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Weekend Edition 23-24 April 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as markets were mauled on Friday ending the worst week in recent times and with investors finding almost nowhere to hide as a slew of factors batter assets.

In brief (TL:DR)

  • U.S. stocks were smacked down on Friday with the Dow Jones Industrial Average (-2.82%), S&P 500 (-2.77%) and the Nasdaq Composite (-2.77%) all bathed in red as hawkish rhetoric rises at the U.S. Federal Reserve and markets bracing themselves for the twin risks of tighter monetary conditions with the risks of recession roaring ahead.

  • Asian markets sank at the close on Friday with Fed policy tightening and the refusal of Beijing to get serious about stimulating its economy and lifting its lockdowns weighed on risk appetite.

  • Benchmark U.S. 10-year Treasury yields pulled back to 2.896% as yields rose high enough to lure some traders back into the fray (yields fall when bond prices rise).

  • The dollar soared against every other major industrialized currency.

  • Oil continued to sink with May 2022 contracts for WTI Crude Oil (Nymex) (-1.66%) at US$102.07 on continued concerns over Chinese demand.

  • Gold provided no safe harbor with June 2022 contracts for Gold (Comex) (-0.71%) at US$1,934.30, with yields rising making the precious metal appear less attractive.

  • Bitcoin (-1.76%) slipped into the weekend again, dipping below the psychologically-significant US$40,000 level of support at US$39,700 diving alongside other assets, on concerns over Fed tightening making the cryptocurrency look less attractive.

In today's issue...

  1. Investors Discover They Have Nowhere to Hide

  2. Cathie Wood Wills Fed to Follow Her Narrative

  3. Cryptocurrency Hackers Find it Harder to Hide

Market Overview

With even the most dovish of policymakers, U.S. Federal Reserve Chairman Jerome Powell, suggesting that the central bank could entertain a rate hike of 0.50% at its next meeting, the knives have finally come out.

Emboldened by increasingly hawkish rhetoric from the boss, other policymakers in favor of more aggressive tightening measures to faceoff the fastest pace of price increases in over four decades are spooking markets and sending assets plunging across the board.

Investors are finding few (if any) places to hide outside of just clinging onto the dollar and praying that this will end soon as everything from China's lockdowns to the ongoing Russian invasion of Ukraine, coupled with high inflation and tightening policy promising nothing but volatility.

Asian markets closed Friday a sea of red against a backdrop of troubles with Seoul's Kospi Index (-0.86%), Tokyo's Nikkei 225 (-1.63%), Sydney’s ASX 200(-1.57%) and Hong Kong's Hang Seng Index (-0.21%) all lower.

1. Investors Discover They Have Nowhere to Hide

  • Virtually every single asset was hammered this week as there appears to be something bearish for everyone.

  • Portfolio diversification ultimately proves futile as stocks, bonds, gold and oil all sink at the end of a horrendous week.

Forget your typical 60/40 stock and bond mix, against a sea of troubles, investors are increasingly finding that they have nowhere to hide and no asset to rely on to bolster battered portfolios.

In a week that most investors would rather forget, both growth and value stocks were hammered – growth as yields soared and on the prospect of higher interest rates, while value on the possibility that excessive policy tightening could tip the economy into recession.

The poster child for growth, the ARK Innovation ETF lost around 11% this week alone, while a basket of Goldman Sachs long-duration (value) stocks has shed around 10%.

And investors hoping that the bonds might otherwise add some ballast to their upending portfolios found that short-dated U.S. Treasuries, those most sensitive to rate hike expectations, faced a brutal selloff, with yields soaring to 2.78%, their highest since the Fed last threatened to tighten at the end of 2018.

Even commodities were not spared, with both gold and oil sinking – oil on the possibility that China’s pandemic lockdowns would put a lid on demand, and gold because yields are soaring.

Industrial metals saw their gains moderate as well as the global economy looks increasingly at risk of recession.

Meanwhile, the dollar gained against every other major industrialized currency, demonstrating just how jittery investors are right now – they believe their money is safer in their mattresses.

So, should investors just hide under the covers?

Given how uncertain the outlook is right now, it’s hard to be in a buying mood and given how quickly markets can snap back, it would be a brave (or foolish) soul who would short the market.

Instead of reacting to present circumstances, investors ought to take a long-term view on where the global economy is headed next and what the likely beneficiaries of the post-inflation-invasion economy looks like.

Will the world turn its back on globalization as it has in so many periods in history? Possibly, but more likely is that the world will become increasingly polarized around two centers, and as history has shown, liberal democracies tend to prevail once they’re awaken from their slumber.

Several sectors look like they could do well regardless of what happens next because the world looks a lot more uncertain than it did just two years ago and that was even when we had to face off with an invisible enemy that was killing us.

Of those sectors, defense contractors which have been slumbering for decades look set to make some solid profits as more countries pledge to splash cash on weapons, from Germany to Japan.

Chipmakers will become strategic assets, so expect them to become more monopolistic, and the electrification of vehicles will proceed in earnest to wean the world off carbon-based fossil fuels that allow authoritarian governments to hold the rest of the world ransom.

2. Cathie Wood Wills Fed to Follow Her Narrative

  • ARK Investment Management's Cathie Wood claims that the U.S. Federal Reserve will not raise rates as aggressively as markets have priced in.

  • Wood's flagship ARK Innovation ETF is down 45% year-to-date, and suggests that inflation could start to decline, giving the Fed sufficient cover to dial down its aggressiveness on tightening, providing a potential bump for risk assets.

It’s only when the tide washes out that you can see who’s been swimming without a bathing suit on.

With the prospect of the most aggressive policy tightening by the U.S. Federal Reserve since Paul Volker was Chairman of the central bank, professional money managers who had prospered during the loose money good times are now having to contend with what the new policy landscape will look like for their funds.

And no preacher of the rolling good times has been as pervasive as Cathie Wood, who claims that the Fed isn’t going to hike rates as much as markets are currently betting.

Wood’s view flies is in stark contrast to the rest of Wall Street, with some financial institutions gearing up for rate hikes as high as 0.75% at each turn.

The CEO and founder of ARK Investment Management, Wood has struggled recently amid fear of inflation but believes that markets have overpriced the prospect of Fed tightening.

Speaking via video at the Seedly Personal Finance Festival in Singapore, Wood expects inflation to end its spike and then decline in “dramatic” fashion, which she claims will provide the Fed some breathing room to dial back the aggressiveness of purported rate hikes.

To be sure, such an idealized scenario would help Wood’s flagship ARK Innovation ETF, which is down a whopping 45% year-to-date and has been nursing billions of dollars in outflows over the past six months.

Wood claims that there could be “a surprise in terms of interest rates not going up as much as the market has priced in.”

But is there anything outside of self-interest to Wood’s optimism on softer policy stance and inflation suddenly disappearing?

There could well be.

For starters, much of the demand for industrial commodities like oil, nickel and copper, as well as foodstuffs like wheat, come from the world’s second largest economy, China.

But with Beijing insisting on zero-Covid whole-city lockdowns, and refusing to ease its monetary policy aggressively or deploy fiscal measures to shore up its rapidly slowing economy, that demand could soon taper off as China pushes ever-closer to the brink of a recession.

Forget 5.5% target economic growth, at the rate Beijing is locking down cities with populations the size of entire countries, and with containers waiting aimlessly at empty ports as well as factories sitting idle in industrial megacities, China would be lucky to get away with even low single-digit expansion.

And that could provide the release valve that’s needed as the U.S. Federal Reserve faces off with the highest level of inflation in four decades.

Already concerns about demand for oil from China have put a lid on further rallies, while both bonds and stocks are sagging.

With Russia now making moves to possibly further its invasion not just to the Donbas in eastern Ukraine but also to the south as well, there is the prospect of a prolonged conflict in the region.

All of which are increasing global recessionary risks and not reducing it.

While the Fed is concerned about inflation, it remains to be seen if it will risk tanking the economy just so that the price of a loaf of bread isn’t inordinately high.

Yes, Wood may be using her pulpit to preach her own beliefs of the market, but there may be some method to the madness in her views on what the U.S. Federal Reserve may do next.

3. Cryptocurrency Hackers Find it Harder to Hide

  • Cryptocurrency exchange Binance manages to uncover around US$5.8 million worth of cryptocurrency from the recent Ronin hack that has been tied to North Koreans.

  • Highly specialized blockchain analytics firms as well as the transparent, immutable and public nature of the blockchain have made it difficult for criminals and hackers to make off with their ill-gotten cryptocurrency.

Just over a week after the U.S. tied one of the biggest crypto hacks to a North Korean group, cryptocurrency exchange Binance said it was able to recover some US$5.8 million worth of the ill-gotten tokens that had made its way onto its platform albeit with an attempt to obfuscate its source.

While cryptocurrencies are pseudonymous – meaning that it’s not possible to know who exactly owns the digital assets tied to a wallet address, it is possible to determine if the proceeds in that wallet are from hacks or other criminal activities.

The blockchain is like one big immutable ledger – meaning that every transaction is tattooed permanently into the blockchain’s perpetual memory and can be traced through its public record.

Last week, the U.S. Treasury Department tied the North Korean hacking group Lazarus to the theft of over US$600 million in cryptocurrency from the Ronin software bridge, which is used by players of the highly popular blockchain game Axie Infinity to transfer cryptocurrencies across blockchain.

Because there are so many blockchains out there, bridges serve an important role to allow interoperability of cryptocurrencies across blockchains, enabling the cryptocurrencies of one blockchain to be “effectively usable” on another blockchain.

Bridges have often been a potential source of weakness in the cryptocurrency sector, but provide an integral service to allow for more transaction fluidity and flexibility.

Binance was able to identify the stolen cryptocurrency in this case as the North Korean hackers had moved it from their wallets to Tornado Cash – a service that allows for anonymous token transfers on the Ethereum blockchain and then to Binance by working with external companies.

Getting away with the ill-gotten cryptocurrency proceeds has been increasingly challenging given the cottage industry of expert blockchain analytics firms which are able to immediately start tracking their movements.

Because the blockchain is transparent, anyone and everyone will be watching as the stolen cryptocurrency makes its way across the cryptosphere – think about it like holding up the local gas station while the whole town is watching you from the time you make off with the loot – they can’t necessarily stop you until you try to spend it or swap it – which is where the North Koreans slipped up by entering Binance.

Earlier this year, the Poly Network compromise saw the hacker return the US$600 million worth of cryptocurrency, claiming that they had were a “white hat” (ethical) hacker and had taken the funds for safekeeping – this despite substantial amounts headed to mixers to attempt to obfuscate their source and destination.

As the cryptocurrency sector evolves, hacks will be a constant bugbear of the industry, but the very nature of the blockchain, in particular its transparency and traceability, means that criminals and hackers will not have an easy time trying to hide their tracks or spend their ill-gotten loot.

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