Daily Analysis 23 March 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as markets wind their way higher with appetite for stocks rising as bonds get hammered.

In brief (TL:DR)

  • U.S. stocks closed higher on Tuesday with the Dow Jones Industrial Average (+0.74%), the S&P 500 (+1.13%) and the Nasdaq Composite (+1.95%) up as bonds sank.

  • Asian stocks gained as investors expanded their search for hedges.

  • Benchmark U.S. 10-year Treasury rose three basis points 2.41% (yields rise when bond prices fall) as the prospect of U.S. Federal Reserve balance sheet runoff starts to hit home.

  • The dollar advanced.

  • Oil edged higher with April 2022 contracts for WTI Crude Oil (Nymex) (+0.81%) at US$110.15.

  • Gold was stable with April 2022 contracts for Gold (Comex) (+0.01%) at US$1,926.90.

  • Bitcoin (+2.77%) rose to US$42,303, as investors fanned out in search of other assets that could hedge against the declining value of safe havens like Treasuries.


In today's issue...

  1. Do the Debt Markets Foretell of More Sanguine Monetary Conditions?

  2. As Goes Alibaba, So Does the Chinese Stock Market

  3. Higher Inflation Could See the Rise of Crypto Games



1. Do the Debt Markets Foretell of More Sanguine Monetary Conditions?

  • When monetary conditions were loose and the prospects good, the spread between high yield debt and that of rock-solid companies were generally quite tight.

  • While the Fed has raised rates, yields are also being pushed higher as investors raise their forecast for how high inflation will run, rocked by the rising cost of energy and food.

An oft heard adage is that the stock market, isn’t the economy.

And while that may be true, the debt market could well be.

When monetary conditions were loose and the prospects good, the spread between high yield debt and that of rock-solid companies were generally quite tight.

Given the abundance of liquidity, investors looking to make their money work harder for them, were willing to lend to some of the riskiest borrowers in a search for yield.

But the U.S. Federal Reserve’s hawkish pivot has changed the calculation, with borrowing costs for companies and individuals rising since last December and the recent rate hikes by 0.25% sending Treasury yields soaring to their highest level in almost three years (yields rise when bond prices fall).

Treasuries are the risk-free benchmark from which virtually all financial markets take dressing, including everything from what we pay on our mortgage to our cars and while yields had been rising for some time, they hadn’t yet bled into corporate debt markets, that is until now.

To be sure, the rising cost of borrowing isn’t down solely to the Fed.

While the Fed has raised rates, yields are also being pushed higher as investors raise their forecast for how high inflation will run, rocked by the rising cost of energy and food.

Financial conditions for borrowers did ease slightly, thanks to a stock market rebound early this week, but even that respite proved temporary as U.S. Federal Reserve Chairman Jerome Powell reiterated that the central bank would soon need to run off its US$8.9 trillion balance sheet, which will send yields rising and tighten conditions further.

Fortunately, most companies managed to make hay while the sun shined last year, borrowing while the going was good, with airlines and cruise companies loading up on debt.

This year, riskier companies with junk-rated bonds have only reached out for US$38.8 billion, down over 70% from a year prior, and conditions are getting tougher for those looking to borrow.

That the debt markets have been regearing themselves since last December suggests that the Fed didn’t even need to actually raise rates to achieve what it set out to do – temper activity through tone.

Since last December, the Fed’s tough talk on inflation has seen markets respond without needing central bank intervention and could ultimately mean that policymakers have the needed flexibility to hold back on rate rises in the event that economic conditions should worsen.



2. As Goes Alibaba, So Does the Chinese Stock Market

  • Yesterday, Alibaba Group announced that it would increase its authorized share repurchases to US$25 billion from US$15 billion previously, to be implemented over the coming two years.

  • The announcement saw Alibaba’s stock rally by over 40% since last week, lifting shares of other Chinese tech firms with it and comes in the wake of top Chinese economic minister Liu He reassuring investors that Beijing would soon finish its “rectification” of the country’s tech giants.

Chinese e-commerce juggernaut Alibaba Group (+7.35%) is serving its patriotic duty in a US$25 billion share buyback plan that looks to shore up investor confidence after slowing growth and a crackdown in the tech sector sent the company’s shares to a multiyear low.

Since Chinese authorities canceled Alibaba Group’s IPO of Ant Group in November 2020, shares in the e-commerce company have lost around 65% of their value.

Yesterday, Alibaba Group announced that it would increase its authorized share repurchases to US$25 billion from US$15 billion previously, to be implemented over the coming two years.

So far Alibaba Group has repurchased US$9.2 billion worth of stock as part of the program.

The announcement saw Alibaba’s stock rally by over 40% since last week, lifting shares of other Chinese tech firms with it and comes in the wake of top Chinese economic minister Liu He reassuring investors that Beijing would soon finish its “rectification” of the country’s tech giants.

Alibaba is currently trading at a forward price-to-earnings multiple of just 12.2, with cash on its balance sheet representing over a quarter of its market value, according to research group Bernstein.

As tech companies go, Alibaba and other Chinese tech giants are a lot cheaper than equivalents in the U.S. but they also face unique challenges that other their American counterparts don’t have to deal with.

Opaque and unpredictable regulatory crackdowns, some of which have the ability to upend entire business models as well as the potential for delisting from New York’s stock exchanges have meant that investing in Chinese tech firms is not for the fainthearted.

While the relatively cheap share price of Alibaba Group has lured in legendary value investors, including Berkshire Hathaway’s Vice Chairman Charlie Munger, the rest of Wall Street has not yet been convinced, nor have global investors.

Since the start of the year, over US$6 billion in flows have been marked moving out of Chinese equities, according to data from Hong Kong and Chinese exchanges.

Alibaba, once a reliable earner, reported its slowest quarterly sales growth in the fourth quarter of 2021 since its IPO in 2014, suggesting that the breakneck pace of growth for the company may be in rearview mirror.

Confidence is a tricky thing to manage, it takes years to build, but only minutes to shake and it could be sometime before investors return in sufficiently large numbers to China’s growth story.

Regulatory crackdowns, threats of U.S. delisting and geopolitical instability as well as a zero-Covid policy are all weighing down the Chinese economy and driving sentiment negative.

Whether these current measures to lighten the crackdown on Chinese tech are a momentary stopgap by Beijing ahead of a major leadership conclave, or whether they will prove durable remains to be seen.

Even then, Alibaba continues to face competition from other e-commerce groups, including Pinduoduo (+18.85%) and JD.com (+1.02%) and newer platforms including Douyin, the sister app to TikTok which lets influencers sell products through streaming content.



3. Higher Inflation Could See the Rise of Crypto Games

  • With inflation running at 10-month highs in Argentina and eroding the value of local salaries, the country has become a hotbed in Latin America for play-to-earn blockchain games.

  • But it’s not all fun and games for players in emerging markets, some of it has a business element to it as well.

Last year, the massively popular blockchain play-to-earn game Axie Infinity made headlines as a combination of rising cryptocurrency prices and a collapse in incomes because of the pandemic saw players from emerging markets relying on the game for an alternative source of living, sometimes even exclusively.

From the crypto-savvy to the clueless, millions of players in emerging markets such as the Philippines and Vietnam collected and reared the cute Axies and the non-fungible tokens associated with them, and making an income sometimes in excess of their previous jobs in the process.

Now with inflation hitting 6.8% in the United States, people in the rich world are having to face the same sort of price pressures that those in emerging markets, especially places like Argentina, have had to contend with for years.

With inflation running at 10-month highs in Argentina and eroding the value of local salaries, the country has become a hotbed in Latin America for play-to-earn blockchain games.

According to data from Decentral Games, the metaverse company with the most players in the world, South America’s second largest economy has leapfrogged to become the world’s fifth largest user base for play-to-earn games globally, while Brazil has jumped to seventh spot.

Both Brazil and Argentina struggling under the weight of double-digit inflation.

In Argentina, prices are growing at a pace of more than 50% annually and wages have grown below inflation for the last four years, while in Brazil, inflation doubled last year to 10% annually, increasing pressure for workers to make ends meet and leaning on play-to-earn to provide additional income.

Within Latin America, Argentina, Brazil and Venezuela are the countries with the most number of Axie Infinity players, where players earn cryptocurrencies by winning collecting and rearing Axies and then winning battles with them.

But it’s not all fun and games for players in emerging markets, some of it has a business element to it as well.

It’s estimated that most Latin Americans play on behalf of Americans because they cannot afford the initial cryptocurrency payment to open their own accounts to start playing.

Several gaming platforms, including Decentral Games, Axie Infinity and Sandbox require users to already have NFTs to play, and users typically buy “NFT delegations” or rent out their NFTs to other players who don’t have the startup capital to buy in.

But Latin America is hardly the only region where play-to-earn games are catching on quickly, for instance, Axie Infinity’s fastest growth is coming from Asia, with Latin America coming in a close second.

Asia and Latin America have both gone through fairly recent periods of high inflation and wages there have generally stagnated.

With the Russian invasion of Ukraine ongoing and putting upwards price pressure on food and fuel in Europe and the U.S., inflation may start to hit harder, especially as wages stagnate – which means that more players may come onboard to these play-to-earn games, not just for entertainment, but as a means to supplement their incomes as well.

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