Many foreign governments hold plenty of US Treasuries.

Amidst this tricky investment landscape, even Bitcoin has recently recovered and zoomed past the $100k mark.

The case for Bitcoin in today’s macro climate is an interesting one. The digital coin has seen strong buying due to its limited quantity. Support at $75K led to another breach of the six-figure mark recently. Bitcoin’s dominance of the crypto market is rising.

Will Bitcoin double from here? Hard to say. The $2 trillion asset would need more and more capital to haul it north. Higher macro volatility may lead to a choppier trend. That said, a few crypto-related equities have rebounded strongly in the 2Q. We take a look at some of them below.

Bitcoin at $100K – A Revival of Crypto Bull Market?

Strategy (US:MSTR): The Bitcoin Juggernaut is going strong. The Saylor-led company is still stacking Bitcoins at a blistering pace. Earlier this month, the company announced a further $21 billion ATM equity offering to buy BTCs. The end-goal? To convert as many MSTR shares as possible into BTCs – a strategy that has worked wonders for the Nasdaq 100 company. So far, the software-turned-bitcoin holding firm had acquired more than 570,000 BTCs (www.strategytracker.com) – a stash worth around $58 billion (assuming $102K per coin). But the company is worth more than $100 billion. This means there is a hefty premium attached to MSTR shares.

Chartwise, demand for Strategy’s shares remains strong. Its share prices have rebounded above $400; the recovery from April lows exceeds 50 percent (see below). Should you buy MSTR shares now? The worry is that the gargantuan ATM may cap the recovery rally here. But as long as the stock market is willing to fund MSTR’s bitcoin buying spree, its share price could stay elevated. Still, MSTR is a volatile stock. A correction in Bitcoin could lead to a sharp drop in the MSTR share price. Perhaps watch to buy on a dip for better risk-reward.

Alternatives: iShares Bitcoin (IBIT)

 

Mara (US:MARA): Rebounds from the range floor

In the last BTC bull run, bitcoin miners enjoyed massive share price gains. Not this time. While the sector did produce very strong gains from time to time, these rallies were unsustained.

Take Mara Holdings (MARA), one of the largest Bitcoin miners in the market. Its share price spiked above $25 on four occasions in the last 18 months. But these advances led to deep corrections. Perhaps investors are not convinced about mining ‘growth’ anymore, since there is a Hard Cap (21 million). The number of bitcoins available to mine dwindle; network difficulty (121T) keeps increasing. In the last three quarters, the firm produced 604, 703 and 666 BTCs respectively. Hardly a fast-growing miner. The company owned 47.5K BTCs. Mara remains loss-making.

Given Mara’s flattish chart pattern, one perhaps should only buy after a deep correction and sell once prices rebound above $22-25.

Alternatives: Riot (US:RIOT), Core Scientific (US:CORZ), HUT8 (US:HUT)

Coinbase (COIN): Prices jumped as it joins S&P 500

Volatility of the crypto exchange company shares spiked in the last few months. Prices first crashed 50 percent; then the stock surged 60 percent from April lows (see below). A key driver of Coinbase’s recovery is its upgrade to the basket of the prestigious S&P 500 Index. Prices immediately gapped up 25 percent when news of this inclusion hit the market. Many S&P index tracker funds would need to buy and hold the 13-year old crypto company.

Technically, the stock is about to test the pattern of falling lows at around $275 – a level that has acted as resistance in the past. If broken, expect a swift rally to $300, the next round number target.

Alternatives: Robin Hood (HOOD), eToro (ETOR)