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Daily Analysis 28 June 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as stocks pull back on the back of higher energy prices with high inflation and risks to economic growth dampening sentiment.

In brief (TL:DR)

  • U.S. stocks opened weaker on Monday with the Dow Jones Industrial Average (-0.20%), S&P 500 (-0.30%) and the Nasdaq Composite (-0.72%) all closing lower on Monday as higher energy costs increased concerns over persistent inflation.

  • Asian stocks fluctuated Tuesday as investors question whether central banks can raise interest rates to rein in inflation without derailing growth.

  • Benchmark U.S. 10-year Treasury yields fell to 3.176% (yields fall when bond prices rise) on growth concerns leading to a reversal in risk appetite.

  • The dollar slipped in Asian trading.

  • Oil gained with August 2022 contracts for WTI Crude Oil (Nymex) (+1.05%) at US$110.72 as the continued absence of Russian crude from global markets continued to weigh on the supply side of the equation.

  • Gold inched higher with August 2022 contracts for Gold (Comex) (+0.12%) at US$1,827.00.

  • Bitcoin (-2.04%) fell to US$20,724, as risk appetite waned against increasing concerns over a global recession and the prospect of stagflation.

In today's issue...

  1. Bank of International Settlements Warns of Stagflation

  2. Exxon Mobil CEO Warns that Abrupt Shift to Renewables Could be Disaster

  3. Crypto's Picks & Shovels Trade More Volatile than Underlying Asset Tracked

Market Overview

Global investors are having to contend with the double whammy of slowing growth and high inflation, with central banks unlikely to be able to rescue markets at this juncture, especially given their focus on putting a lid on price pressures.

The odds of a recession are on the rise, and institutional portfolio rebalancing as another quarter draws to a close will heighten volatility in an attempt to maintain a mix of stocks and bonds, which would explain the recent pullback in yields.

Asian markets were mixed with Tokyo's Nikkei 225(-0.15%), Seoul's Kospi Index (-0.04%) and Hong Kong's Hang Seng Index (-0.86%) down, while Sydney’s ASX 200 (+0.54%) was higher on a rally in commodities in the morning trading session.

1. Bank of International Settlements Warns of Stagflation

  • The Bank of International Settlements warns that policymakers are at risk of pushing the global economy into stagflation, marked by high inflation and low growth.

  • Central bankers are hamstrung because they cannot determine if the factors causing inflation are likely to be transitory or durable and how to respond to them is oftentimes a political rather than economic exercise.

The global economy may be teetering on the brink as it enters a new era of soaring inflation which requires central banks to raise rates, threatening even more malaise, at least according to the Bank of International Settlements (BIS).

In its annual report, the BIS said that the possibility of stagflation looms over the global economy as dangers of an era of unprecedented inflation dovetails with slowing growth and tighter financial conditions.

Policymakers have raised interest rates to combat record high inflation and no less than 70 central banks have increased borrowing costs, with half of them caving in to implementing outsized rate hikes of 75 basis points or more at a time.

However, keeping inflationary pressures at bay while concurrently softening the impact on economic activity is a large ask, and the likelihood is high that policymakers will get it wrong, which is why the BIS is suggesting that odds of a favorable outcome could improve if policies tighten in a timely and decisive manner.

But trying to enact policy when the economic sands are constantly shifting is like trying to juggle while driving a car blindfolded.

Policymakers are not soothsayers and can only respond to real-time data on the fly, which is bad for businesses trying to plan out their inventories, purchases and hiring.

Under such circumstances, companies will understandably err on the side of caution, especially if sentiment and outlook appear poor.

Complicating matters is that righting monetary policy, especially after decades of easy conditions, is challenging both politically and practically.

The Chairman of the U.S. Federal Reserve serves at the President’s pleasure for four-year terms, and who would want a recession as their legacy?

U.S. midterm elections are also around the corner and if policymakers yank the cord too hard, the landing won’t be hard, the floor will disappear from beneath the American economy.

Which is why the BIS’s call for policymakers to enact “reforms to support long-term growth” which paves the way for more normalized “fiscal and monetary policy settings” is more aspirational than practical and which is why investors should expect more inconsistency and volatility.

There are no more low-hanging fruit in fixing monetary and fiscal policy because the global economy has gotten so punch drunk off liquidity that the hangover is too much for most policymakers to bear.

2. Exxon Mobil CEO Warns that Abrupt Shift to Renewables Could be Disaster

  • Global economy continues to demand access to affordable energy and sudden shift to renewables could stymie long term structural changes needed to combat climate change.

  • Oil and gas sector represents a good interim buy, but investors may be wary of holding on to winning trades for too long as once supply normalizes, ESG concerns may outweigh practical deliverables from legacy energy sector.

Years of underinvestment in fossil fuels and extraction have meant that even the slightest supply shocks can have serious repercussions throughout the global economy. Which is why Exxon Mobil (+2.45%) CEO Darren Woods cautions that a sudden shift to renewable energy will culminate in unideal outcomes for society. In an interview with CNBC’s David Faber, Woods was wary of government policy that would fail to harmonize the “current demand for affordable energy with the need for lower emissions” adding that an “underinvestment in the oil and gas industry” was the root cause of higher prices. U.S. President Joe Biden is battling record low approval ratings and appealing to the energy industry to pump out more as is their patriotic duty, but the call is falling on deaf ears as the sector has suffered years of regulations and financial penalties for its ties to carbon emissions. To that end Woods is correct in suggesting that the transition needs to be gradual to be sustainable and Biden’s call for more affordable energy is perhaps what is politically expedient as opposed to what is practically possible. Woods states that higher oil and gas prices are already forcing European consumers to a corner to utilize fossil fuels such as coal, instead of renewable energy, because in desperate times, people will understandably reach for what is most readily accessible. Europe’s economic powerhouse Germany, has long relied and expected an easy and cheap supply of Russian gas to fuel its industrialized economy, only to realize that the horse trade it made with Putin left it extremely vulnerable should tensions flare up.

Years of underinvestment in alternative energy sources, let alone renewable ones, has meant that Germany has had to turn to coal for the first time in decades, a highly pollutive fuel.

In trying to pursue renewables, politicians may have thrown the baby out with the bath water, as evidenced from the current mad scramble to replace Russian gas with anything else.

Woods reaffirmed his company’s commitment to balancing existing demands for affordable energy together with the need for reduced emissions, but it perhaps took the current crisis to serve as a wake-up call that transitions need time.

To that end, the legions of renewable energy companies, years away from likely generating any meaningful amount of electricity to the grid, could be interesting long-term speculative bets, especially if they are attracting deep discounts at the moment (they are not).

If and when energy markets normalize again, it’s less clear if the recent rally in the oil and gas sector will be durable, because investors have a habit of forgetting the immediate issues to gamble on the next shiny new thing.

3. Crypto's Picks & Shovels Trade More Volatile than Underlying Asset Tracked

  • Investors betting on listed cryptocurrency firms have been more heavily exposed to volatility as business and commercial risk is lumped onto companies dealing in already volatile assets.

  • Investors looking for exposure into crypto would have been better off just buying the tokens to begin with as corporations cottoning on to the rise and fall of the industry prove far more volatile and susceptible to downturns.

The “picks and shovels” trade was very attractive in the early days of cryptocurrency’s admission into the mainstream investor consciousness.

Part of the reason for this of course was that outside of Grayscale’s Bitcoin Trust vehicle, there were few (if any) institutional gateways to participation in the cryptocurrency sector.

And investors loathe to fumble with private keys and unregulated exchanges found themselves betting on the listed companies that serviced the cryptocurrency sector, from miners to exchanges.

But far from track the rise and fall of the cryptocurrency markets, these listed cryptocurrency firms have ended up tracking most of the decline, with just a hint of the rally.

Over the past week, underwhelming results from listed cryptocurrency firms have seen shares in their company fall, despite a recovery in broader indices.

Since December, some of the biggest names in the cryptocurrency sector are down mor than the cryptocurrencies that they facilitate the trading in or have on their books with Coinbase Global (-10.76%) down 75%, to MicroStrategy (-4.24%) which is down 62%, or more than the 60% fall in Bitcoin over the same period%.

Digital token mining giants like Marathon Digital (-7.68%) and Riot Blockchain (-5.78%) have also fallen faster than Bitcoin and that’s because contrary to popular belief, listed crypto companies aren’t “crypto lite” promising all of the flavor and none of the fat.

Whereas buying a cryptocurrency outright exposes an investors to one level of volatility, buying a company involved in the business also introduces new layers of risk, including management and business model.

If nothing else, betting on cryptocurrency companies is akin to taking leveraged bets on what is already one of the most volatile asset classes on earth.

Buying listed crypto companies is not for the fainthearted, nor for those unwilling to do the work – it requires a study not just of the cryptocurrency sector, but the business models, management teams and other factors required from typical equity investing.

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