Daily Analysis 18 March 2022 (10-Minute Read)

Hello there,

A fantastic Friday to you as stocks continue their advance.

In brief (TL:DR)

  • U.S. stocks were higher on Thursday with the Dow Jones Industrial Average (+1.23%), the S&P 500 (+1.23%) and the Nasdaq Composite (+1.33%) all up as options set to expire this Friday could swing markets in either direction.

  • Asian stocks slipped Friday as a rally in Chinese technology shares fizzled.

  • Benchmark U.S. 10-year Treasury yields rose one basis point to 2.18% (yields rise when bond prices fall).

  • The dollar was steady.

  • Oil extended a surge with April 2022 contracts for WTI Crude Oil (Nymex) (+1.73%) at US$104.76 after the Kremlin cast doubt on how much progress ongoing cease-fire talks are making.

  • Gold was lower with April 2022 contracts for Gold (Comex) (+0.21%) at US$1,939.10.

  • Bitcoin (+1.36%) fell to US$40,542 in Asian trading with surging oil prices putting a damper on otherwise brighter sentiment on risk assets.


In today's issue...

  1. Just What the Market Ordered, More Volatility

  2. Chinese Shares May be Saved by Beijing Playing to Washington’s Rules

  3. American Consumer Protection Key to Biden’s Cryptocurrency Plan


Market Overview

Global stocks have rebounded in recent days, putting them on course for their best week since November 2020.

That suggests some of the worst fears about the inflationary commodity shock and hit to confidence from the war have eased.

At the same time, the continued fighting and tightening U.S. Federal Reserve monetary policy point to the likelihood of more cross-asset swings ahead and the war in Ukraine and the sanctions imposed on Russia continue to shape sentiment.

Asian markets were mixed Fridaywith Tokyo's Nikkei 225 (+0.27%) and Sydney’s ASX 200 (+0.32%) up, while Hong Kong's Hang Seng Index (+1.78%) and Seoul's Kospi Index (+0.12%) were down in the morning trading session.



1. Just What the Market Ordered, More Volatility

  • After a week of market gyrations, enough to give even the most steely-eyed investor whiplash, Wall Street is bracing for US$3.5 trillion in single-stock and index-level options expiry, according to Goldman Sachs.

  • With market sentiment poor, the odds are that there will be more traders looking to buy puts rather than calls and as these expire, there could be a sharp rally as dealers seek to cover their positions as the options near expiry.

As if the pandemic wasn’t bad enough, policy tightening, Putin’s invasion of Ukraine and now a panoply of options set to expire, look to roil markets teeming with jittery investors, ready to buy and sell at the drop of a pin.

After a week of market gyrations, enough to give even the most steely-eyed investor whiplash, Wall Street is bracing for US$3.5 trillion in single-stock and index-level options expiry, according to Goldman Sachs (+0.74%).

Concurrently, more near-the-money options are maturing than at any time since 2019, which suggests that traders are likely to trade around those positions, adding to heightened volatility in either direction.

The end of the first quarter of 2022 is also coincident with the rebalancing of a benchmark indices, including the S&P 500, which tends to spark higher volumes.

According to some traders, the jump in equities over the past several days isn’t so much due to optimism that the U.S. Federal Reserve can engineer a smooth path towards a more normal monetary policy, but dealers covering short positions to balance exposures, with demand for bearish stock hedges still elevated.

To be sure, there are plenty of reasons for investors to be cautious.

With the Russian invasion of Ukraine bogged down, each day that the conflict drags on increases the risk of indiscriminate violence by Russian President Vladimir Putin, including the use of a tactical nuclear weapon, that could very easily shock markets into submission.

China’s promise to bolster financial markets and the Fed’s view that the U.S. economy is robust enough to chart absorb rate hikes may be reasons for optimism, but then again, the Fed was also misled in its beliefs about inflation.

As options contracts expire, the bigger question is whether traders will continue to pile on protective puts (the option to sell at a specific price) or instead chase the market’s rebound with calls (the option to buy at a specific price) and right now markets could go either way.

With the benchmark S&P 500 up by almost 6% over the past three sessions, its best rally since 2020 when central banks shored up financial markets with copious amounts of liquidity, some analysts are becoming bullish again even though overall market sentiment is weak.

The issue with options is that they tend to exacerbate swings in the market – when a dealer sells a put option, the dealer is essentially taking a bet that the price of the security will increase, the trader buying the put option is betting that the price will decrease.

But the dealer has no intention to take a directional bet, so to offset that unwanted risk, will sell some of the security that they hold, to maintain a neutral position.

When the put options expire or get exercised, the dealer will reverse those hedging moves by buying the underlying security (e.g. if the option is exercised, the dealer needs to buy up the security to deliver on the option) which can potentially drive the asset price up very sharply.

With market sentiment poor, the odds are that there will be more traders looking to buy puts rather than calls and as these expire, there could be a sharp rally as dealers seek to cover their positions as the options near expiry.

All of which could see markets rally sharply and hard, for what might appear to be no apparent reason, but will likely be attributed (wrongly) to the Fed’s policy moves as well as China’s support for its economy.



2. Chinese Shares May be Saved by Beijing Playing to Washington's Rules

  • Beijing is prepared to make concessions on the disclosure of Chinese audit information in an effort to clear the impasse that could threaten the continued listings of over US$2 trillion of shares in U.S.-listed Chinese companies.

  • While ostensibly, Beijing has been wary of permitting foreign regulators to dive into company accounts and documents, alleging risks such as providing access to sensitive intellectual property, the bigger concern is probably under the umbrella of “national security.”

With a rapidly slowing economy and a president looking to secure an unprecedented third term in office, the last thing Beijing needs at the moment is a massive delisting of US$2 trillion worth of shares on American bourses.

Which may explain why Beijing is prepared to make concessions on the disclosure of Chinese audit information in an effort to clear the impasse that could threaten the continued listings of over US$2 trillion of shares in U.S.-listed Chinese companies.

A week after the U.S. Securities and Exchange Commission threatened to delist some Chinese companies from U.S. exchanges, Beijing plans to provide some audit information to U.S. accounting regulators.

While ostensibly, Beijing has been wary of permitting foreign regulators to dive into company accounts and documents, alleging risks such as providing access to sensitive intellectual property, the bigger concern is probably under the umbrella of “national security.”

Diving into the inner workings of many state-owned Chinese companies listed on U.S. exchanges and even those that are privately held, could throw up transactions and ties which may prove publicly inconvenient for many high-level Chinese officials.

As such, Beijing is proposing a pragmatic system which will require companies to check back with authorities before making financial audit information available to foreign regulators, which will provide a possible path forward and the first time China will disclose financial information of its companies outside of its borders.

Beijing has long been cagey with its companies, even if they are listed overseas, prohibiting access to files and other documents for audit purposes, but which also clashes with the Trump-era U.S. Holding Foreign Companies Accountable Act, passed in 2020 requiring the U.S. public Accounting Company Accounting Oversight Board to examine audits of Chinese and Hong Kong companies.

Last week, the SEC threw down an ultimatum for five Chinese companies to comply with audit requests within the next three years or face ejection from New York exchanges.

But it remains to be seen if Washington will accept Beijing’s counter proposal to submit its companies to audit, with “Chinese characteristics” as to the nature of such audits.

With the Chinese economy facing major headwinds, soaring commodity and energy costs hitting consumers and ill-conceived pandemic lockdowns dampening sentiment, the last thing China needs is a wave of delistings cutting its companies off access to foreign capital markets and global investors.

China’s Vice Premier, Liu He, and also the country’s top economic official, reassured investors this week that Beijing would take measures to support the economy and financial markets after a sharp selloff in Chinese equities was exacerbated by Russia’s invasion of Ukraine.

Beijing’s dogged resistance of condemning the Russian invasion and Chinese President Xi Jinping’s apparent doubling down on his close friendship with Russian President Vladimir Putin is also weighing on sentiment and appetite for Chinese shares.



3. American Consumer Protection Key to Biden's Cryptocurrency Plan

  • The U.S. Federal Trade Commission and the Consumer Financial Protection Bureau have largely taken a backseat to the SEC and CFTC, a closer examination of Biden’s executive order on cryptocurrencies actually directs the CFPB and the FTC to more closely study how they can police cryptocurrency transactions for fraud and abuse.

  • Because the U.S. approach to cryptocurrencies thus far has been to leave it to the CFTC and SEC, which treat them as commodities and securities respectively, frauds that aren’t covered by those definitions, such as false advertising, aren’t covered by federal regulators.

While the Securities and Exchange Commission and the Commodities and Futures Trading Commission have been the U.S. financial watchdogs most closely associated with cryptocurrency regulation, U.S. President Joe Biden’s executive order on the nascent asset class actually puts consumer protection front and center.

Whereas the U.S. Federal Trade Commission and the Consumer Financial Protection Bureau have largely taken a backseat to the SEC and CFTC, a closer examination of Biden’s executive order on cryptocurrencies actually directs the CFPB and the FTC to more closely study how they can police cryptocurrency transactions for fraud and abuse.

In a move similar to Singapore’s approach to cryptocurrencies, which is to protect retail investors and consumers from the volatility inherent in the digital asset class, the FTC and CFPB will protect consumers against “unfair” and “deceptive” acts and practices, with the CFPB having additional powers to prosecute “abusive” acts and practices.

Given how the vast majority of traders on various cryptocurrency exchanges continue to be retail, these broad enforcement agencies could play a major role in the development of cryptocurrencies and centralized exchanges in the U.S., especially in key areas like fraud protection and consumer privacy.

Because the U.S. approach to cryptocurrencies thus far has been to leave it to the CFTC and SEC, which treat them as commodities and securities respectively, frauds that aren’t covered by those definitions, such as false advertising, aren’t covered by federal regulators.

Yet with some studies finding that as much as a quarter of Americans having exposure to cryptocurrencies, consumer protection could help stabilize the market, by providing a bigger oversight umbrella, especially for cases which fall outside of the ambit of the SEC and CFTC.

But Biden’s executive order, calling for more consumer protection and oversight, is also tacit recognition that for a segment of Americans at least, cryptocurrencies could be replacing traditional systems for transactions.

Because the CFPB also oversees customer information and data breaches, cybersecurity at cryptocurrency exchanges operating in the U.S. would need to be beefed up and that could provide the assurance that more consumers need to adopt the nascent asset class.

Perhaps most significant, Biden’s executive order will force agencies like the CFPB, FTC, SEC and CFTC to lay down the rules on who does what on cryptocurrency regulations, avoiding the unnecessary and unproductive turf wars, like those between the FBI and CIA, which let the 9/11 terrorists slip through the cracks.

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