Daily Analysis 14 April 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as market turn upwards as investors become introspective on just how far the U.S. Federal Reserve is prepared to take rate hikes given the increasingly uncertain economy.

In brief (TL:DR)

  • U.S. stocks ended higher on Wednesday with the Dow Jones Industrial Average (+1.01%), the S&P 500 (+1.12%) and the Nasdaq Composite (+2.03%) all up.

  • Asian stocks rose Thursday after China again indicated looser monetary policy is on the way and bond traders dialed back aggressive bets on U.S. Federal Reserve interest-rate hikes.

  • Benchmark U.S. 10-year Treasury yields were at 2.69% (yields rise when bond prices fall) suggesting investors are rethinking just how far the Fed will hike rates.

  • The dollar was steady.

  • Oil held most of a rally with May 2022 contracts for WTI Crude Oil (Nymex) (-0.75%) at US$103.47 on continued supply concerns.

  • Gold was little changed with June 2022 contracts for Gold (Comex) (-0.24%) at US$1,980.00.

  • Bitcoin (+3.22%) recovered to US$41,386 in line with other risk assets as investors and traders reconsidered their bets on just how aggressive the Fed would be when it comes to policy tightening especially given the risks of recession.


In today's issue...

  1. What happens when the world’s factory catches Covid?

  2. Avalanche of Stock Options Set to Expire this Month, Get Used to It

  3. Move Over Bitcoin, It’s Time for the Alts to Shine


Market Overview

The commodity-fueled jump in costs exacerbated by Russia’s war in Ukraine continues to ripple across the global economy and color market sentiment.

JPMorgan Chase & Co. CEO Jamie Dimon said inflation and the Ukraine conflict were creating “significant” challenges, with the firm was among the first of the big U.S. banks to report earnings.

China is expected to cut a key policy interest rate for the second time this year on Friday and reduce the reserve requirement ratio soon - the nation’s cabinet has strongly signaled the latter as Covid lockdowns sap the economy.

Outside of China, monetary settings continue to tighten in the campaign to curb the cost of living. South Korea raised its key interest rate and Singapore further tightened policy, spurring advances in their currencies.

Asian markets were mostly up on Thursday with Seoul's Kospi Index (-0.12%) down slightly, while Tokyo's Nikkei 225 (+1.26%), Hong Kong's Hang Seng Index (+0.35%) and Sydney’s ASX 200 (+0.47%) were all higher in the morning session.



1. What happens when the world's factory catches Covid?

  • While the lockdown of Shanghai has been making headlines, yesterday, dozens of manufacturers of crucial electronic components in cities surrounding China’s financial center, halted production as lockdown rules spilled over to neighboring industrial cities.

  • There is growing pressure on trade, with imports into China falling on a year-on-year basis for the first time since August 2020.

What happens when the factory to the world catches Covid? We’re about to find out as Chinese President Xi Jinping sticks to his dogged determination to deploy a zero-Covid policy that’s fomenting unrest in some of China’s largest cities even as it cripples supply chains.

Watching from the outside looking in, China looks like a slow-moving train wreck, from its crackdown on its once vaunted tech companies to its now struggling real estate sector, everywhere global investors look in China there are more risks than opportunities.

And now, add to the list the world’s largest electronics manufacturing hubs surrounding Shanghai being ground to a halt, and China’s economic woes looks longer than a 5-year-old’s Christmas wish list.

While the lockdown of Shanghai has been making headlines, yesterday, dozens of manufacturers of crucial electronic components in cities surrounding China’s financial center, halted production as lockdown rules spilled over to neighboring industrial cities.

The latest round of production disruptions in China’s major manufacturing hubs are raising risks for China’s rapidly slowing economy and even at the very pinnacle of China’s leadership, there are signs that not everyone agrees with Xi’s zero-Covid policies.

On Monday, Chinese Premier Li Keqiang warned for the third time in a week of the dangers that pandemic control measures posed to the Chinese economy, in stark contrast to Xi’s insistence that zero-Covid was the correct path forward.

According to the state-owned Xinhua News Agency, Xi said in a trip to Hainan with respect to Covid,

“Prevention and control work cannot be relaxed.”

But Xi’s bold gamble as he seeks an unprecedented third term in office as China’s leader could have long-term consequences for the Chinese economy.

Beijing has stubbornly refused to import mRNA vaccines, which have been proved to be more effective against the most severe effects of Covid and strict measures have meant that there have been limited opportunities for herd immunity to develop in China.

Economists at Nomura estimate that as many as 45 cities with some 373 million people in China were under some form of lockdown, a sharp increase from 23 cities and 193 million people just a week ago.

There is growing pressure on trade, with imports into China falling on a year-on-year basis for the first time since August 2020.

Production delays and disruptions could have material impact on other economies as well, at a time when consumer confidence in major markets like the U.S. is starting to show signs of weakness.

Some of the world’s biggest tech companies like Apple (+1.63%) could be affected as well, with some Chinese factories that assemble components for the iPhone suspending production.

And even where production can continue, it can be as low as 40% of capacity, with raw materials unable to head to factories and finished goods unable to move out.

Nevertheless, the impact on major tech firms like Apple is expected to be limited for now, because the Chinese factories affected assemble less popular models of the iPhone and the flagship iPhone 14 is only due to kick off production late in the third quarter.

But for other manufacturers, especially for printed circuit boards, and every other electronics gadget, from toasters to Toyotas, these chip shortage delays that plagued the world during the pandemic are likely to worsen.



2. Avalanche of Stock Options Set to Expire this Month, Get Used to It

  • Making matters worse for stock traders, a massive US$2 trillion worth of options on equities are set for expiration this week.

  • As monetary and fiscal support ebbs, investors have been hunkering down and the outlook is positively gloomy.

From China’s stubborn insistence on pandemic lockdowns and a zero-Covid policy to the ongoing Russian invasion of Ukraine, there appears to be no shortage of challenges to the global economy.

Against that backdrop, central bank policy tightening and soaring inflation are leading many investors to question where the next bout of global growth is going to come from.

Making matters worse for stock traders, a massive US$2 trillion worth of options on equities are set for expiration this week.

According to estimates by Goldman Sachs, around US$495 billion in single-stock derivatives are set to expire today, while another US$980 billion of S&P 500-linked contracts and US$170 billion in options tied to the State Street fund tracking the benchmark are all running out as well.

In the past, such massive options expiries have roiled markets and indexes have exhibited a consistent pattern of declining on days when contracts close out, as trades rush to cover bullish long positions.

As monetary and fiscal support ebbs, investors have been hunkering down and the outlook is positively gloomy.

More money managers are predicting a period of stagflation marked by lower growth and still-high inflation, which means that any rally in equities is likely to be short-lived as traders take the opportunity to selloff their bullish positions and take money off the table.

The flipside of course is that as investors become more pessimistic and pour into bonds, this will help put a lid on yields and tempt yield-hungry investors to head out into more risky assets.

And because predicting the future has become even more challenging, it’s likely that investors will avail themselves of more options to hedge their positions either way, meaning this regular volatility wrought by options expiries is a trend that is likely to be durable.

Growing options volume has become a regular feature of post-pandemic markets, with bullish options contracts a favorite amongst the retail investing crowd who spent much of their time in lockdown trading off their phones using apps like Robinhood (+4.02%) and SoFi (+1.74%).

With markets looking choppier, demand for bearish put options (the option to sell at a specific price) in demand.



3. Move Over Bitcoin, It's Time for the Alts to Shine

  • In the past several weeks, smaller market cap and lesser-known cryptocurrencies commonly referred to as “altcoins” have been outperforming Bitcoin, leading some observers to suggest that the cryptocurrency markets may be in “altcoin season” again as Bitcoin’s dominance wanes.

  • Many rallies in altcoins have coincided with developments or major announcements peculiar to those specific cryptocurrencies only and had little to do with the broader market sentiment, providing a bit of a buffer for a basket of digital assets.

The reason why you’ll never see any aisle markings in a Costco is that part of its highly successful business model is to ensure that shoppers wander around the store and pick up stuff they wouldn’t otherwise have if they knew exactly where everything was.

That spirit of discovery in Costco is what keeps it so profitable and may be what’s contributing to a recent rise in so-called altcoins (anything but Bitcoin) as investors search for opportunities outside of the benchmark cryptocurrency.

In the past several weeks, smaller market cap and lesser-known cryptocurrencies commonly referred to as “altcoins” have been outperforming Bitcoin, leading some observers to suggest that the cryptocurrency markets may be in “altcoin season” again as Bitcoin’s dominance wanes.

Part of that interest in altcoins has of course been spurred by upcoming software upgrades in the Ethereum blockchain which has the potential to revolutionize the cryptocurrency industry, promising a shift to the far less energy-intensive proof-of-stake method to secure the blockchain as well as allowing more transactions at vastly increased speeds.

But it’s not just Ether which has been doing well relative to Bitcoin, other so-called “Ethereum killers” like Solana and Avalanche have also been outperforming the original cryptocurrency.

The cryptocurrency markets have surged in both interest and size since the start of the pandemic, with investors racing to find and place bets on the next Bitcoin and an entire industry fueled by serious venture capital money has been feeding growth.

Investors already participating in the cryptocurrency ecosystem through their stakes in both Bitcoin and Ether were looking to diversify away from just the largest cryptocurrencies, both as a portfolio hedge but also to take part in the more substantial upside potential.

According to data from CoinMarketCap, Bitcoin’s share of the total market cap of cryptocurrencies, also referred to as its “dominance” has declined from 65% before the pandemic, to around 40% today.

But with great viability also comes great volatility and altcoins tend to be far more volatile than Bitcoin or more “established” cryptocurrencies like Ether, although the potential for big payoffs could be far larger as well.

Many rallies in altcoins have coincided with developments or major announcements peculiar to those specific cryptocurrencies only and had little to do with the broader market sentiment, providing a bit of a buffer for a basket of digital assets.

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