Daily Analysis 17 May 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as markets continue to turn in unpredictable directions given a flurry of conflicting data.

In brief (TL:DR)

  • U.S. stocks were mostly lower Monday with the Dow Jones Industrial Average (+0.08%) up slightly, while S&P 500 (-0.39%) and the Nasdaq Composite (-1.20%) were down.

  • Asian stocks rose Tuesday amid a jump in some Chinese technology firms and as investors evaluated China’s efforts to stamp out a Covid outbreak.

  • Benchmark U.S. 10-year Treasury yields rose one basis point to 2.89% (yields fall when bond prices rise).

  • The dollar fell for the first time in weeks.

  • Oil was lower after jumping with June 2022 contracts for WTI Crude Oil (Nymex) (-0.10%) at US$114.09 on concerns over Chinese demand, but prices remain elevated in response to supply side concerns.

  • Gold rose with June 2022 contracts for Gold (Comex) (+0.59%) at US$1,824.70.

  • Bitcoin (-2.48%) fell to US$29,978 (at the time of writing) as the fallout of the TerraUSD collapse continues to ricochet throughout the industry.


In today's issue...

  1. China’s Economy is Shutting Down, Literally

  2. Your Portfolio Looks a Mess, What Should You Do?

  3. Bitcoin Fans Buy the Dip on Terra Fallout


Market Overview

A challenging global economic outlook amid elevated food and fuel costs and tightening monetary settings continues to shape sentiment.

U.S. data on Monday showed New York state manufacturing activity unexpectedly shrank in May for the second time in three months, that followed Chinese figures revealing a collapse in economic activity due to Covid-linked curbs.

The economic reports have fanned concerns of a downturn in the global economy alongside persistent price pressures that are forcing the U.S. Federal Reserve and a slew of other central banks to tighten monetary policy at the worst possible juncture.

Asian markets rose Tuesday with Tokyo's Nikkei 225 (+0.45%), Sydney’s ASX 200 (+0.18%), Hong Kong's Hang Seng Index (+1.81%) and Seoul's Kospi Index (+0.67%) all up in the morning trading session as Chinese tech firms recover.



1. China's Economy is Shutting Down, Literally

  • China’s overall economic activity in April contracted sharply as Shanghai was not alone in its lockdowns.

  • Making matters worse, China is rapidly descending into a police state with plans to “strictly limit” citizens from traveling overseas on grounds of the pandemic.

Imagine a city where not a single car was sold in an entire month – well imagine no longer, because that’s precisely what happened in China’s commercial hub of Shanghai.

According to Bloomberg, not a single car was sold in Shanghai last month, symptomatic of the zero-Covid lockdowns that continue to stymie economic activity in the city of 23 million.

Unsurprisingly, China’s overall economic activity in April contracted sharply as Shanghai was not alone in its lockdowns.

Retail sales, the country’s main gauge of consumer activity fell by 1.1% year-on-year while industrial production fell by 2.9%.

Given the extent of China’s lockdowns, the numbers reported by Beijing look somewhat suspect, but are the first “official” revelation of the increasing economic toll from China’s approach to the coronavirus.

Even before the Covid lockdowns, China’s economy was being ravaged by a liquidity crisis plaguing the real estate sector, crackdowns on tech and afterschool education and the potential delisting of overseas firms.

While Beijing effectively cut mortgage base rates for new lending to first time buyers over the weekend, from 4.6% to 4.4%, it’s not likely to move the needle as Chinese consumers appear to have lost confidence altogether and sentiment is poor given the dire economic outlook.

Making matters worse, China is rapidly descending into a police state with plans to “strictly limit” citizens from traveling overseas on grounds of the pandemic.

Chinese tech stocks have made a small rebound in recent times, spurred in no small part by Chinese mutual funds and other state-owned institutions actively buying up the dip to prop up the markets, but in the absence of retail investors, any rally is likely to be short-lived.

Although JPMorgan has walked back its “uninvestable” call on China, likely due to political reasons, global investors have plenty of food for thought before wading back in.

Chinese real estate companies of late have been defaulting on their dollar-denominated offshore bonds, whereas onshore yuan bonds have been rescued by local lenders and it remains to be seen if the rights of global investors will be respected in the future.

Whereas China has never made any sort of pretense of adhering to the rule of law, as long as asset prices kept rising, there was always some “other” investor to hand off the bag to.

But with the Chinese economic outlook becoming increasingly uncertain and Chinese President Xi Jinping set to install himself for an unprecedented third term in office, it would be a plucky investor to wade back in to catch falling knives at this point.



2. Your Portfolio Looks a Mess, What Should You Do?

  • Assets which have been touted as a replacement for stocks and bonds, including cryptocurrencies and gold, have only helped deepen portfolio losses.

  • Current market conditions have provided a timely reminder for investors that diversification needs to expand beyond just stocks and bonds and encompass other asset classes as well.

For many investors at this point, the best option may be to not look, but those who have been looking, may be wondering if there are anywhere to hide from the market turbulence at all.

With both stocks and bonds falling in tandem in the first quarter, typical 60/40 stock and bond portfolios have been smashed.

The benchmark S&P 500 has lost 16.44% year-to-date, while the Bloomberg Global Aggregate Bond Index has left investors nursing a 6% loss.

Assets which have been touted as a replacement for stocks and bonds, including cryptocurrencies and gold, have only helped deepen portfolio losses.

For years, the 60/40 balanced approach represented the conventional wisdom for portfolio asset allocation, where investors would set aside 60% to equities for capital appreciation and 40% for bonds to offer income and risk mitigation.

That portfolio allocation strategy worked in large part as equities rose in a straight line to record highs and interest rates fell to new lows, fueling demand for bonds.

But with global central banks offering investors a double-whammy of raising rates and cutting back bond purchases as well as running off balance sheets in the case of the U.S. Federal Reserve, there are understandably no offramps from market volatility.

And holding on to cash isn’t the answer as well, especially with U.S. headline inflation pushing 8.3% per annum.

While the classic 60/40 stock and bond portfolio delivered an annual return of 11.1% annually from 2011 to 2021, or 9.1% adjusting for inflation, according to Goldman Sachs, these returns do not look sustainable over the next decade.

Stocks are near all-time-highs, valuations are stretched, and key U.S. benchmarks are increasingly concentrated in a handful of the biggest tech companies.

In the meantime, bonds are facing inflation and the prospect of a rising interest rates, while the U.S. Federal Reserve looks set to pare down its balance sheet leaving the bond market without its biggest buyer.

Against this backdrop, more investment managers are advising their clients to diversify their portfolios and manage return expectations.

But diversification is easier said than done.

Currencies, commodities and other “real assets” like infrastructure and real estate are replete with volatility and liquidity risks.

Investors pondering a shift into commodities will recall that not so long ago, crude prices were negative, and the last commodity bull market ended abruptly.

Invesco (-0.84%), which manages over US$1.61 trillion in assets, recommends a 50/30/20 portfolio, with 50% in equities, 30% in bonds and 20% in alternatives.

Current market conditions have provided a timely reminder for investors that diversification needs to expand beyond just stocks and bonds and encompass other asset classes as well.

Given that the last quarter saw a major war, a huge commodities shock and a very hawkish shift in central bank policy, in addition to the collapse in Chinese markets, stocks and bonds have held up admirably, but if ever there was a call to diversify, this would be it.



3. Bitcoin Fans Buy the Dip on Terra Fallout

  • According to data compiled by CoinShares, investors added some US$299 million to Bitcoin products, while funds focused on other cryptocurrencies like Solana, Ether and Polkadot saw outflows.

  • Prices for major cryptocurrencies including Bitcoin have stabilized somewhat and Bitcoin’s continued resilience by hugging the US$30,000 level has provided some degree of comfort for investors.

While cryptocurrencies were savaged over the past week on the failure of algorithmic stablecoin TerraUSD, the idea that investors exited the market altogether was exaggerated.

Instead, many long-term cryptocurrency investors sought safety in the “original” digital asset – Bitcoin.

According to data compiled by CoinShares, investors added some US$299 million to Bitcoin products, while funds focused on other cryptocurrencies like Solana, Ether and Polkadot saw outflows.

Even in a market as volatile as cryptocurrencies, there are perceived “havens” in times of tumult and investors may have been moving out of stablecoin pairs into Bitcoin as a result.

Bitcoin, which spawned the trillion-dollar cryptocurrency industry is still seen as the most resilient digital asset, especially given that its creation cannot be pinned down to an individual or group of individuals and it still has the biggest name recognition.

Outside of cryptocurrency circles, many still use Bitcoin, blockchain and cryptocurrency as interchangeable terms.

There is also no shortage of Bitcoin maximalists who see the cryptocurrency as the currency of the future, including El Salvador President Nayib Bukele, who this week hosted representatives from over 40 countries in what’s been dubbed as “Davos for Bitcoin.”

Cryptocurrencies have increasingly become correlated with tech stocks and U.S. equities as more institutional investors have waded into the space and macro conditions have seen sharp falls in prices, even without the TerraUSD collapse.

Prices for major cryptocurrencies including Bitcoin have stabilized somewhat and Bitcoin’s continued resilience by hugging the US$30,000 level has provided some degree of comfort for investors.

A significant amount of futures were also liquidated in last week’s carnage, helping to deleverage the cryptocurrency markets in general as well, which should provide investors with some respite.

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