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Daily Analysis 29 June 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as stocks wind lower amidst continued growth fears and increased volatility in the bond markets.

In brief (TL:DR)

  • U.S. stocks marked a second consecutive day of declines on Tuesday with the Dow Jones Industrial Average (-1.56%), S&P 500 (-2.01%) and the Nasdaq Composite (-2.98%) all sharply down, as the global economic outlook appeared gloomy given central bank policy tightening.

  • Asian stocks sank on Wednesday as investors worry that a lack of growth will be the biggest challenge for markets.

  • Benchmark U.S. 10-year Treasury yields eased to 3.167% (yields fall when bond prices rise) as risk sentiment soured.

  • The dollar held gains in Asian trading.

  • Oil slipped with August 2022 contracts for WTI Crude Oil (Nymex) (-0.66%) at US$111.02 on concerns over demand growth.

  • Gold was flat with August 2022 contracts for Gold (Comex) (+0.02%) at US$1,821.60.

  • Bitcoin (-2.01%) slipped to US$20,320, following the lead of equities and threatening to duck below the psychologically-significant US$20,000 level of support, which it has straddled for weeks.

In today's issue...

  1. Finding Yield in the Frontier Markets

  2. Asian Central Banks Buffet Currencies Against Dollar's Rally

  3. Goldman Sachs downgrades Coinbase Global to "SELL"

Market Overview

Global stocks are being whipsawed on an almost daily basis, with investors swinging from optimism to pessimism, from concerns over growth to worries about recession, all against a backdrop of inflation.

Over the long-term, stocks have performed admirably against inflation, but investors are understandably sticking to cash for now, until things become more certain.

There are signs that China may be loosening up its Covid-19 protocols in an effort to reintegrate with the global economy, but investors are not holding their breath as measures instituted are also just as quickly rolled back only to be replaced by harsh lockdowns and fresh quarantine requirements.

Asian markets went into Wednesday in the red with Tokyo's Nikkei 225 (-1.13%), Seoul's Kospi Index (-1.58%), Hong Kong's Hang Seng Index (-1.63%) and Sydney’s ASX 200 (-1.11%) all down in the morning trading session.

1. Finding Yield in the Frontier Markets

  • Containment of Sri Lanka's economic implosion has some plucky investors looking for high-yields in selected emerging market debt.

  • Short-term risk of default in emerging markets could provide fertile ground for a lucrative trade, but much will depend on the U.S. Federal Reserve's commitment to rate hikes.

Given how sovereign debt yields have been soaring of late, it would come as a surprise that some investors are still yield-starved and willing to stomach higher levels of risk in the pursuit of profit.

With indicators of duress emerging in bond markets suggesting that poorer nations will soon face a slew of restructuring, plucky investors are picking through the rubble and looking for gems.

In the wake of Sri Lanka’s economic collapse, panic selling was rampant, sending the average yield in junk-rated emerging economies close to 900 basis points north of U.S. Treasuries, which is the highest risk premium seen in 13 years (except Covid’s hit in 2020), according to JPMorgan Chase data.

However, early fears of widespread contagion in emerging market debt may have been overplayed and fund managers are looking for bargains in emerging market debt that may be more resilient to default or restructuring.

There is a growing sense amongst managers that frontier markets have been excessively penalized in the recent selloff and some currently offer very attractive yields.

And even if debt restructuring were to occur, bonds of frontier markets stand to offer greater recovery values compared to current bond prices, at least according to Barclays and Bluebay Asset Management.

The selloff in frontier markets started last year, caused by investors de-risking the riskiest parts of their portfolios in light of the U.S. Federal Reserve’s tightening policy, which also sent Treasury yields soaring.

Yields in frontier market bonds soared, compared with the safest Treasuries, to compensate investors for the additional risk of holding these securities.

But the possibility of more sanguine Fed policy in the later part of this year, could put some investors in a good position to capture the high yields in frontier assets at the moment, especially given that the short-term default risk appears to have abated.

2. Asian Central Banks Buffet Currencies Against Dollar's Rally

  • Asian central banks are cleaning out their coffers to shore up their currencies as a soaring dollar erodes the purchasing power of their currencies.

  • Commodity-exporting Asian countries are likely to perform better than non-commodity exporting ones especially as Asian central banks are better capitalized today to withstand the onslaught of a roaring greenback, compared with in 1997.

Central banks in Asia have been saving for a rainy day for decades and now that day has come.

In the aftermath of the 1997 Asian Financial Crisis, reforms and risk management saw Asian central banks beef up dollar reserves and other reserve assets, to respond appropriately should their currencies come under pressure once again.

Now as the U.S. Federal Reserve embarks on its most aggressive series of interest rate hikes in decades, years of accumulating foreign-exchange reserves has enabled central banks in Asia to ante up and shore up their rapidly weakening currencies against a strengthening dollar.

But that’s not to say that Asian central banks aren’t taking body blows.

As of June 17, Thailand’s reserves have fallen to US$221.4 billion, their lowest level in over two years, while Indonesia’s reserves are sitting at their lowest level since November 2020.

Meanwhile, South Korean and Indian reserves have fallen to their lowest in over a year.

While Asian central banks recognize that fighting the Fed is an exercise in futility, at the very minimum central bankers have helped to stabilize their domestic currencies, to prevent a repeat of 1997.

According to strategists at Goldman, high-yielding emerging Asian currencies may not expect to see any respite soon as they are likely to be continuously pressured by declining external finances and the ongoing risk-off sentiment sparked by the Fed’s tightening policies.

With another large Fed rate hike due later next month, Asian central bankers are bracing themselves for another bout of currency volatility at the worst possible time with high inflation and commodity prices roiling their already pandemic-ravaged economies.

Against this backdrop, investors can expect to see some opportunists bet against emerging market currencies.

Whereas bets against the Bank of Japan have thus far tested, but not broken its resolve, given that Japan is the world’s second largest holder of U.S. Treasuries, the same can’t be said for other Asian countries.

At some point, bets against the Bank of Japan may lose steam and other emerging market currencies, particularly non-commodity exporting nations, could draw a new bout of predatory currency attacks.

3. Goldman Sachs downgrades Coinbase Global to "SELL"

  • Goldman Sachs (-0.43%) downgrades cryptocurrency exchange Coinbase Global (-8.54%) to sell, but average analyst sentiment suggests that shares in the exchange could more than double regardless.

  • Coinbase Global's main challenge won't necessarily come from declining retail trading revenue, but from competition from Binance.US and unless it innovates to introduce new products, it will come under pressure unless there is a reversal in interest rate hikes.

Cryptocurrency exchange Coinbase Global has been downgraded to a ‘sell’ rating by Goldman Sachs analysts amid the bearish sentiment pervading the digital asset markets.

Shares of Coinbase Global have largely tracked the decline in cryptocurrency prices, with a 75% slump this year in line with the biggest cryptocurrency by market cap, Bitcoin, which now trades at less than half of what it was worth six months ago.

Goldman Sachs analyst William Nance, suggested in a note to clients that Coinbase Global must make “substantial reductions in its cost base” so that it can dampen the deleterious effect of cash burns as “retail trading activity dries up.”

To that end, Coinbase Global has been cutting jobs while at the same time rescinding offers to new hires as the so-called Crypto Winter sets in.

But while cutting costs is one part of the equation, the exchange also needs to find ways to drum up more revenue in order to make it through the Crypto Winter and on that front, Coinbase Global’s recent discontinuation of Coinbase Pro could be a step in the right direction.

Coinbase Pro was intended to be a platform for institutional investors to access cryptocurrencies, but running two separate platforms, one for retail and one for institutional, would be counterintuitive at a time when volumes are starting to fall given the duplication of cost.

But could Coinbase Global represent a contrarian bet, one for the future?

As of Monday’s close, data compiled by Bloomberg suggests that Coinbase Global has 20 buy ratings, 6 holds, and 5 sell recommendations and the average analyst targets a share price of US$117, well over a 100% from where the exchange currently trades.

Coinbase Global remains well-capitalized, and as long as it can keep expenditure in check, has the potential to last out the Crypto Winter, rewarding shareholders who believe in its potential.

But the exchange also faces stiff competition from Binance.US, a rival cryptocurrency exchange which has the backing of the world’s largest cryptocurrency exchange by trading volume

To that end, Coinbase Global may have its work cut out for it, as Binance.US cutting its trading fees saw an immediate decline in Coinbase Global’s stock price and Binance.US can be a loss-leader for, using the ample revenues of its parent to help it weather body blows in a race to the bottom.

Investors looking to pick up Coinbase Global on the cheap need to be cognizant of competition from Binance.US, especially if the latter deploys zero-fee cryptocurrency trading, something which will affect Coinbase Global immensely.

For Coinbase Global to round the corner, innovation is key and it needs to work well with regulators to find new opportunities in new products such as tokenized securities or other nascent asset classes like NFTs.

But the odds of that happening in a hurry are slim to none, especially given that rival offshore

exchange FTX’s Sam Bankman-Fried has cozied up with Washington and is now making overtures to acquire retail brokerage app Robinhood Markets (-2.80%).

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