Daily Analysis 21 July 2022 (10-Minute Read)

Hello there,

A wonderful Thursday to you as the stock rally sputters in Asia amid growth concerns.

In brief (TL:DR)

  • U.S. stocks continued to rise on Wednesday with the Dow Jones Industrial Average (+0.15%), S&P 500 (+0.59%) and the Nasdaq Composite (+1.58%) all up.

  • Asian stocks slid with U.S. futures Thursday as investors weighed signals from the latest corporate earnings and geopolitical risks in Europe.

  • Benchmark U.S. 10-year Treasury yields fell about one basis point to 3.01% (yields fall when bond prices rise) but remain elevated.

  • The dollar edged lower.

  • Oil slipped with August 2022 contracts for WTI Crude Oil (Nymex) (-1.88%) at US$102.26 as growing stockpiles of crude and gasoline tempered fears of a tight market.

  • Gold edged lower with August 2022 contracts for Gold (Comex) (-0.61%) at US$1,707.20.

  • Bitcoin (-2.04%) fell to US$22,891 as Tesla disclosed that it sold about 75% of holdings of the cryptocurrency during the second quarter of this year.


In today's issue...

  1. Recession or Inflation – What should worry investors more?

  2. Global Investors Cut China Sovereign Bond Holdings

  3. Tesla Dumps Bitcoin to Bolster Balance Sheet


Market Overview

Risk sentiment remains fragile as investors debate whether equities have reached a trough after this year’s selloff amid the war in Ukraine, a slowdown in China and the prospect of a U.S. recession.

Investors are also assessing earnings to gauge how companies are managing amid the highest inflation in generations and escalating borrowing costs.

Asian markets were mixed on Thursday with Tokyo's Nikkei 225 (+0.11%) and Seoul's Kospi Index (+0.46%) up, while Sydney’s ASX 200 (-0.06%) and Hong Kong's Hang Seng Index (-1.26%) were down in the morning trading session.



1. Recession or Inflation - What should worry investors more?

  • Inflation and recession are closely linked because to battle high prices, the Fed could raise interest rates so fast that it triggers an economic slowdown.

  • Against this backdrop, what should investors do to position their portfolios to manage either outcome?

On the one hand, inflation will see central banks continuing to tighten, hitting stocks, on the other hand, a recession will hit bottom lines and bring stocks lower, but which is worse?

A Bloomberg monthly survey of economists suggests that the odds are close to 50-50 that a recession hits the U.S. next year, while headline inflation has risen the most since 1981, and the U.S. Federal Reserve appears determined to act.

Inflation and recession are closely linked because to battle high prices, the Fed could raise interest rates so fast that it triggers an economic slowdown.

Against this backdrop, what should investors do to position their portfolios to manage either outcome?

To be sure, inflation is here and now and some money managers are recommending energy and financial companies, as they are the most likely to benefit from higher prices.

Banks make more money when interest rates rise as they can charge more on loans and years of underinvestment in capacity have meant that energy companies and those extracting raw materials can’t suddenly increase their production, facilitating higher prices.

But other money managers suggest that investors ought to be paying more attention to the warning signals of a recession.

A recession may be worse because firms in tech and finance, which are usually big hirers when times are good, will dial back on recruiting, then start to lay off, which hurts consumption.

Which is why some money managers are suggesting that planning for a recession may be the safest option for most investors, including keeping enough savings to cover a year without salary in the event of being laid off.

Given the record amount held as cash in the U.S. right now, it appears that many investors are taking that advice to heart, but inflation eats away at the value of savings.

There’s also the false notion that if a recession occurs, inflation will automatically dissipate, but that’s not necessarily the case at all.

In the 1970s, the U.S. experienced a painful period of stagflation, with soaring prices and negative growth, fueled in large part by the energy crisis.

With Russia’s invasion of Ukraine wearing on, supply of fertilizers, agricultural commodities and energy, especially natural gas, will remain off global markets and continue to contribute to higher prices for some time and that has a material impact on inflation.

And that’s why investors may consider holding on to hard assets, including gold or gold mining

companies, along with agricultural commodities that are not as sensitive to economic cycles.



2. Global Investors Cut China Sovereign Bond Holdings

  • With China’s economy showing signs of slowing and the increased likelihood that Beijing will need to step in at some point to shore up its rapidly deteriorating real estate sector, global investors have cut holdings of China’s sovereign bonds for a fifth straight month in June.

  • There are a variety of factors underpinning the drop in global demand for Chinese sovereign debt, including a weakening yuan as the monetary policies of the U.S. and China diverge, falling yields relative to U.S. Treasuries and geopolitical concerns.

Culturally, the Chinese loathe debt and have historically tried to pay off any loans well in advance of when they have been due.

But decades of reform and economic expansion have remade the Chinese psyche to see debt as an instrument to gin up another indelible Chinese trait – the penchant for speculation, which is what has led to China’s current real estate crisis.

With China’s economy showing signs of slowing and the increased likelihood that Beijing will need to step in at some point to shore up its rapidly deteriorating real estate sector, global investors have cut holdings of China’s sovereign bonds for a fifth straight month in June.

It doesn’t help that rising U.S. Treasury yields have dulled the attractiveness of yuan-denominated debt and global funds held just US$340 billion of Chinese government bonds in June, according to data released by the People’s Bank of China.

There are a variety of factors underpinning the drop in global demand for Chinese sovereign debt, including a weakening yuan as the monetary policies of the U.S. and China diverge, falling yields relative to U.S. Treasuries and geopolitical concerns.

China’s benchmark 10-year yield rose 0.08% in June alone, its biggest jump since last October, on the back of a record supply of government debt and much lower liquidity.

In comparison, the benchmark U.S, 10-year Treasury yield soared by 1.69% over the same period as the U.S. Federal Reserve raised interest rates.

All this complicates matters for Beijing, at a time when a bailout of its real estate sector seems all but inevitable.

Beijing has already pledged fiscal intervention as its economy slows, to cope with rolling zero-Covid lockdowns and a prolonged property slump, including an unprecedented issuance of US$220 billion worth of special bonds for the rest of the year, heaping on more debt to the existing yuan-debt supply.



3. Tesla Dumps Bitcoin to Bolster Balance Sheet

  • According to Tesla’s second quarter earnings, the company converted about 75% of its Bitcoin into dollars, adding some US$936 million of cash to its balance sheet, but suffering an impairment as a result of the sale.

  • Bitcoin slipped below US$24,000 and was trading around US$22,780 at the time of writing as news of the Tesla sale roiled a nascent recovery in cryptocurrencies.

With a CEO as irascible as Elon Musk, electric vehicle maker Tesla’s (+0.80%) holdings of Bitcoin were always going to be touch-and-go and given how Musk walked away from his acquisition of Twitter, it ought to come as no surprise that he would back down from Bitcoin.

According to Tesla’s second quarter earnings, the company converted about 75% of its Bitcoin into dollars, adding some US$936 million of cash to its balance sheet, but suffering an impairment as a result of the sale.

A Blomberg Intelligence estimate suggests that Tesla’s Bitcoin impairment could be as much as US$740 million.

Although Musk has long expressed interest in Bitcoin and Dogecoin, and at one point allowed customers to buy Tesla’s electric vehicles with Bitcoin, only to suspend that move late, the recent sale of Bitcoin into the dip may have had more to do with accounting than ideology.

A quick read of Tesla’s cashflow statement reveals a cashflow bonus of US$936 million from the sale of Bitcoin, with the cashflow change of around US$847 million as a result.

In other words, without the cash infusion from the sale of Bitcoin, Tesla would likely have been cashflow negative this past quarter, which seems to suggest that the electric vehicle maker might have been trying to dress up its earnings.

Like other companies, Tesla has been dealing with inflation and an overall slowing economy this past quarter, and a sharp decline in cryptocurrency prices has not helped its balance sheet which at one point held some US$1.5 billion worth of Bitcoin.

During a call with investors, Musk addressed the Bitcoin sale claiming that “it should not be taken as some verdict on Bitcoin,” but was more to address “overall liquidity of the company given COVID shutdowns in China.”

China has emerged as a key market for Tesla, but the electric vehicle maker has not been immune to Beijing’s policies, including its zero-Covid lockdown policies that has hit Tesla’s factories as well as demand for its products.

Bitcoin slipped below US$24,000 and was trading around US$22,780 at the time of writing as news of the Tesla sale roiled a nascent recovery in cryptocurrencies.


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