Daily Analysis 25 April 2022 (10-Minute Read)

Hello there,

A magnificent Monday to you as markets continue to get mauled with Beijing doubling down on its zero-Covid policy while simultaneously conducting a purge in the Chinese financial services sector.

In brief (TL:DR)

  • U.S. stocks closed sharply down on Friday with the Dow Jones Industrial Average (-2.82%), S&P 500 (-2.77%) and the Nasdaq Composite (-2.77%) all awash in red on myriad concerns from policy tightening to slowing economic growth.

  • Asian markets sank Monday as China’s worsening Covid situation amplified concerns about a slowdown in demand in the world’s second-largest economy.

  • Benchmark U.S. 10-year Treasury yields fell five basis points to 2.85% (yields fall when bond prices rise) on heightened uncertainty.

  • The dollar extended an advance as investors opted for safe havens.

  • Oil continued to sink with June 2022 contracts for WTI Crude Oil (Nymex) (-2.83%) at US$99.18 on continued concerns over Chinese demand.

  • Gold provided no safe harbor with June 2022 contracts for Gold (Comex) (-0.52%) at US$1,924.30 as all assets have been dumped.

  • Bitcoin (-1.25%) slipped into the week again at US$39,081 (at the time of writing) and looking well on its way to crash through several key support levels at US$38,500 as a bout of fear has set in on all manner of assets.


In today's issue...

  1. Don’t Expect Slower Growth to Change the Fed’s Mind

  2. Beating Ploughshares into Swords

  3. NFTs Never Give Up


Market Overview


Fears a wider lockdown in the Chinese capital amid the government’s steadfast adherence to its Covid-zero policy is spooking investors worried about disruptions to the global supply chain and demand.

The outlook for inflation continues to overhang the markets. U.S. Federal Reserve Chairman Jerome Powell endorsed a 50 basis-point increase next month and at least one more such move, outlining his most bold approach yet to reining in surging prices.

Stronger tightening signals from the European Central Bank are also undermining risk appetite.

Asian markets opened Monday uniformly lower with Seoul's Kospi Index (-1.42%), Tokyo's Nikkei 225 (-1.60%), Sydney’s ASX 200 (-1.57%) and Hong Kong's Hang Seng Index (-2.58%) all down in the morning trading session.



1. Don't Expect Slower Growth to Change the Fed's Mind

  • The rapid slowdown in the U.S. economy comes on the back of a scorching 6.9% of growth in the fourth quarter of 2021.

  • Because the U.S. Federal Reserve is more focused on inflation right now, there are growing concerns that higher commodity prices and borrowing costs will be the double-whammy that will possibly tip the economy into recession.

With the U.S. dealing with the fastest pace of price increases in over four decades, poorer-than-expected economic growth is unlikely to shake an increasingly hawkish U.S. Federal Reserve.

Driven largely by a reversal of the last quarter’s unexpected boom in inventory accumulation, the U.S. Department of Commerce is widely expected to report on Thursday that the U.S. economy grew at an annualized pace of just 1% in the first three months of 2022, according to a survey of economists by Reuters.

The rapid slowdown in the U.S. economy comes on the back of a scorching 6.9% of growth in the fourth quarter of 2021, when companies were looking to stock up on their inventories to cater to the expected post-pandemic surge in demand against the backdrop of fraying supply chains.

Late last year, the flow of goods around the world eased and businesses found themselves producing far more than they sold in the fourth quarter of 2021, driving inventories higher and sending production lower in the first quarter of 2022.

While some analysts expect that personal consumption will rise to whittle down these inventories, that’s not a given because inflation is starting to have a drag on consumer sentiment and the economy is already showing signs of slowing down.

Because the U.S. Federal Reserve is more focused on inflation right now, there are growing concerns that higher commodity prices and borrowing costs will be the double-whammy that will possibly tip the economy into recession.

The Fed can only work with past data, and the effects in the first quarter of higher input and borrowing costs haven’t yet been fully felt because financial conditions still remained relatively loose and household finances remain strong, increasing the risks of policy missteps.



2. Beating Ploughshares into Swords

  • Unfortunately, 77 years after the end of the Second World War, the world finds itself still dealing with the ideological and national rivalries of the last major global conflict.

  • Russia’s invasion of Ukraine has fueled expectations of surging government orders, higher revenues and stronger profits for companies in the defense sector.

Decades of peace have lulled the world into assuming that the unassailable march of globalization would usher in a period of unprecedented wealth and harmony amongst nations, built around global institutions based on mutually beneficial interdependencies.

Unfortunately, 77 years after the end of the Second World War, the world finds itself still dealing with the ideological and national rivalries of the last major global conflict.

Russia and China both plagued by what their leaders believe have been decades of humiliation at the hands of the victorious powers at the end of the Cold War, are forming an authoritarian axis against increasingly tired Western liberal democracies whose populations are loathe to be dragged into another consuming conflict.

Against this backdrop, years of underspending on defense equipment may about to be reversed as the aggressors in the last major global conflict, Germany and Japan, are set to cast off their postwar guilt and gird their loins for the tough task ahead of defending the existing world order.

The obvious beneficiaries of what is likely to be a durable trend in defense spending will be defense contractors whose shares have languished as years of peace led to complacency and underinvestment in global militaries.

After September 11, 2001, most governments focused on the threat of asymmetric warfare from terrorist organizations, and military strategists largely thought that outside of America’s archrival China, conflicts were likely to be limited to skirmishes with irregular forces.

That shift in military doctrine led to global underinvestment (outside of China and Russia) in nation versus nation type weapons such as ballistic missiles and large surface combatants, spending which most benefits defense contractors.

With the world becoming increasingly insecure, an MSCI index tracking aerospace and defense shares has beaten a broader gauge of global stocks by 17% in dollar terms since January, only the third time the sector has outperformed since 1999.

And that may just be the beginning as governments increase military spending on a variety of weapons, especially big-ticket items like fighter aircraft, tanks and armored vehicles.

Russia’s invasion of Ukraine has fueled expectations of surging government orders, higher revenues and stronger profits for companies in the defense sector.

The abysmal performance of the Russian army, given its serious deficiencies in logistics will also see governments invest and spend more in companies that cater to that most important segment of the defense sector which typically flies under the radar.

Whereas companies like Lockheed Martin (+1.40%) and General Dynamics (-1.29%) make headlines for their high-profile weapons, the less glamorous aspect of fueling and feeding armies is often also the most high-margin segment of the business, which benefits names like Halliburton (-3.23%) and AECOM (-4.93%), which are all logistics providers.

Some analysts have warned that it’s premature to take big bets on the defense sector with regional conflicts in the past having seen similar gains, only to be returned six months later.

Much depends on how an investor views the Russian invasion – as simply a localized conflict, akin to Iraq’s invasion of Kuwait, or the belligerence of a nuclear-armed second-rate power trying to reassert its dominance on the global stage.

Either way, Germany and Japan have been woken from their slumber and are likely to spend somewhere in the region of 2% of their GDP on defense.

Investors concerned about the durability could place strategic bets on military logistics providers because offshore deployments by the U.S. are likely to increase in the medium term, which will shore up demand for these services – militaries are likely to buy bedding for soldiers ahead of ballistic missiles.



3. NFTs Never Give Up

  • Non-fungible token or NFT sales have plunged by around 50% this year alone, a handful of new projects are hoping to revive enthusiasm for a market that lives and dies on hype and sentiment.

  • It remains to be seen if the recent uptick in volumes is genuine, or if NFT fever has returned to the market, especially if risk appetite wanes against a backdrop of tightening monetary policy.

Despite the challenging year for cryptocurrencies in general and even though best estimates suggest that non-fungible token or NFT sales have plunged by around 50% this year alone, a handful of new projects are hoping to revive enthusiasm for a market that lives and dies on hype and sentiment.

There are some green shoots of recovery, with weekly volume now up around a third from a low in March, according to data from blockchain analytics firm Nansen, but the overall NFT market remains small.

Cryptocurrency exchange Coinbase Global (-4.22%) launched an NFT index this week in addition to a trial version of an NFT marketplace that could lead a jump in transactions as the space becomes more accessible for investors.

According to DappRadar, the first quarter of 2022 saw around 200,000 daily unique wallets interacting with NFTs, which could see a surge if even a fraction of Coinbase Global’s 90 million verified users comes onboard to embrace NFT trading.

In a sector already known for speculation, NFTs represent speculation on steroids, as evidenced by the investor who paid around US$2.9 million for Twitter founder Jack Dorsey’s first tweet which was made into an NFT, and which attracted a bid of just US$280 two weeks ago.

Nevertheless, NFT proponents remain undeterred, with new developments from Yuga Labs, the creator of the white-hot Bored Ape Yacht Club, arguably one of the most successful NFT collections, possibly enticing NFT investors back into the fray.

In March, Yuga Labs raised a whopping US$450 million to fuel its expansion plans and its ApeCoin commands a staggering US$4 billion market cap, according to data from CoinMarketCap.

Capitalizing on the popularity of Bored Ape, Coinbase Global last week announced a Bored Ape film series, to drum up interest and trading in the NFTs.

But NFTs are very much art and susceptible to wild price swings – one man’s masterpiece is another man’s madness and data from Nansen confirms that as many as one in three NFT projects have little to no trading, given how users and collectors are constantly moving on the next big thing.

Trading volumes are also highly suspect, with many NFT prices being derived from wash trading (trading amongst insiders to jack up the price).

It remains to be seen if the recent uptick in volumes is genuine, or if NFT fever has returned to the market, especially if risk appetite wanes against a backdrop of tightening monetary policy.

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