Daily Analysis 20 July 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as investors speculate this year's stock rout may have hit bottom and bargain hunters start picking up equities once again.

In brief (TL:DR)

  • U.S. stocks closed higher on Tuesday with the Dow Jones Industrial Average (+2.43%), S&P 500 (+2.76%) and the Nasdaq Composite (+3.11%) all up.

  • Asian stocks extended a rally Wednesday amid a dip in the dollar and speculation that the worst of this year’s equity rout may be over.

  • Benchmark U.S. 10-year Treasury yields were at 3.02% (yields rise when bond prices fall) on risk taking seeing a departure from haven assets.

  • The dollar has shed about 1% this week, underscoring waning haven demand for the greenback and a brighter mood in markets.

  • Oil slipped with August 2022 contracts for WTI Crude Oil (Nymex) (-0.66%) at US$103.53.

  • Gold edged lower with August 2022 contracts for Gold (Comex) (-0.11%) at US$1,708.90.

  • Bitcoin (+5.33%) rose to US$23,290 and hovered above US$23,000 after climbing out of a one-month-old trading range, moving in sync with stocks as risk assets gain the upper hand.


In today's issue...

  1. Stock Investors Are Out of the Market

  2. China’s Once Hot Property Market is Rapidly Unraveling

  3. SEC Tries to Inch its Way to Remain Crypto-Regulatory Relevant


Market Overview

Speculation that company earnings will hold up and that the U.S. Federal Reserve will avoid very aggressive monetary tightening appears to be giving investors some comfort.

The euro hovered around a two-week high against the dollar on the possibility of a bigger-than-expected European Central Bank interest-rate hike Thursday.

Chinese share gains were more muted given property-sector and Covid challenges.

Asian markets were higher on Wednesday with Seoul's Kospi Index (+0.67%), Sydney’s ASX 200 (+1.65%), Hong Kong's Hang Seng Index (+1.34%) and Tokyo's Nikkei 225 (+2.67%) all up.



1. Stock Investors Are Out of the Market

  • Some of the biggest investors in the world have cut their equity allocations on increased concern that tighter central bank monetary policy and higher interest rates will affect company valuations at a time when economic growth appears to be slowing.

  • Against the gloomy macroeconomic backdrop, any rally in equities is likely to be short-lived, and a clear dovish shift in monetary policy will be needed for a durable rally.

For the first time since the 2008 Financial Crisis, global money managers are expressing what a Bank of America survey suggests is a “dire level” of pessimism that could indicate a possible bottom in equity prices.

Some of the biggest investors in the world have cut their equity allocations on increased concern that tighter central bank monetary policy and higher interest rates will affect company valuations at a time when economic growth appears to be slowing.

Fund managers this month reduced their net overweight position in stocks to their lowest level since October 2008, when the fallout of the Lehman Brothers collapse first started to hit markets.

Cash holdings meanwhile have soared to a 21-year high of 6.1% of assets under management, according to the BoA survey of 259 investment managers with combined assets of US$722 billion and which was published yesterday.

The BoA survey suggests that professional investors aren’t yet convinced equities have bottomed out especially given the macroeconomic uncertainty – soaring inflation, war and slower growth.

Slower growth from higher interest rates is expected to hit corporate bottom lines and some of the world’s biggest firms are already expressing caution in their previously aggressive hiring and expansion goals.

BoA’s survey also revealed that over 58% of respondents were taking lower than normal levels of risk in their portfolios, with increased allocation to defensive U.S. sectors, including healthcare, utilities and consumer staples, which are seen as less vulnerable to recession.

More money is flowing into the dollar and dollar-denominated assets as well, with global money managers rotating out of eurozone equities, while bonds, especially U.S. Treasuries, have seen an uptick, which is helping to put a lid on yields.

Prolonged high inflation in the U.S. now has investors betting that the U.S. Federal Reserve will raise rates by another 1.5% this year, and median estimates of the Fed’s rate will likely end the year around 3.4% up 1.5% from estimates in March.

Against the gloomy macroeconomic backdrop, any rally in equities is likely to be short-lived, and a clear dovish shift in monetary policy will be needed for a durable rally.



2. China's Once Hot Property Market is Rapidly Unraveling

  • According to Caixin, a Chinese new site, hundreds of contractors say they themselves can no longer afford to pay their own bills because developers, including China Evergrande Group, still own them money.

  • Although Beijing has urged banks to boost lending to help builders complete their projects and are said to be mulling measures to provide grace periods on payments for homebuyers, bigger monetary policy moves have so far been lacking.

If China Evergrande Group’s bond defaults were the first signs of a crack in the dam of China’s economy, then that crack has since developed into a fault line which threatens to take down a significant portion of the world’s second largest economy with it.

As more homebuyers default on their mortgages – the contagion has now spread to 91 cities where disgruntled buyers have refused to pay their mortgages on stalled developments – builders and contractors are now stiffing banks on their loans as developers fail to pay up.

Because developers are struggling to access credit, especially on global bond markets where even the sturdiest players are offering exorbitant yields with few takers, many aren’t able to complete their projects or pay contractors.

According to Caixin, a Chinese new site, hundreds of contractors say they themselves can no longer afford to pay their own bills because developers, including China Evergrande Group, still own them money.

The repercussion of cascading defaults threatens to derail China’s economy where as much as 29% of GDP is related to the real estate sector and 70% of the overall economy is affected by the fortunes of a once thriving industry.

Homebuyers defaulting on their mortgages and contractors stiffing the banks on theirs comes at the worst possible time for Chinese President Xi Jinping, who is looking to install himself for a third term as president, and then possibly leader for life.

Bailing out some of the country’s real estate developers could exacerbate threats of non-payment by those who didn’t receive relief, while bending to demands for support would necessarily put a strain on state finances, at a time when Xi needs stability.

Although Beijing has urged banks to boost lending to help builders complete their projects and are said to be mulling measures to provide grace periods on payments for homebuyers, bigger monetary policy moves have so far been lacking.

Part of the problem of course is that China is heavily dependent on foreign imports of raw materials, especially oil, which is denominated in dollars.

As the greenback strengthens, it becomes hard for China to cut interest rates aggressively as a weak yuan, whilst helping exports, would hurt China’s ability to import the raw materials that it so desperately needs to power its economy.

Separately, overstocked retailers in the U.S. mean that even though Chinese imports are cheaper, demand in the U.S. has been lower and is likely to be in the coming periods.

Europe, another major destination for Chinese wares, is also in the throws of a major economic slowdown because of soaring energy prices, in particular natural gas, as well as the European Central Bank being forced to walk up interest rates, as the euro slips below the dollar for the first time ever.

Although Chinese lenders have put on a brave front, they are sitting on massive exposure to borrowers with some US$5.7 trillion of outstanding residential mortgages and US$1.93 trillion loaned to China’s embattled real estate developers.



3. SEC Tries to Inch its Way to Remain Crypto-Regulatory Relevant

  • Instead of staking its claim through permission, the SEC is using omission, and looking to exempt selected cryptocurrency firms from specific securities laws that would help the industry come into compliance.

  • The SEC’s repeated rejection of a spot-backed Bitcoin ETF provides little motivation for companies which are currently operating in a regulatory no-man’s land to sit down for a chat with regulators as well.

With a bipartisan bill that would hand over most of the jurisdiction of cryptocurrencies to the U.S. Commodity and Futures Trading Commission making its slow but sure passage through Congress, the U.S. Securities and Exchange Commission is making a last-ditch attempt to stake whatever remaining regulatory claim it has left in an industry dubbed the “Wild West.”

But instead of staking its claim through permission, the SEC is using omission, and looking to exempt selected cryptocurrency firms from specific securities laws that would help the industry come into compliance.

In an interview with Yahoo! Finance (yes it’s still around), Gensler, who last taught blockchain at the MIT Sloan School of Management before taking up the role of SEC Chairman said,

“We do have robust authorities from Congress to use our exemptive authorities that we can tailor.”

Because of the Lummis-Gillibrand bill that is making its way through Congress, which would give the CFTC additional authority to oversee cryptocurrencies deemed to be commodities, the SEC is making moves before the bill becomes law to try to assert some jurisdiction.

Gensler takes the view that cryptocurrencies which more closely resemble asset-backed securities and equity offerings ought to come under the purview of the SEC.

Where a stick may have been Gensler’s preferred tool in the past, he’s now offering a carrot to crypto companies,

““There’s a potential path forward. I’ve said to the industry, to the lending platforms, to the trading platforms: ‘Come in, talk to us.’”

Whether leaders of crypto companies will take the bait is another story altogether and stakeholders have long grumbled that the SEC has never provided a clear path to allow companies to register their product offerings.

The SEC’s repeated rejection of a spot-backed Bitcoin ETF provides little motivation for companies which are currently operating in a regulatory no-man’s land to sit down for a chat with regulators as well.

Two out of the top three cryptocurrency exchanges in the world are not based in the U.S. and have taken steps to ensure that they are just one step removed from the jurisdiction of the SEC.

Those that were within the grasp of the SEC have not fared well.

Embattled crypto lender BlockFi, which received a capital injection from cryptocurrency exchange FTX US, reached a settlement with the SEC in February this year, even though BlockFi had claimed at the time that it would pursue SEC registration of the product.

The SEC may nonetheless be running out of time to stake its claim on the cryptocurrency landscape’s jurisdiction and more assertive moves by the agency could lead to a regulatory turf war adding uncertainty to an industry where several high-profile collapses because of excessive leverage have already rattled the nerves of investors.

Celsius Network, a cryptocurrency lender has filed for Chapter 11 bankruptcy protection and Three Arrows Capital, a major cryptocurrency hedge fund, has filed for Chapter 15 relief, with billions of dollars in unpaid loans.

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