Daily Analysis 15 March 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as markets continue to tank on the prospect that China may come to the aid of Russia's invasion of Ukraine by supplying both financial and military support.

In brief (TL:DR)

  • U.S. stocks were lower on Monday with the Dow Jones Industrial Average flat (+0.00%), while the S&P 500 (-0.74%) and the Nasdaq Composite (-2.04%) were down, with tech stocks taking a heavy beating on the prospect of policy tightening.

  • Asian stocks remained under pressure Tuesday as Russia’s war in Ukraine and the risk of aggressive U.S. monetary policy tightening to quell inflation sapped sentiment.

  • Benchmark U.S. 10-year Treasury yields rose about two basis points to 2.15% (yields rise when bond prices fall) on anticipation of tightening by the U.S. Federal Reserve.

  • The dollar ticked up.

  • Oil continued to fall with April 2022 contracts for WTI Crude Oil (Nymex) (-4.23%) at US$98.65, dropping below US$100 for the first time in weeks.

  • Gold retreated with April 2022 contracts for Gold (Comex) (-0.73%) at US$1,946.50.

  • Bitcoin (+2.18%) rose to US$38,899 as investors bought the benchmark cryptocurrency, subscribing both to it's alleged role as an inflation hedge as well as a possible beneficiary in the event that major central banks don't tighten as much as expected.


In today's issue...

  1. The Great Stock Market Rotation

  2. There’s No Price Low Enough to Entice Investors to Chinese Stocks

  3. El Salvador Experiments with a Sovereign Bitcoin Bond


Market Overview

Traders have begun to price in a more forceful path for U.S. Federal Reserve hikes and now expect about seven quarter-point moves in 2022.

Inflation was already high before the war and sanctions on Russia sparked a commodity shock, aggravating global economic challenges and creating a parlous environment for both stocks and fixed income.

The panoply of risks, from geopolitics to the threat of policy errors as central banks grapple with high inflation, suggests more volatility lies ahead.

Asian markets were mostly lower on Tuesday as traders evaluated China data with Tokyo's Nikkei 225 (+0.37%) up, while Sydney’s ASX 200 (-0.66%), Hong Kong's Hang Seng Index (-2.88%) and Seoul's Kospi Index (-0.75%)were all down in the morning trading session.



1. The Great Stock Market Rotation

  • With soaring inflation and the prospect of central bank monetary policy tightening looming over the horizon, that stock rotation made sense, but with the benefit of hindsight, the timing could not have been worse.

  • Nevertheless, for investors with a long-term investment horizon, equities will still remain a core portfolio asset class to hedge against inflation.

Before the first Russian tank rolled into Ukraine, stock analysts were calling it the great “stock market rotation” from expensive U.S. tech stocks, to -called “value” plays in sectors such as airlines, hospitality, and commodities – at least one of those sectors worked out.

With soaring inflation and the prospect of central bank monetary policy tightening looming over the horizon, that stock rotation made sense, but with the benefit of hindsight, the timing could not have been worse.

Now another type of rotation looks set to take place with equity inflows potentially topping over US$230 billion in the coming weeks as funds seek to rebalance their portfolios.

According to JPMorgan Chase, U.S. pension plans and overseas sovereign wealth funds are expected to shore up stock markets shaken up by the Russian invasion of Ukraine.

Sharp declines in global equity markets are believed to now require large institutional investors to rebuild their equity holdings to ensure that these positions are consistent with their long-term asset allocation strategies.

As the first quarter of 2022 comes to a close, this quarterly rebalancing could support equity prices towards the end of this month to maintain the standard 60/40 stock and bond portfolio.

The Russian invasion of Ukraine has seen the value of bond holdings soar as demand for haven assets like U.S. Treasuries rose against the uncertain geopolitical backdrop and this has meant that such typical 60/40 portfolios are now heavily weighted to bonds.

According to JPMorgan Chase strategist Nikolaos Panigirtzoglou, U.S. defined pension plans, which collectively manage around US$8 trillion in assets, would need to shift at least US$126 billion into stocks from bonds, to ensure that portfolios reach their long-term return targets.

Japan’s US$1.6 trillion Government Pension Investment Fund could move US$40 billion while another US$22 billion could enter equity markets via Norway’s US$1.3 trillion Government Pension Fund Global, also known as the “Oil Fund.”

A rise in global oil prices will mean that other sovereign wealth funds in oil-rich countries, including Saudi Arabia and other countries in the Middle East, will have more dry powder that is likely to move into equities, as prices come down sharply.

Overall cash holdings by the world’s largest investors have increased sharply in recent weeks, even above the level reached in March 2020 during the early stages of the pandemic, when concern over the economy led to steep declines in asset prices and investors holding hard to cash.

Nevertheless, for investors with a long-term investment horizon, equities will still remain a core portfolio asset class to hedge against inflation.



2. There's No Price Low Enough to Entice Investors to Chinese Stocks

  • U.S. intelligence reports that China is mulling the provision of military aid to Russia’s invasion of Ukraine is shaking the confidence of already jittery investors who have reeled from the repeated regulatory crackdowns that has targeted once immensely profitable sectors.

  • The biggest risk for investors trying to call a bottom is that Chinese firms could have far more to fall before rebounding and even timing the markets amidst a backdrop of geopolitical uncertainty and regulatory arbitrariness is like trying to pick lottery numbers.

One oft-quoted adage on investing by legendary value investor Warren Buffett is that if you like eating hamburgers, why wouldn’t you buy more when the price of hamburgers drops? Instead investors more often than not buy more hamburgers but sell stock.

But what happens if someone stops liking hamburgers?

That appears to be happening with Chinese stocks as a rout which has left them at a 75% discount finds few buyers (if any).

U.S. intelligence reports that China is mulling the provision of military aid to Russia’s invasion of Ukraine is shaking the confidence of already jittery investors who have reeled from the repeated regulatory crackdowns that has targeted once immensely profitable sectors.

From afterschool education to food delivery companies, Beijing’s “common prosperity” push is putting pressure on profits and shaking out investors who had bought into the economic miracle that is China.

Even at these “distressed” prices, few professional investors are being tempted to buy into Chinese companies, especially given Beijing’s reluctance to condemn the Russian invasion of Ukraine and appears to be mulling the provision of military hardware as Moscow gets bogged down in a military campaign that has so far failed to achieve any of its stated objectives.

Valuations of Chinese companies are at their lowest in more than a decade and while some investors are holding on, few are looking to add or dollar cost average.

The Nasdaq Golden Dragon Index has lost its sheen.

Home to the likes of e-commerce giant Alibaba Group Holdings (-6.74%) and search engine Baidu (-0.83%), the Nasdaq Golden Dragon Index has plunged a whopping 29% over the last three sessions and is now trading at its lowest since July 2013.

Closer to Beijing, Hong Kong witnessed a selloff in Chinese companies, which posted their worst day since the 2008 financial crisis, coming in the wake of Washington’s warning that Russia had asked China for military assistance in its war against Ukraine.

While Beijing has denied the allegations, traders aren’t sticking around to find out, and concern is growing that should Chinese President Xi Jinping back his buddy Russian President Vladimir Putin, China too could see itself subject to sanctions.

The Biden administration has already warned that it is prepared to retaliate should Beijing back its belligerent neighbor as it draws closer with the Kremlin.

Plucky investors looking to pick up Chinese stocks on the cheap should note that the turning point for American depository receipts of Chinese shares faces several headwinds.

New rules which will require Chinese companies to bring their accounting standards up to scratch with U.S. regulations could see a wave of Chinese delistings from American exchanges and relisting in Hong Kong has proved far from straightforward.

Several high-profile Chinese firms that have delisted in the U.S. have struggled to relist in Hong Kong, with its more stringent listing requirements and even where they have listed, failed to find a receptive audience.

Making matters worse, Beijing’s doubling down on its Covid-zero policy is rattling sentiment, with Shenzhen, a tech hub and home to some 17.5 million people, just the latest major Chinese city to go into lockdown.

The biggest risk for investors trying to call a bottom is that Chinese firms could have far more to fall before rebounding and even timing the markets amidst a backdrop of geopolitical uncertainty and regulatory arbitrariness is like trying to pick lottery numbers.

Instead, investors have and rightly so, decided to sit on the sidelines, waiting for a sufficient period of calm before trying to go in again on the upswing.



3. El Salvador Experiments with a Sovereign Bitcoin Bond

  • With its economy in tatters and its financial system on the brink of imploding, El Salvador is doubling down on its initial Bitcoin bet to try and bail the country out of its current quagmire.

  • If Bitcoin rallies hard, as Bukele and his cadres are hoping, Bitcoin could help alleviate some of El Salvador’s financial woes.

Prior to El Salvador, an impoverished South American country of 6.4 million people, declaring that Bitcoin would be accepted as legal tender within the country, few (if any) people in other parts of the world could have pointed it out on a map.

With its economy in tatters and its financial system on the brink of imploding, El Salvador is doubling down on its initial Bitcoin bet to try and bail the country out of its current quagmire.

To be sure, there are few institutional investors who are likely to participate in El Salvador’s Bitcoin bond sale, and with the price of Bitcoin in decline, it’s even less clear if retail investors globally will have the stomach to bet on a risky asset tied to a basket case economy.

El Salvador is scrambling for funds to repay and refinance its expiring debt and its sovereign bonds have fallen to junk status in the past year as investors worry that its budget deficit, which the IMF says could reach 5% this year, is unsustainable.

The International Monetary Fund has urged El Salvador to revoke Bitcoin’s status as legal tender, but with few options to revive its moribund economy, Bitcoin appears to be the country’s best bet.

El Salvador’s millennial President Nayib Bukele is embarking on the world’s boldest economic experiment, with its 10-year “volcano bond” hoped to raise US$1 billion that he wants to use to finance a new Bitcoin City near the Honduran border that will be powered by geothermal energy from a nearby volcano.

If the bond is oversubscribed, it could help El Salvador avoid an austerity package that would otherwise be implemented by the IMF, or a painful sovereign debt restructuring.

While institutional investors are watching the bond issuance with interest, almost all said they would not participate, noting that buyers were more likely to be retail cryptocurrency investors.

The “volcano bond” will be sold on cryptocurrency exchange Bitfinex, which is closely associated with the controversial dollar-based stablecoin Tether, and is likely to attract existing cryptocurrency investors accustomed to trading on such exchanges.

Bond investors are expected to be able to pay in dollars, Bitcoin or Tether and offer an annual coupon of 6.5%, plus 50% of the gain in the price of Bitcoin after 5 years.

If Bitcoin rallies hard, as Bukele and his cadres are hoping, Bitcoin could help alleviate some of El Salvador’s financial woes.

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