Novum Alpha - Daily Analysis 11 May 2022 (10-Minute Read)
A wonderful Wednesday to you as markets meander through a sea of macro challenges, with sentiment stabilizing.
In brief (TL:DR)
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In today's issue...
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Market OverviewThe U.S. consumer-price index is expected to moderate but stay above 8%, while Chinese factory-gate inflation may dip below that level.
Disruptions linked to Russia’s war in Ukraine and China’s outbreak are stoking the cost of living.
Ukraine and Russia clashed over natural gas sent via pipelines to Europe in a spat that could disrupt supplies sending prices for that commodity soaring.
Asian markets continued to fall Wednesday with Tokyo's Nikkei 225 (-0.15%), Hong Kong's Hang Seng Index (-0.58%), Seoul's Kospi Index (0.20%) and Sydney’s ASX 200 (-0.38%) were all down in the morning trading session.
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1. A Chinese Silver Bullet Won't Save the Global Economy
Plus one, minus one, equals zero.
Which is why global investors looking for some reprieve in a sea of red will find no solace in China’s stimulus of its rapidly slowing economy.
Back in 2008, while the West was floundering from a financial crisis of its own making, China responded with an unprecedented flurry of fiscal fixings, some US$586 billion at the time, plus an unprecedented surge in bank lending that spurred demand.
In the process, China’s voracious appetite for commodities and consumer goods helped to power a sharp rebound in major trading partners like Australia and Brazil and had spillover effects for global companies that supplied the world’s second largest economy.
Eight years later, Beijing had to whip out the same tools to reflate its economy, albeit on a smaller scale in 2016, using fiscal spending again to prime and pump the real estate market.
Will this time be different?
Some analysts are suggesting that the China’s planned stimulus is unlikely to do much to reverse the global economic slowdown, the same way that peeing in the ocean isn’t likely to change its total volume.
China’s economy is over twice the size it was compared to 2008, and so it would need a lot more stimulus to even move the needle, let alone change the course of an economy that accounts for almost a fifth of global output.
Even under the present circumstances, China’s policymakers have shown they have no appetite for anything even remotely close to the 2008 fiscal measures, which left a legacy of debt and sparked record corporate defaults.
Although Beijing is promising a US$670 billion raft of government spending and tax cuts, relative to GDP, that’s less than half what was rolled out in 2008 – China’s economy got bigger, so any meaningful stimulus must rise proportionately, but it’s not.
And unlike 2008, when stimulus would have rippled through the economy practically instantaneously, citizens sequestered at home can’t be spending, and a determination by Beijing not to rely on the real estate sector means that it’s hamstrung in its reflation efforts.
Far from being the force that lifts the global economy, Chinese President Xi Jinping’s zero-Covid policies are likely to see significant disruptions to China’s growth and take the rest of the world economy down with it.
Commodity price rises are already showing signs of tapering on fears of a global recession at a time when the world’s major central banks are raising interest rates to combat inflation.
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2. Stocks are Plummeting but Where's the Bottom?
The thing about doomsday predictions is that eventually, they’ll prove to be accurate.
Whether it’s the caricatured bearded man walking down the street with a sign that declares “The End is Near,” or the tweed-coated economics professor declaring that the market bubble will “pop” – none of this is useful to investors (traders) who need to make real time decisions about their portfolios.
Sell now to cut losses and pick up when markets have bottomed out or buy now, knowing that there’s no real way to time the bottom?
That’s the billion-dollar question.
But looking at the data, it’s not as if the entire stock market is in capitulation mode – just its most frothy components and that appears to be driven by valuation.
For a relatively long time, naysayers had been declaring that stocks had become “too expensive” relative to fundamentals, only to rally harder, as if thumbing their nose at the pessimists, and persistently loose monetary policy has provided for that.
But now that the U.S. Federal Reserve is removing the punch bowl, punch-drunk investors are having to contend with an investment landscape that has become far more discerning and increasingly focused on valuations.
While the selloff has been brutal, not everyone has suffered equally – high-flying tech shares have been hammered, whereas companies that make everyday household items and churn out reliable profits have even rallied against broader benchmarks.
Suddenly, investors are waking up to the fact that companies need to generate profits to justify their share prices, when before it was all about growth.
Yet despite robust corporate earnings announced over the past few weeks, stocks have continued to tumble because investors aren’t sure if the earnings multiples that they’re paying for are justifiable against the current monetary policy climate.
Valuation and profits are of little to no use in timing market entries and exit – expensive stocks can always get more expensive, and naysayers have been proved wrong often enough to sound almost bigoted.
Correlations between bond yields and earnings multiples for stocks are no longer as reliable as they once were, which is what’s driving investors to fall back on first principles – valuation.
But there is simply too much uncertainty right now over interest rates, inflation and invasion for investors to call a bottom.
The Fed has provided some clarity on its interest rate path in the coming months, but where borrowing costs ultimately settle at the end of the year is perhaps more important because nobody knows what the multiples should be and where the Fed is in relation to inflation.
It’s entirely possible that by the end of the year, inflation pressures ebb, mangled supply chains are rehabilitated and the Russian invasion of Ukraine becomes a far more localized conflict, providing the Fed room to ease off the tightening.
It is also possible that the Fed is behind the curve and that inflation runs away forcing sharper rate hikes – but this is a less likely scenario.
The reason of course is that a recession is looming and that should in the interim at least, put a damper on demand.
Because the ultimate destination of rates affects what it’s worth paying for stocks, markets could still have far more to correct and the economy would need to be in far worse shape before it’s likely that the Fed would ease back on tightening.
And that’s why valuation matters in this environment, it’s almost the only thing that investors have.
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3. Bitcoin Holds Rebound in Otherwise Bleak Conditions
While the general macro climate is full of malady, the cryptocurrency markets are facing additional challenges that are peculiar to the space.
Bitcoin held on to a partial rebound after dipping below US$30,000 earlier this week, helped by steadying sentiment in financial markets, but more importantly buoyed by expectations that rescue may be in store for an algorithmic stablecoin that has cast a pall over the sector.
That algorithmic stablecoin is TerraUSD, or UST for short, that maintains its one-to-one ration to the dollar.
UST lost its peg, plunging to as low as US$0.67 at one stage before retracing to US$0.80 – hardly the stuff of stability and adding a dose of irony to the moniker “stablecoin.”
So disastrous has been the UST episode that even U.S. Treasury Secretary Janet Yellen mentioned TerraUSD’s de-pegging as a reason why a regulatory framework for stablecoins is needed.
Not helping matters is that stablecoins typically are in demand during periods of exuberance in the cryptocurrency markets, which do not reflect current sentiment.
That lack of demand has also provided the perfect backdrop for one or more actors which are actively trying to undermine the TerraUSD’s peg to the dollar.
While Terraform Labs, which powers the Terra blockchain and issues UST declared that it would be doing what it could to shore up the embattled stablecoin, a triangular attack on both UST, Luna and Bitcoin are keeping a lid on any immediate rallies for cryptocurrencies.
Bitcoin has struggled this year alongside stocks, which it has had its strongest correlation with in years and until sentiment in broader markets improve, will make it difficult to breakout of its current levels.
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May 11, 2022