2022.04.11 Weekly Note
Tell me anything that’s good for markets…
Apart from countries taking an increasingly firmer stance towards Russia and supporting Ukraine with arms and food supplies as well as anti-war peace protests, there is a distinct lack of positives circulating in news stories. But where there has been some pain in markets, there are usually some good contrarian opportunities and I think it would be shrewd to stay on the lookout for these than get caught up in the mostly unidirectional news. Also, to learn something my recent experiences, turning over trades quicker with shorter holding periods still seems the way to go in the current environment.
The S&P 500 will plunge 11% by the end of 2022 as ‘inflation shock’ sparks a recession, Bank of America says (Insider) After the “inflation shock” comes the “rates shock,” which will ultimately lead to a “recession shock,” according to the note. And that recession will cause the S&P 500 to fall below the key 4,000 level by the end of 2022 which represents potential downside of 11% from current levels. Nearly all prior recessions have been preceded by inflation surges, including in the late 1960’s, early 1970’s, and in 2008. “Last dominos to drop in terms of recession expectations is higher yields and weaker dollar.” After the “inflation shock” comes the “rates shock,” which will ultimately lead to a “recession shock,” according to the note. And that recession will cause the S&P 500 to fall below the key 4,000 level by the end of 2022 which represents potential downside of 11% from current levels.
Recession Risk Is Rising, Economists Say (WSJ) Economists surveyed by The Wall Street Journal this month on average put the probability of recession sometime in the next 12 months at 28%, up from 18% in January and 13% a year ago. The median economist in the survey projected the Fed will take the federal funds rate’s midpoint range to 2.125% by the end of 2022, and 2.875% by December 2023 — close to the Fed’s own projections. “To be seen not fighting it is politically unwinnable. But the only policy response the Fed has is to tighten, Fed actions to curb inflation will lead to a recession sooner rather than later”. “The Ukraine crisis will cause another boost to inflation in the near term, but the wage-price spiral that has started already is a more permanent threat to price stability”. “The problem is really excess demand, resulting from last year’s fiscal and monetary policies, The longer the Fed waits to get inflation under control, the deeper the recession will be”. “There is still a lot of pent-up demand and momentum in the economy, Higher interest rates may cut growth from about 4–5% to about 2–3% this year, so we’ll see a significant slowdown in growth, but a recession seems unlikely at this time.
Fed’s Brainard Says Reducing Elevated Inflation ‘Is of Paramount Importance’ (WSJ) Central bank official previews plans for significant decline in Fed bondholdings beginning next month. “Accordingly, the committee will continue tightening monetary policy methodically through a series of interest-rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”
What the 2008 Financial Crisis Tells Us About Today’s Inflation Surge (WSJ) Inflation models that central banks have used since the 1990s may no longer be adequate. The eruption of the financial crisis 14 years ago and the surge of inflation in the past year both caught the experts largely by surprise. Both began in the U.S. then spread around the world. Forecasts are often wrong, but last year’s errors “went beyond what many regarded as plausible.”
Interest-Rate Surge Ripples Through Economy, From Homes to Car Loans (WSJ) At the beginning of 2022, average interest rate on a 30-year mortgage hovered above 3%, it stands at 4.72% today. that translates into sharply higher borrowing costs for Americans looking to buy a home — and it is only the beginning. Higher rates will make monthly mortgage payments — already at the least affordable level since November 2008 — even less so. A median American household needed 34.2% of its gross income to cover mortgage payments on a median-priced home in January, up from 29% a year earlier according to the Atlanta FED. The average rate on a new-car loan with a five-year term reached 4.21% in early April, according to Bankrate.com, up from 3.86% at the beginning of the year. The average credit-card APR stood at 16.4% on April 6, according to Bankrate.com. It was 16.3% on Jan 5.
How high do mortgage rates need to climb before it’s time to worry? Above 5.75%, says UBS (MarketWatch) UBS team also assumes mortgage rates heading toward 6% would come as home prices flatten out after two years of upwardly spiraling. UBS estimates that roughly 28% of median household income now goes toward monthly mortgage payments, nearing the 31% threshold seen in the mid-2000s in the run-up to the global financial crisis but doesn’t anticipate another 2008-style housing meltdown.
Curtin: Inflationary Psychology Has Set In. Dislodging It Won’t Be Easy (Barrons) Richard Curtin is a research professor at the University of Michigan and has directed the consumer sentiment surveys since 1976. There is a high probability that a self-perpetuating wage-price spiral will develop in the next few years. Households have already become less resistant to paying higher prices and firms have become less resistant to offering higher wages. Prices and wages will continue to spiral upward until the cumulative erosion in inflation-adjusted incomes causes the economy to collapse in recession. It is like the children’s game of musical chairs: Everyone knows the game will end, but they feel compelled to keep racing around the circle at an ever-faster pace hoping their forced exit will leave them in the best possible position — even if it still means an inflation-adjusted loss…
Ukraine, Russia Gear Up for War’s Biggest Battles (WSJ) Ukraine and Russia poured reinforcements into eastern Ukraine this weekend, preparing for what is likely to become the war’s biggest battles as refugees continued to flee the looming Russian assault. Russia’s main objective now is to seize the parts of the eastern Donbas region not yet controlled by Moscow. Unlike the first phase of the six-week-old conflict, that shift is forcing Ukraine into fighting conventional battles involving tanks, artillery and aircraft on flat, often barren terrain that allows Russia to leverage its superiority in military equipment. Attempting to disrupt the Ukrainian redeployment, Russia has said that its forces carried out a series of airstrikes on Ukrainian railway hubs. Some 52 people died in Friday’s Russian missile attack on the railway station in the Donbas city of Kramatorsk just as it was packed with civilians trying to board evacuation trains toward the relative safety of western Ukraine, according to Ukrainian authorities. Moscow denied it carried out that particular strike. “The battle for Donbas will remind you of the Second World War, with its large operations and maneuvers, the involvement of thousands of tanks, armored vehicles, planes and artillery. And this will not be a local operation, based on what we see in Russia’s preparations,” Ukraine’s Foreign Minister Dmytro Kuleba said after meeting North Atlantic Treaty Organization ministers this past week. “Either you help us now — and I’m speaking days, not weeks — or your help will come too late and many people will die.”
European Countries Debate How to Cut Purchases of Russian Oil (WSJ) Disagreements among European governments make an early decision unlikely, and any exit from Russian oil is expected to be gradual.
Palladium Extends Gains After Suspension of Russian Refiners (Bloomberg) On Friday, London Platinum & Palladium Market suspended Krastsvetmet and Prioksky Plant of Non-Ferrous Metals from its goods delivery and sponge accreditation lists. The LPPM’s announcement reverses its decision one month ago to continue letting the Russian plants supply precious metals to the trading hub. The CME then suspended the approved status for warranting and delivery of certain platinum and palladium brands from the two refiners until further notice. Russia produces about 40% of freshly mined palladium, which is mostly used in catalytic converters for gasoline-powered vehicles.
Finland Hit by Cyber Attack, Airspace Breach as NATO Bid Weighed (Bloomberg) Cyber attack toppled ministries websites, some other services. Russian state airplane may have breached Finnish airspace.
Bank of England Raises Key Rate for Third Time, Cites Ukraine Price Pressures (WSJ) The Bank of England raised its key interest rate for the third time in as many policy meetings Thursday, a fresh sign that central banks in many parts of the world are giving priority to countering a surge in inflation rather than slowing growth as their economies brace for the negative impact of Russia’s war on Ukraine. “Global inflationary pressures will strengthen considerably further over coming months, while growth in economies that are net energy importers, including the United Kingdom, is likely to slow.”
Europe Is in Recession, and the U.S. May Be Able to Avoid One, Dario Perkins Says (Barrons) The European economy is probably contracting right now, because inflation is hitting 7% to 8% and wages are going up 1%. People are getting very squeezed by this and we’re not yet seeing it in the data because it’s too early. But certainly there’s been a short-term contraction in the economy — it’s just whether it spills over into a deeper, broader problem. There’s still a good chance that we can shake this off. If this [invasion is] over, the slowdown is going to fade very quickly. If this goes into months, then the chance of a broad recession in Europe suddenly increases a lot.
France’s Macron to face far-right rival Le Pen in presidential election runoff (CNBC) French leader Emmanuel Macron and his far-right rival Marine Le Pen are set to face off in the final vote on April 24. A flurry of early projections and exit polls showed incumbent Macron came first with 28.1–29.5% of the vote, followed by Le Pen on 23.3–24.4%. The surging cost of living and the Russia-Ukraine war have been front and center. Support for Macron had jumped following Russia’s unprovoked invasion of Ukraine and his mediation efforts earlier this year.
Shanghai Has Recorded More Than 130,000 Covid Cases — and No Deaths (WSJ) In a Covid-19 outbreak that has locked 25 million people at home, the city of Shanghai has reported more than 130,000 cases since March 1, but says there have been no deaths and currently only one patient with severe illness. Hong Kong has followed a similarly strict model as mainland China in the pandemic, and saw a steep rise in deaths following a recent outbreak there. In March, the city reported tens of thousands of cases and hundreds of deaths a day. Taiwan, with many fewer cases than the mainland, reported a Covid death on Saturday, the fourth this year.
Surreal photos show Shanghai (Insider), a financial hub of 26 million, turn into a ghost town amid mass Covid lockdown; Bankers and traders in Lujiazui — China’s answer to Wall Street — are reportedly sleeping in their offices to ensure smooth business operations.
Harvard Endowment’s Debate Shows Private Equity’s China Struggle (Bloomberg) New allocations to China PE funds drop to lowest since 2018, China market turmoil, Covid restrictions hurt fundraising. In a sign of a potential pullback, Harvard University’s endowment is considering tapering its investments in China, according to people familiar with the matter, who asked not to be named discussing private information. A pension fund for Pennsylvania state employees hasn’t committed new cash to Chinese private equity funds in the past 12 months, while Florida’s pension system has halted new investments in China as it assesses the risks.
China Targets Big Tech’s Algorithms as Crackdown Persists (Bloomberg) China kicked off a formal campaign to rein in the potential abuse of algorithms by internet giants from ByteDance Ltd. to Tencent Holdings Ltd., taking aim at the way social media platforms serve up ads and content to hook users. The Cyberspace Administration of China will conduct on-site inspections of firms and ask them to submit their various services for review, the internet watchdog said in a statement Friday. Large-scale websites, platforms and products with big influence will be targeted, it said. It’s part of a broader effort that started in late 2020 to curtail the widening influence of China’s largest and richest corporations, whose platforms now control every sphere of public discourse and entertainment.
Elon Musk suggests people who subscribe to Twitter Blue should be able to pay with dogecoin (CNBC) Billionaire CEO of Tesla and SpaceX who revealed this week that he owns 9.2% of Twitter is a prolific Twitter user, often moving markets with his tweets, and tweeting about Twitter again: appointed to Twitter’s board of directors on Tuesday and said he looked forward to working with the board to make “significant improvements to Twitter in the coming months.” “Everyone who signs up for Twitter Blue (ie pays $3/month) should get an authentication checkmark,” “Price should probably be ~$2/month, but paid 12 months up front & account doesn’t get checkmark for 60 days (watch for CC chargebacks) & suspended with no refund if used for scam/spam,” “And no ads. The power of corporations to dictate policy is greatly enhanced if Twitter depends on advertising money to survive,” also proposed pricing “should be proportionate to affordability & in local currency. Maybe even an option to pay in Doge?”
Cathie Wood sold 90% of her Twitter stock this year. Then Elon Musk sent the shares soaring (Insider) and her stake would be worth $700 million if she’d held onto it. ARK’s funds held around 15.4 million Twitter shares at the very start of 2022, according to data from trading tracker Cathie’s Ark. By April 7, that holding was closer to 1.3 million shares. Wood had previously invested heavily in Twitter. ARK notably bought more than 1 million shares worth almost $49 million after then-chief executive Jack Dorsey resigned at the end of November.
Stock Splits Actually Work — Just Not for the Reason Everyone Thinks (Barrons) Stock splits are back in vogue, and the market is quickly rewarding companies that divide their shares. Google parent Alphabet, Amazon.com, Tesla, and GameStop are among the latest companies to seek approval from their shareholders for splits. Each of them enjoyed a post-announcement rally. “By itself, a stock split should neither create nor destroy any value,” says Christopher Harvey, Wells Fargo’s head of equity strategy. “The stocks that split typically have positive price momentum, generally good things are happening at the company, and fundamentals are improving. That’s what the market is focused on, and a stock split is just something you do when that’s happening.” In other words, it’s more correlation than causation. But the numbers speak for themselves: Since 1980, S&P 500 stocks that have announced splits have beaten the index by 16 percentage points, on average, over the following 12 months, according to BofA Securities researchers.
Washington Debates Cryptocurrency Rules, With Sights Set on Stablecoins (WSJ) Digital assets tied to the dollar could pose risk to broader financial system, policy makers say. Often billed as one-to-one representations of a currency like the dollar, stablecoins have recently exploded in popularity as investors use them for trading other cryptocurrencies. There are dozens of stablecoins, though a handful pegged to the dollar account for most of the market value, which grew roughly 500% in the 12 months ending in October, according to a report from the Biden administration.
Crypto Use Is More Prevalent in Corrupt Countries, IMF Study Finds (Bloomberg) Cryptocurrencies are more popular in countries perceived as corrupt or with strict capital controls , boosting the case for greater regulation of the industry, the International Monetary Fund said in a recent report. The report shows why countries might want to require intermediaries, such as digital currency exchanges, to implement know-your-customer procedures — ID verification standards that are designed to prevent fraud, money laundering and terrorism financing, the organization said. Some countries, like the U.S., have already instituted those kinds of controls
The Infuriating Reality of Traveling with Bitcoin in the World’s Crypto Capital (Bloomberg) What really happens in El Salvador when you settle up with the cabbie, the waiter, and the peanut vendor. I wave my iPhone, packed with Bitcoin ready to show their value as an honest-to-goodness medium of exchange. Then the official interrupts my reverie. “I’m sorry, sir,” she says. “Only cash or credit.” I approach a dozen cab drivers who are chatting and waiting for fares. I pop the question: “Will you take my Bitcoin?” Two throw up their arms and walk away. One says he knows a guy who does, but he’s not here. The rest ignore me and continue their conversations…
LAST WEEK’S ACTION
Commodities continues to perform strongly while negatively impacting risk assets as inflation and higher interest rates continues to sour global economic outlook. USD and CNH traded through recent highs, commodity linked-currencies maintaining strength while European currencies still reeling in the impact of the Ukraine conflict.
US benchmarks the weakest, Switzerland UK and Spain performing well despite the weakness in neighbouring markets.
US equities broadly traded back into the low ends of the recent range, while Energy and Defensives (Real-estate, Staples, Healthcare, Utilities) traded through the highs of previous weeks. Small-caps performed the worst while large-cap Value IWD finished green supported by Energy and Defensive stocks.
Looking at XLK:(XLP+XLV+XLY) for Growth vs Value:
Tech stocks are now relatively oversold against the Defensive sectors almost reaching their respective 3sd bands on both Daily and Weekly timeframes. The weekly oscillators is also suggesting a bounce could be imminent also.
Individually and on the weeklies, XLK has touch the first SD band and the 50retrace of the recent rally, while the Defensives XLP XLU XLV are around the 3sd band with the highs interestingly aligning to mark out a trendline. Momentum studies on the Hourly timeframes for both are also producing conditions conducive to a short-term pivot.
Dow Transports DTX is often a good indicator of sentiment towards the underlying US economy (truckers, logistics, railroads, airlines) and given the inflation/recession/quantitative-tightening narratives dominating markets, as well as higher gas prices and parts of the yield curve inverting, it probably shouldn’t come as a surprise this index has sold off heavily in recent weeks following the first Fed hike last month. DTX deserves some attention this week especially those looking to time the dips and see whether we get any form of upside confirmation to last Thursday’s bullish reversal print.
Semi-conductors SMH are some way’s off their highs and have seen some heavy selling last week also into a strong pivot area which has the potential to carve out a right shoulder. DeMark also suggests a bounce is imminent and this area would be as good a place as any in the recent price ranges. Given the popularity in the higher-beta semi-conductor stocks and the backdrop of supply bottlenecks for very highly demand products, I think this has a good chance of leading the bounce in tech stocks, which has done on numerous occasions including the aggressive one mid-March.
SPX net-dealer gamma is negative but nearer to ATM skews does appear more balanced and potentially heavier on the calls. A build of calls in the next session or two could be a good confirmation point for a more positive swing to recent sentiment.
SPX at-the-money volatilities and low risk premiums is still remarkably subdued given the weakness in equities in recent weeks. Either bets are fairly balanced with some well defined risk ranges for equities to chop around in, or markets very complacent about downside risks. Either way, there is no indication of fear here and this could be supportive for sentiment to turn more positive, if not even for a brief period. Would be interested to see whether these metrics stay subdued as we head into earnings season and forward growth expectations is likely to be pessimistic.
Last week the chart that caught the most attention was the yield curve inverting between several durations and going forward, I suspect real yields will be of major focus as the 10year is less that 15bp away from neutral. Given inflation is continuously on the rise along with nominal yields, Ukraine conflict induced inflation pressures to persist, and Fed tightening to impact inflation expectations further out, it won’t be long til we see the 10yr real yield back in positive territory.
As the saying goes — volatility begets volatility.Where you have commodities and rate volatility like we have now, volatility in stocks and currencies tends to follow.
Commodities looks to be gearing up for another leg higher as price action looks more compressed to the upside with the increasingly shorter distances between the highs, versus the wider spacing between swing lows.
While oil prices have dropped off, other commodities are still pushing highs as seen in the CRB ex-Energy index as a result of the Ukraine conflict (in Feb) and Russia sanctions (more recently) causing Agriculture and Metal supply disruptions, and it doesn’t look like stopping anytime soon.
Most currencies except NOK and RUB weakened against the USD trading at or below recent lows. There is some strong momentum behind the USD and looks set to continue with US rates on an upward path and ongoing supply chain issues negatively impacting the global economy.
Index view reinforces my bias to stay short JPY and EUR against long USD as well as against AUD CAD ZAR NOK to choose from for pro-risk pairings.
EUR risk reversals are still negatively skewed, however judging from the move into early March, it does look like there is some room for some risk premia to come back in and further weigh on the Euro.
Lookout for Turnaround Tuesday…
On the lookout for some tactical pro-risk opportunities as the market is coming off some selling pressure last week, which would set us up for a potential Turnaround Tuesday bounce, especially if we finish the Monday with some continued weakness. I like buying Semi-Conductor stocks (I’ve initiated a position in NVDA on last Friday’s close and may add another if it dips towards 225) as Demark sequential is signalling the sell-off in these stocks is nearing exhaustion. SMH should be a good alternative for the more ETF-minded. Also the backdrop of supply chain tightness while these goods are in high demand across all product classes should still remain supportive. For macro instruments, Nasdaq looking for a squeeze as we head into earnings season and AUDJPY would appear the most suitable candidates, while long GBPUSD makes for an interesting tactical choice.
but maintain short-risk bias big picture
Lack of positive news and persistence of supply chain issues is turning into negative feedback loop of negatives upon negatives.
March inflation (CPI on Tuesday, PPI Wednesday) is strongly expected to have accelerated and while it may be starting to slow on m/m-basis, inflationary pressures are expected to continue reverberating through the economy and we are still some ways from Fed’s target rate. To add, strength of US consumers points to strong Retail Sales while surging prices-paid data for upcoming Import prices and Jobless claims trending lower (all on Wednesday) should bolster the case for higher rates.
Sell EUR rallies
There could be some knee-jerk rallies from headlines around the French elections in the coming weeks. While the Ukraine conflict does not look like resolving anytime soon, any EUR rallies should be good opportunities to get short an economy that is already cratering from rampant inflation, lowered output/growth and sentiment.
Long high Commodity-beta assets
Currencies with high Terms of Trade paired tactically against EUR and JPY where I would maintain a short bias due to the backdrop of higher rates, particularly of US treasuries — stronger real yields and USD.
Have a great week trading!