Hello there,

A magnificent Monday to you as Washington and Moscow give peace a chance which has helped with investor sentiment.

In brief (TL:DR)

• U.S. stocks closed lower on Friday with the Dow Jones Industrial Average (-0.68%), S&P 500 (-0.72%) and the Nasdaq Composite (-1.23%) all down and markets remain closed on Monday for a holiday, but could see a bump if U.S. President Joe Biden and Russian President Vladimir Putin meet to defuse tensions.

• Asian stocks pared losses Monday after U.S. President Joe Biden and Russian counterpart Vladimir Putin agreed to a summit on condition Russia doesn’t invade Ukraine.

• Benchmark U.S. 10-year Treasury yields declined three basis points to 1.93% Friday (yields fall when bond prices rise) as investors stayed keen on haven assets last week.

• The dollar slipped.

• Oil gave up some gains with March 2022 contracts for WTI Crude Oil (Nymex) (-0.13%) at US$90.95 on the prospect of Iranian supply keeping a lid on prices.

• Gold was flat with April 2022 contracts for Gold (Comex) (-0.09%) at US$1,898.10.

• Bitcoin (-1.92%) was marginally higher at US$39,257 out of the weekend on the prospect of a defusing of tensions between Washington and Moscow over the continuing crisis in Ukraine.

In today's issue...

1. War, what is it good for?

2. Funds that Bet on China’s Distressed Debts Dialing Back

3. European Union Open to Cryptocurrency with Regulation Attached

Market Overview

Investors have oscillated from risk assets to havens, buffeted by a stream of headlines about diplomatic moves to tackle the eastern European crisis.

Earlier, the U.S. has told allies that a Russian invasion of Ukraine could target multiple cities beyond the capital, Kyiv. Biden said on Friday he’s convinced Putin has decided to move against Ukraine. Moscow continues to deny it plans to invade.

The standoff, along with the worry that tightening U.S. Federal Reserve monetary policy could choke growth in the world’s biggest economy, raise the likelihood of more swings in markets in an already volatile year.

Asian markets were lower on Monday with Tokyo's Nikkei 225 (-0.72%), Seoul's Kospi Index (-0.56%) and Hong Kong's Hang Seng Index (-0.58%) all down, while Sydney’s ASX 200 (+0.25%) managed a slight gain.

1. War, what is it good for?

• Over the past week, the on-again, off-again prospect of Russia invading Ukraine has roiled markets, sending the price of oil and gold rising and falling as regularly as the tide.

• The problem facing investors today is that they are having to consider the prospect of a Russian invasion of Ukraine, against the backdrop of decades of relative peace.

Investors are often the first casualties of war before even a single shot is fired in anger.

The Ukraine crisis may yet produce the biggest war Europe has ever seen since 1945, or some strange hybrid shadow war that does no one any favors.

Then again, Putin may march his troops back to their home bases far from Russia’s border with Ukraine, to enjoy some well-deserve R&R.

War scares are golden opportunities for speculators – bet right and make a killing but get it wrong and prepare to be slaughtered.

Over the past week, the on-again, off-again prospect of Russia invading Ukraine has roiled markets, sending the price of oil and gold rising and falling as regularly as the tide.

Stock markets have swung violently in both directions and if the VIX, an indicator of volatility, was a person’s EKG, they would have died and been resurrected several times by now.

The problem facing investors today is that they are having to consider the prospect of a Russian invasion of Ukraine, against the backdrop of decades of relative peace.

To be sure, there have been numerous conflicts since 1945, but a Russian invasion of Ukraine is no American invasion of Iraq or Afghanistan and would bring to bear the might of Russian armies on a Europe that had hitherto been content to underfund its own military materiel base.

War would add to already heightened inflationary pressures as sanctions on Europe would be a massive win for investors long on gold, oil and gas and the rare earths like palladium that Russia exports.

It’s only because Iran is making its way out of the diplomatic doghouse, with a possible nuclear deal on the table, that oil prices haven’t yet shot past US$100.

Conflict in Ukraine would tighten financial conditions even as major central banks are already having to do so because of price pressures, hurting European businesses and consumer confidence.

But most importantly, a decisive Russian victory, whether in ending Ukraine’s bid to become a westward-looking democracy on a path to membership of the European Union and NATO, could well embolden Chinese leaders to make a move on Taiwan.

And while the U.S. is treaty-bound to defend Taiwan if it should be invaded, Americans will be hesitant to say the least, to send their sons and daughters to fight off a nuclear-tipped power that it has relied on for almost everything on their Amazon wish lists.

America and Americans on both sides of the aisle have shown increasingly limited appetite to risk blood and treasure to export democratic values which they can barely agree on at home.

And a world that can no longer rely on American exceptionalism to defend democratic values across the globe would have a profound effect on the perceived purpose of indefinitely funding American profligacy or the value of the dollar.

But if both Moscow and Beijing get it wrong, if Washington decides to honor its longstanding commitment to rebuff aggression and autocracy in all its forms and become a champion of democracy once again, then the world may find itself in a bigger war than anything being contemplated.

2. Funds that Bet on China's Distressed Debts Dialing Back

• The panic selling of Chinese debt, for cents on the dollar, became a clarion call for the type of professional investor who relish such opportunities, daring to venture where angels fear to tread.

• These returns are all the more surprising considering that the turbulence in China’s real estate sector caught out some of the savviest global asset managers.

Goldman Sachs (-0.87%) raised eyebrows last year when it started to soak up debt of China’s most embattled borrowers – heavily leveraged property developers who were feeling the sting of Beijing’s crackdown on the highly geared real estate sector.

But the panic selling of Chinese debt, for cents on the dollar, became a clarion call for the type of professional investor who relish such opportunities, daring to venture where angels fear to tread.

When it comes to Chinese debt though, it pays to have a close ear to the ground and some of China’s most low-profile hedge funds have made a killing, as much as 319%, from their high-yield strategies, after scooping up distressed debt issued by property firms and local government financing vehicles.

These returns are all the more surprising considering that the turbulence in China’s real estate sector caught out some of the savviest global asset managers.

The gains made last year by China’s private bond funds, the local equivalent of hedge funds, could have been an outlier, having gained an average 8.9% return overall, according to Shenzhen PaiPaiWang Investment & Management, a local research provider.

Many professional Chinese bond funds bet on an absence of “white knights” to rescue embattled borrowers at the eleventh hour, when pain tolerances peaked and then scooped up the debt at pennies on the dollar that they then sold back to the market when conditions improved.

But as the liquidity crisis for China’s embattled borrowers starts to spread, increasing contagion risks are dampening appetite for this high-stakes poker game.

Chinese private bond funds are now turning more cautious even as property prices appear to be stabilizing, in a sign that risks are rising in a sector that makes up almost a third of GDP and as much as 70% of the Chinese economy.

Default risks are rising even as the People’s Bank of China is pumping stimulus and liquidity back into the financial system and a crisis of confidence may be the turning point where the house takes back all previous winnings and then some.

3. European Union Open to Cryptocurrency with Regulation Attached

• Beneath the exchange-traded products and the islands of crypto innovation in cities like Berlin and Tallinn lies a continent that has an at best uneasy relationship with digital assets.

• The European Union remains concerned that criminal organizations and terrorists can exploit the anonymity of cryptocurrencies to use them for nefarious purposes and to obfuscate fund flows.

Considering the number of cryptocurrency-linked investment products listed on European stock exchanges, and one could be misled into thinking that the European Union has declared open season on the nascent asset class.

But beneath the exchange-traded products and the islands of crypto innovation in cities like Berlin and Tallinn lies a continent that has an at best uneasy relationship with digital assets.

Speaking at the Munich Security Conference last Friday, the EU Commissioner for Home Affairs, Ylva Johansson said of cryptocurrencies,

“I’m not uncomfortable with digital currencies but we need to regulate them in a proper way.”

The European Union remains concerned that criminal organizations and terrorists can exploit the anonymity of cryptocurrencies to use them for nefarious purposes and to obfuscate fund flows.

Johansson’s statement reflects the increasingly divergent approaches of major economies towards cryptocurrencies, with the U.S. pursuing one of cautious curiosity and China adopting an all-out ban.

Last week, one of the world’s largest asset managers, Fidelity, launched a physically-backed Bitcoin exchange traded product listed on Frankfurt’s Xetra exchange and will also start trading on Zurich’s SIX Swiss Exchange in the coming weeks.

Fidelity’s move was in response to a growing demand for digital assets among European investors. And comes three months after Invesco brought its own Bitcoin ETP to the market.

There has been a growing willingness by large asset managers to enter the cryptocurrency arena, including from Blackrock (-0.85%), the world’s biggest asset manager.

Fees for these institutional-grade Bitcoin products however remain much higher than for traditional instruments, and the Fidelity product has ongoing charges of 0.75%.

And although the Fidelity Bitcoin ETP launched with just US$6 million of assets, this could be just the start as a recent survey conducted by Fidelity Digital Assets revealed that 70% of institutional investors expect to buy or invest in digital assets in the “near future.”

Over 90% of the respondents to the Fidelity survey also said they were interested in digital assets and expected to have an allocation to the asset class within the next five years.