Daily Analysis 27 April 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as stocks wind lower on poorer-than-expected earnings reports and with recession risks looming.

In brief (TL:DR)

  • U.S. stocks fell on Tuesday with the Dow Jones Industrial Average (-2.38%), S&P 500 (-2.81%) and the Nasdaq Composite (-3.95%) all down sharply.

  • Asian markets fell Wednesday as mixed corporate earnings, China’s Covid struggles and the prospect of aggressive U.S. Federal Reserve monetary tightening all pointed to a deteriorating economic outlook.

  • Benchmark U.S. 10-year Treasury yields rose about one basis point to 2.73% (yields rise when bond prices fall).

  • The dollar was around the highest level in nearly two years.

  • Oil climbed past US$102 a barrel amid the escalating tension with June 2022 contracts for WTI Crude Oil (Nymex) (+0.66%) at US$102.37, with Europe looking at curbing Russian barrels.

  • Gold inched lower with June 2022 contracts for Gold (Comex) (-0.16%) at US$1,901.10.

  • Bitcoin (-4.38%) dipped to US$38,406 (at the time of writing) alongside other risk assets as the outlook becomes increasingly grim across all asset classes.


In today's issue...

  1. As goes General Electric so goes the General Economy

  2. How do we avoid a recession?

  3. Bitcoin for your Retirement Account?


Market Overview

Stocks fell Wednesday as mixed corporate earnings, China’s Covid struggles and the prospect of aggressive Federal Reserve monetary tightening all pointed to a deteriorating economic outlook.

The energy brinkmanship and disappointment over earnings from the likes of Alphabet Inc. and Texas Instruments Inc. sowed further doubts about the outlook for markets.

The mood was already fragile due to Fed tightening to quell runaway inflation and slowing activity in China as Covid lockdowns bite.

Asian markets fell Wednesday with Seoul's Kospi Index (-1.10%), Tokyo's Nikkei 225 (-1.88%), Hong Kong's Hang Seng Index (-0.56%) and Sydney’s ASX 200 (-0.54%) were all down in the morning trading session.



1. As goes General Electric so goes the General Economy

  • Yesterday, GE warned that its full year results would come in at the lower end of its earlier forecasts sending the stock plummeting by 10% in early trading.

  • GE’s problems reflect those of the broader economy as well, including supply chain constraints which have lowered output for its commercial aircraft engines business.

Founded in 1892, few companies represent the heart of the American economy and innovation as much as General Electric (-10.34%).

Although its consumer appliances division is the most visible to the general public, a significant portion of GE’s sales are to the U.S. Department of Defense and its other business units cover everything from commercial to consumer finance, infrastructure (including diesel locomotives, jet engines, water treatment systems and energy grids) consumer and industrial technologies, and healthcare.

Which is why GE’s performance is often closely watched as a proxy to how the U.S. economy is performing outside of technology.

Yesterday, GE warned that its full year results would come in at the lower end of its earlier forecasts sending the stock plummeting by 10% in early trading and rippling through the rest of the stock market as CEO Larry Culp warned of a series of “macro headwinds” that is putting pressure on revenues, even as the 130-year-old conglomerate prepares to split into three separate companies.

To be fair, GE has struggled for years, culminating in its unceremonious ejection from the Dow Jones Industrial Average in 2018 after over a century as one of the original components of the benchmark index, but things were looking up for the conglomerate as prepared to split into three business units centered around aviation, healthcare and energy.

And GE’s problems reflect those of the broader economy as well, including supply chain constraints which have lowered output for its commercial aircraft engines business, despite a restart in the aviation sector post-pandemic, as well as weaker revenue growth in its healthcare division, where lockdowns in China are affecting demand.

Making matters worse, GE took a US$230 million pre-tax charge for the first quarter to March 31, to reflect the impact of the Russian invasion of Ukraine, reflecting impairments on receivables, inventories and other assets as well as investments in Russia where it has suspended operations, and which represented 2% of group sales.

Although some of GE’s woes are idiosyncratic, lowered expectations for the group’s adjusted earnings per share are fueling concerns that the macro landscape is proving unfavorable for equities in general, especially as the U.S. Federal Reserve prepares to take its most aggressive action in decades on inflation.

Earlier this month, Wall Street’s biggest banks reported a decline in dealmaking earnings, while pandemic darlings like Netflix (-5.48%) saw a fall in subscribers, and now with an industrial giant like GE being hammered by macro factors, it may be the last shoe to fall.

All eyes now will be on the Fed and whether it will risk a potential economic slowdown or even triggering a recession in its fight against inflation and the odds of a policy misstep as well as the stakes could not be higher.



2. How do we avoid a recession?

  • Hot on the heels of a crippling global pandemic that was met with unprecedented fiscal and monetary responses, a nuclear-armed waning power is trying to flex one last time by invading a neighbor.

  • The key metric that investors should be looking at then is labor force participation rate in the U.S., which has been rising, but not far enough.

With investors starting to price in a Fed-induced recession, there are conflicting views as to whether the market can avoid monetary policy becoming the last straw that breaks the camel’s back.

In a paper by former U.S. Treasury Secretary Lawrence Summers and former Harvard Kennedy School research fellow Alex Domash, the duo point out that since 1955, there have been at least 8 instances where wage inflation was above 5% and unemployment was below 4% (as it is now) and in all 8, a recession followed within two years.

But history is not destiny and just as the world managed to avoid a global conflict for almost eight decades after the end of the Second World War, there’s a change that this time really is different.

To begin with, this is an anomalous moment in history, with no similar analogues.

Hot on the heels of a crippling global pandemic that was met with unprecedented fiscal and monetary responses, a nuclear-armed waning power is trying to flex one last time by invading a neighbor.

Many of the supply chain issues caused by the pandemic haven’t even been figured out yet, even as new problems from Russia’s invasion of Ukraine are making things worse.

Add to that mix China’s debilitating coronavirus lockdowns of commercial and industrial centers and it’s evident that the supply side of the equation is contributing significantly to higher prices, even as sentiment is starting to plateau.

So, what would the U.S. Federal Reserve do?

Goldman Sachs economist David Mericle believes that what forces the Fed into a recession-strength action on policy is where a wage-price spiral emerges because if salaries aren’t rising too fast, the Fed could wait out inflation, especially since it’s being worsened by supply chain issues.

Wages, unlike the prices of goods and services, tend to be sticky – once increased they’re hard to decrease and when the cross a certain growth threshold, they feed a wage-price spiral that the Fed will be forced to break.

The danger is that the U.S. is getting there – the Employment Cost Index is running at around 4% now, but so long as productivity is increasing at the rate of between 1% to 1.5%, employers should be able to put a lid on prices.

Any higher than that however, and the Fed may be forced to induce a recession as a means to break the descent into an uncontrollable wage-price spiral.

The key metric that investors should be looking at then is labor force participation rate in the U.S., which has been rising, but not far enough.

A higher labor force participation will help to bring down the pressure on employers to keep jacking up wages to attract more workers.

The Employment Cost Index report for March comes out at the end of this week and will provide further insight as well as an additional datapoint as the Fed prepares for its next policy meeting in May.

While most investors have already priced in a 0.50% rate hike at the next Fed meeting, slowing earnings growth, the prospect of a recession, as well as labor participation, will all factor into considerations by policymakers.

If a recession is to be avoided, it will be right down to the wire.



3. Bitcoin for your Retirement Account?

  • Fidelity Investments is set to allow investors to put a Bitcoin account in their 401(k) plans, the first major retirement-plan provider to do so.

  • Fidelity’s embrace of cryptocurrencies is bringing the nascent asset class into the mainstream, a move that could prompt wider acceptance amount employers.

One of the world’s largest asset managers, Fidelity Investments, is set to allow investors to put a Bitcoin account in their 401(k) plans, the first major retirement-plan provider to do so.

For non-Americans, the 401(k) is an employer-sponsored defined-contribution pension account and employee funding comes directly off their paycheck which may be matched by their employer and like provident funds or pension contributions in other countries.

There are two types of 401(k) plans, traditional and Roth 401(k), with contributions and withdrawals on the latter having no impact on income tax, whereas for traditional accounts, contributions may be deducted from taxable income, while withdrawals are added to the same.

The benefit of the Roth 401(k) is tax-free capital gains, which could become a major draw especially for investors who want to get in on Bitcoin, given its price potential.

While employees won’t immediately be able to start adding cryptocurrencies to their nest eggs right away, later this year, the 23,000 American companies that use Fidelity to administer their retirement plans will have the option to put Bitcoin in them.

Under any other market conditions, America’s biggest retirement plan provider adding Bitcoin to its mix of offerings would have acted as a huge boost on Bitcoin’s price as it is a major endorsement by a mainstream retirement plan provider.

But Fidelity’s move comes at a time when Bitcoin’s correlation with stocks is at its nadir, in part due to rising borrowing costs and the prospect of tighter monetary conditions, and the volatility in the markets is not helping an already volatile asset class.

Under Fidelity’s plan, retirement savers could add as much as 20% of their nest eggs to Bitcoin, though that threshold could be lowered by plan sponsors.

And Fidelity has no intention to stop at Bitcoin, expecting to roll out other cryptocurrencies in the future.

Fidelity’s embrace of cryptocurrencies is bringing the nascent asset class into the mainstream, a move that could prompt wider acceptance amount employers.

With over 20 million participants and some US$2.7 trillion in assets under administration, Fidelity has been growing its presence in the cryptocurrency business, having launched its own trading and custody platform in 2018 that caters to hedge funds and other professional investors.

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