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Weekend Edition 4-5 June 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as U.S. stocks entered the weekend hammered by stronger-than-expected U.S. jobs data, raising fears that the U.S. Federal Reserve will act more aggressively in tightening conditions.

In brief (TL:DR)

  • U.S. stocks continued to fall on Friday awith the Dow Jones Industrial Average (-1.05%), S&P 500 (-1.63%) and the Nasdaq Composite (-2.47%) all lower as risk appetite receded on concerns that a tight labor market could fuel a wage-price spiral that forces the Fed to act more decisively on rates.

  • Asian stocks closed mostly higher on Friday as they were spared the U.S. jobs data but look set to open weaker on Monday with a stronger dollar anticipated.

  • Benchmark U.S. 10-year Treasury yields rose to 2.94% (yields rise when bond prices fall).

  • The dollar gained.

  • Oil gained with July 2022 contracts for WTI Crude Oil (Nymex) (+2.54%) at US$118.87 as the European Union unveiled a fresh set of sanctions that encompasses Russian oil.

  • Gold fell with August 2022 contracts for Gold (Comex) (-1.13%) at US$1,850.20.

  • Bitcoin (+1.06%) rose into the weekend to US$29,829 on thinning volumes and with few catalysts to take the benchmark cryptocurrency higher.

In today's issue...

  1. Analysts are Turning the Corner on China, Should Investors?

  2. All that Matters for Investors is Macro

  3. Japan Joins the UK in Seeking Protection for Stablecoin Investors

Market Overview

Strong U.S. jobs data is proving to be a headache for investors as they can only spell problems for stocks as an emboldened U.S. Federal Reserve moves to prevent a wage-price spiral by ratcheting rates higher which will bring stocks down and risk a recession.

Macroeconomics will continue to be the theme for investors until several major issues get sorted, including the Russian invasion of Ukraine, China's Covid-19 lockdowns and the Fed's monetary policy path.

Until such time that the circumstances become clearer, investors can expect that most major indices will continue to trade rangebound.

Asian markets closed higher into the weekend with Tokyo's Nikkei 225 (+1.27%), Seoul's Kospi Index (+0.25%) and Sydney’s ASX 200 (+0.88%) up, while Hong Kong's Hang Seng Index (-1.00%) was lower.

1. Analysts are Turning the Corner on China, Should Investors?

  • Analysts have stopped revising down estimates for Chinese equities, suggesting that they may have hit a bottom.

  • Lack of transparency, geopolitics and existing structural issues all suggest that investors proceed with extreme caution when wading back into Chinese assets.

For most investors busy with their day jobs or other pursuits, analyst reports can be useful even if on a broad macro level, to determine where the next pocket of opportunities lie.

But China, which was once seen as a limitless font of economic potential, has suffered both a confidence and an economic crisis, entirely of Beijing’s own making.

The seemingly relentless crackdown on once lucrative sectors, from real estate to technology, and the brutal zero-Covid lockdowns had even led analysts at banking giant JPMorgan Chase to declare (now retracted) that China was “uninvestable.”

Now analysts are suggesting Chinese assets may have finally bottomed out, with many stopping downward estimate revisions.

Mind you, that’s not to say that analysts have suddenly turned bullish on China, they’ve simply become less bearish, citing policy stimulus and easing pandemic curbs as lifting sentiment.

So is China out of the woods just yet?

Goldman Sachs and China International Capital expect profits at Chinese firms in the benchmark MSCI China to rise by the second half of this year.

And tech giants including Alibaba Group Holding and Baidu all delivered better-than-feared results, helping lift their share prices.

But the rebound may also have to do with the fact that many analysts are also groping in the dark when it comes to China – by simultaneously undershooting and overshooting.

So deprived of bullish news have global investors become that many will cling on to even the slightest sliver of hope that things are turning around in the world’s second largest economy, especially when conditions everywhere else seem to be dire.

But therein lies the challenge with reading too much into analyst estimates.

Few analysts predicted the arbitrary and sudden crackdown on China’s real estate, tech and afterschool education sectors by Beijing.

Nor would many analysts have bet on Beijing suffering a second Covid-19 wave that would result in rolling lockdowns, especially since China appeared to be one of the first countries in the world to have gotten the early variant of the coronavirus under control.

Which is why investors could be investing prematurely by investing on the latest string of analyst reports that are simply declaring things are near the bottom.

Calling bottoms is a tricky business even where information is transparent, but China still has some serious structural issues to deal with before even the most optimistic investor ought to take a long-term bullish position.

For starters, the copious amounts of leverage coursing throughout China’s real estate sector is a matter that has yet to be unequivocally resolved and that’s not to mention the defaults where the dust has yet settled.

The status of Chinese firms currently listed on American exchanges remains uncertain and the global appetite for Chinese assets especially given the increasingly complex geopolitical situation remains unclear.

All of these factors have and will continue to weigh on whether or not investors should wade back into embattled Chinese assets because trying to find a bargain could also unwittingly result in catching falling knives.

2. All that Matters for Investors is Macro

  • High correlation between stocks inter se has meant that investors are all focusing on a single data point, whether central banks will tip the economy over into a recession.

  • Day traders are struggling to cope with the extreme swings in volatility and instead investors are likely to keep key indices rangebound until the macroeconomic situation becomes clearer.

Forget about technical analysis for a moment and ignore earnings, unprecedented day-to-day volatility in equity markets is forcing investors of every stripe to take a closer look at macroeconomics, even if they never had before.

Never before has obsession with a single input, the economy, driven measures of correlation among individual stocks to levels not seen since the coronavirus crash.

While a rising tide indeed lifts all boats, a receding one grounds them just as well and investors are fretting that the U.S. Federal Reserve is the wave-making machine, resulting in intraday swings of 1% or more in the benchmark S&P 500 for the longest streak in a decade.

Burned by the volatility where stocks can swing violently in either direction both inter and intraday, many day traders have simply sat out altogether, while professional investors are taking longer-term positions, betting on their ability to divine the future.

Stocks have been moving in sync across the board and while theoretically this creates stock-picking opportunities, when good companies fall as much as bad, sifting the wheat from the chaff is not for the faint-hearted.

At its core, the main concern is that policymakers tighten monetary conditions too much, to tip the economy into a recession, which means even the star performers at the moment will fall.

And higher interest rates means that investors are less willing to pay a premium for high-growth stocks that have enjoyed decades of loose conditions and ample liquidity.

The only sector that is doing well is energy, with the surging price of oil, but that also creates another set of concerns as on the even of the last financial crisis, oil prices were surging as well and investors buying in now may be catching the sector at its peak, as was the case in 2008.

Against this backdrop of breakneck whiplash-inducing uncertainty, investors see a range-bound market, with many investors appearing to be prepared to sell on near-term rallies, and become buyers again when prices dip slightly – few appear prepared to bet on a durable direction.

3. Japan Joins the UK in Seeking Protection for Stablecoin Investors

  • Japan indicates that stablecoin issuers in the country will need to come from a small clutch of issuers and it will require certain standards for the protection of investors, especially retail.

  • Move follows United Kingdom Treasury's plan to have the Bank of England move in to protect retail investors should stablecoin issuers fail.

In 2018, few would have thought that cryptocurrencies would one day grow to such size and significance that they would eventually be deemed “too big to fail.”

But that appears to be exactly what authorities in the United Kingdom and Japan are communicating by pledging intervention in the event that stablecoins should collapse.

In the aftermath of the ruinous collapse of algorithmic stablecoin TerraUSD, regulators across the globe are scrutinizing stablecoins more closely as their use increases throughout the financial system.

Stablecoins, the earliest of which was USDT, issued by a company called Tether, were a means by which cryptocurrency traders could take a breather from the volatility inherent in trading digital assets.

Initially only backed by assets such as actual dollar deposits, the stablecoin universe has now expanded such that many issuers in essence exercise some form of fractional reserve banking, with backed stablecoins not necessarily equating to unequivocal dollars in bank accounts.

Then there are algorithmic stablecoins that maintain a peg with a currency like the dollar through the use of other underlying cryptocurrencies, sometimes a combination of other stablecoins and volatile tokens, or sometimes just the tokens altogether, as was the case of TerraUSD and its sister token Luna.

But since billions of dollars were lost in the TerraUSD collapse and with many retail investors badly burned as a result, regulators are looking to see if they can do more to protect the most vulnerable investors.

Last week, Japan passed a landmark law clarifying the legal status of stablecoins, essentially classifying them as digital currencies and imposing a mandatory link with the yen that will enshrine the fight to redeem them at face value.

Japan’s Financial Services Agency is expected to clarify the rules for stablecoin issuers in the coming months but the law will come into effect in 2023 and may make it difficult for foreign players to enter the Japanese market to issue a yen-backed stablecoin.

Under the new legal definition in Japan, the issuance of stablecoins will be restricted to banks, trust companies and certain licensed money transfer agents.

Last month, the United Kingdom’s Treasury revealed that it was working on plans for the Bank of England to take over collapsed stablecoin issuers to prevent a cryptocurrency crash affecting financial stability.

Under the U.K.’s plan, the Bank of England would place the stablecoin issuers into special administration with the goal to protect consumers if the issuers failed, and they would fall under similar rules as banks and other systemically important institutions.

Whether or not the U.S. will follow suit with similar consumer protections is however, less clear.

The U.S. had a long history of wildcat banking during its Free Banking Era from 1836 to 1865 when so-called wildcat banks that issued their own paper currency, existed alongside more stable state banks, because the country had no national banking system.

Given the reluctance of the U.S. Federal Reserve to issue its own central bank digital currency, with or without the Fed’s acquiescence, the demand for dollar-based stablecoin means that for now, these wildcat dollar-based stablecoin issuers will continue to exist.

Whether the Fed will intervene in the event of their collapse however is even more uncertain.

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