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Weekend Edition 19-20 February 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as investors wonder if this is when Russia will finally strike and invade Ukraine, or was it all just a high-stakes bluff?

In brief (TL:DR)

  • U.S. stocks continued their decline into Friday with the Dow Jones Industrial Average (-0.68%), S&P 500 (-0.72%) and the Nasdaq Composite (-1.23%) all down as Washington continues to warn of an imminent Russian invasion of Ukraine.

  • Asian stocks were lower across the board on Friday, dragged down especially by Chinese tech stocks.

  • Benchmark U.S. 10-year Treasury yields continued to slide to 1.928% (yields fall when bond prices rise) as investors fled to haven assets.

  • The dollar rose.

  • Oil gave up some gains with March 2022 contracts for WTI Crude Oil (Nymex) (-0.75%) at US$91.07 as traders sat on the sidelines with geopolitical tensions in Ukraine approaching their nadir.

  • Gold was flat with April 2022 contracts for Gold (Comex) (-0.12%) at US$1,899.80.

  • Bitcoin (-1.30%) continues to come under pressure at US$40,200 as risk appetite waned against a potential Russian invasion of Ukraine.

In today's issue...

  1. Chinese Tech Platforms Face Brunt of Common Prosperity Push

  2. Are Investors Betting Too Heavily on an Apocalypse?

  3. Regulators are Gunning for Cryptocurrencies & That's Good

Market Overview

Stocks fell and bonds climbed to end a week marked by geopolitical tension in a tense standoff between the U.S. and Russia as well as worries over the U.S. Federal Reserve's monetary policy tightening.

The weekend will be a tense one for investors, especially given the Presidents Day holiday in the U.S. which will see markets closed on Monday.

What will Russian President Vladimir Putin do?

The door for diplomatic options to end tensions is still there and U.S. officials have offered to meet with their Russian counterparts next week, but anything could happen at this point.

Nevertheless, it may make more sense for investors to remain calm as historically, conflict has had a tenuous link to the performance of markets.

Asian markets closed lower on Friday with Sydney’s ASX 200 (-1.02%), Tokyo's Nikkei 225 (-0.41%) and Hong Kong's Hang Seng Index (-1.88%) all down, while Seoul's Kospi Index (+0.02%)managed a slight gain.

1. Chinese Tech Platforms Face Brunt of Common Prosperity Push

  • Chinese tech stocks continue to be whiplashed by regulators intent on redistributing power and profits to the common man

  • Buying opportunities exist for Chinese sectors that are in line with Beijing's grand vision and which tend not to concentrate power or profits, including green energy, artificial intelligence and electric vehicles

It’s no secret that the world’s biggest tech platforms have a license to print money by coalescing their massive user bases and monetizing them.

Whether it’s content creators or delivery drivers, many of the people who are responsible for a tech platform’s enormous profits also share very little in them.

Most platforms, whether they be ride-hailing apps or social media, typically share a small sliver of the advertising revenues or fees with the people who actually do the work that make these platforms powerful and rich beyond the dreams of avarice.

And while not much has been done in the U.S. about these one-sided practices, Beijing appears to be determined to do something about it, to pursue its goal of “common prosperity.”

Which is why investors who had bought the dip on embattled Chinese food delivery giant Meituan (-14.86%) were in for a rude shock as on Friday, when regulators said they would push to lower the fees food platforms can charge restaurants for delivery.

Meituan’s Hong Kong shares shed over US$26 billion in market value on the announcement, as Beijing continues its crackdown on the Chinese tech sector, dragging down the Hang Seng Tech Index.

Other Chinese tech giants were dragged along for the process.

Given China’s slowing economy, Beijing has been looking for ways to ensure a more equal distribution of wealth, as well as provide support for small businesses which rely on tech platforms to reach their end customers.

Cutting platform fees and offering a fair share of the profits is one way of course, but will necessarily put pressure on profits for the tech incumbents.

And investors who had bought the dip on Chinese tech shares will no doubt be shaken by the latest regulatory moves.

Nevertheless, there is still significant value for investors willing to look thematically at Chinese tech shares, despite the regulatory uncertainty.

Green energy, electric vehicles, automation and artificial intelligence are likely to continue to enjoy Beijing’s favor and remain resilient to regulatory action, whereas tech companies where power and profits are concentrated in the platform will remain under pressure.

2. Are Investors Betting Too Heavily on an Apocalypse?

  • Pessimism may be overbought as it's unlikely that Russia will mount a full scale invasion of Ukraine that could threaten to set off a more widespread conflict

  • U.S. President Joe Biden unnecessarily contributing to market volatility, the last time pessimism was this high, stocks rallied hard in the aftermath

While the presidencies of Biden and Trump couldn’t be more different than chalk and cheese, both have one thing in common – the ability of the White House to rile markets and add to volatility against an already challenging market backdrop.

During the Trump administration, stocks swung wildly from the then-President’s tweets during the trade war with China.

This time, U.S. President Joe Biden’s repeated warnings that Russia will imminently invade Ukraine are increasingly sounding like the boy who cried wolf.

Every day that Putin doesn’t have Russian troops storm Kyiv makes Biden’s repeated warnings sound hollow and undermines Washington’s credibility.

Complicating matters, in the world of high stakes geopolitical poker, “sleepy” U.S. President Joe Biden is up against one of the tour’s most seasoned hustlers, Russian President Vladimir Putin.

Biden providing running commentary on the Ukraine situation has done nothing other than to induce volatility, especially because it’s not what markets need to hear at the moment.

The CBoE Volatility Index, a measure for just how jittery investors are, edged higher for a second straight week to 27.75 on Saturday, compared with 17.22 at the end of 2021, while the benchmark S&P 500 fell below its 200-day trend line.

Some analysts have suggested that the shakeout has mainly been in retail investors with more “paper hands,” a group whose influence on market prices has grown significantly over the course of the pandemic.

The potential for a major Ukrainian conflict has driven some retail investors to sell out of nervousness, while gold has soared above US$1,900 and Treasuries surged higher on similar concerns.

But investors can and ought to take comfort from one fact – periods where the consensus seems to expect the worst have historically been great opportunities to buy the dip.

According to an Investors Intelligence survey, which examines hundreds of newsletters to assess views on the market, the ratio of bulls to bears stands at 1.2, the third-lowest ever.

Prior instances when the reading sat in that region have preceded an average 8.2% rally in the S&P 500 over the next six months, an advance much bigger than the average performance overall according to data compiled by Strategas Research Partners.

And it could happen.

Consider the alternative scenario, Russia conducts an all-out invasion of Ukraine, beginning with air strikes to control the skies, a massive artillery barrage that would kill hundreds of thousands of civilians and then a ground offensive to take Kyiv in a matter of weeks.

Washington then imposes economic sanctions on Russia, against a backdrop of global condemnation and increased calls for western powers to act decisively to deter such acts of aggression that undermine the sovereignty of nation states.

A western coalition is formed, and armies are assembled to push Russia out of Ukraine.

This scenario would be similar to the first Gulf War, where Iraq invaded Kuwait and a coalition led by the United States pushed Iraq back out again, but with one major difference, that war was not fought between two global powers with nuclear options.

Biden can’t risk dragging the U.S. into a conflict that most Americans don’t care about and with his approval ratings already near rock bottom and Putin will be betting on that.

But what nobody knows for sure is whether Putin will make the move to grab Ukraine while nobody’s watching.

Either way, conflict is not immediately bad for investors because markets often shrug them off, because they are unlikely to have a material impact on economic fundamentals or corporate profits.

Consider that since hostilities broke out in 1939 till the end of the Second World War in 1945, the Dow Jones Industrial Average was up over 50%.

Because the relationship between geopolitical crises and market outcomes aren’t as simple as they seem, investors this time may have priced too much pessimism into their investment calculations.

3. Regulators are Gunning for Cryptocurrencies & That's Good

  • G20 finance ministers and central bankers are likely to embrace greater cryptocurrency regulation and reporting frameworks

  • Cryptocurrencies not thought to pose any systemic risk at the moment, but that could change as it forms part of more portfolios

Since 2018, the clarion call for regulators to take a more serious look at cryptocurrencies has varied in volume, but with prices surging last year, the legion of newly-minted digital asset rich and depleted national coffers from the pandemic are forcing a more urgent look into the space.

Last week, Fidelity, one of the world’s largest asset managers revealed that US$331 million of cryptocurrency donations were received in 2021 by its charitable arm, a 12-fold increase over 2020 and some of that giving may not necessarily have come from the heart.

Tax optimization strategies to reduce capital gains tax on well-time cryptocurrency investments may also have been a motivation as investors wait for clarity from the U.S. Internal Revenue Service on the tax treatment of digital assets.

The issue has provoked rising angst among regulators, who are growing increasingly concerned that while cryptocurrencies remain a small sliver (almost a rounding error) in the world of global assets, they could soon reach a point where they threaten global financial stability (gasp).

A report by the Financial Stability Board (FSB), a global committee of regulators and central bankers and includes the European Central Bank, the U.S. Federal Reserve and the Bank of England noted,

“(Cryptocurrencies) are fast evolving and could reach a point where they represent a threat to global financial stability.”

The FSB is concerned about the ease with which cryptocurrencies can be used for money laundering and to obfuscate funds derived from nefarious activities, but the elephant in the room is stablecoins, cryptocurrencies backed by real assets such as dollars.

Although the market cap for stablecoins is still relatively small, at just US$155.6 billion, as more investors and institutions incorporate cryptocurrencies into their portfolio strategies, that significance could rise.

Stablecoins are the most common trading pair for cryptocurrencies, ahead of Bitcoin or Ether, which used to be well ahead of stablecoins.

Because stablecoins are not comprehensively regulated, the prospect of any one or more of them failing could ricochet into other cryptocurrencies, affecting investor portfolios and rippling into other asset classes where liquidations prove necessary to cover losses.

The FSB is aware of the dangers and G20 finance ministers and central bankers are likely to embrace the call for new data reporting requirements and other prudential controls – a move that should be welcome by cryptocurrency stakeholders.

With greater certainty comes greater participation, and while it may take time to implement proposed reforms, with global implementation necessarily uneven, at the very least global lawmakers and central bankers are finally sitting up to take notice of an asset class once dismissed and rubbished.

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