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Novum Alpha - Daily Analysis 21 June 2022 (10-Minute Read)

A terrific Tuesday to you as stocks get a brief respite and as U.S. markets prepare to come out of a holiday, with doubts lingering over the strength and durability of the rebound.


In brief (TL:DR)

  • U.S. stocks ended a mixed bag last Friday and ahead of the Juneteeth long weekend with the Dow Jones Industrial Average (-0.13%), as blue chips pulled back, while the S&P  500 (+0.22%) and the Nasdaq Composite (+1.43%) were higher thanks to a rebound in tech stocks. Futures action points to a decent open, but doubts remain over the strength of the rebound. 
  • Asian stocks recovered on Tuesday as sentiment stabilized and with no fresh market shocks but the resilience of the rebound remains in question. 
  • Benchmark U.S. 10-year Treasury yields closed flat last Friday 3.284% (yields fall when bond prices rise) but demand retreated slightly as risk appetite returned in Asia. 
  • The dollar dipped in Asian trading. 
  • Oil gained with July 2022 contracts for WTI Crude Oil (Nymex) (+2.24%) at US$112.01 above US$110 again on optimism over demand. 
  • Gold fell with August 2022 contracts for Gold (Comex) (+0.19%) at US$1,853.80 on the back of a rising dollar.
  • Bitcoin (+2.76%) stabilized at US$20,589, rebounding alongside stocks and other risk assets. 


In today's issue...

  1. If 75-basis-point hikes aren't super-sized, what is? 
  2. The Great Chinese Junk Bond Selloff is Worrying
  3. Crypto Startups Faceoff Austerity as Cold Winter Bites 


Market Overview

Investor sentiment has stabilized somewhat, despite continued hawkish comments by U.S. Federal Reserve officials and with inflation stubbornly persistent and likely to remain that way for some time to come.
Asian stocks staged a rebound on Tuesday as traders assessed the possible impact of fresh Covid-19 outbreaks in Shenzhen and Macau, both major cities in China. 
Asian markets were higher on Tuesday with Tokyo's Nikkei 225 (+2.14%), Seoul's Kospi Index (+0.92%), Hong Kong's Hang Seng Index (+1.43%), and Sydney’s ASX 200 (+1.50%) all up in the morning trading session. 



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1. If 75-basis-point hikes aren't super-sized, what is?

  • Investors need to manage their expectations as 0.75% rate hikes by the U.S. Federal Reserve become par for the course, as opposed to the more modest 0.50% hikes earlier. 
  • Odds of a U.S. recession increasing as Fed has shown that it's behind the curve when it comes to policy, raising the specter of a hard landing for the U.S. economy. 
Although U.S. Federal Reserve Chairman Jerome Powell had promised at the conclusion of the last Federal Open Market Committee meeting that he didn’t expect any future super-sized rate hikes, what that means is a subject of much debate.
Last week, U.S. policy makers raised the federal funds rate by three quarters of a percentage point, with the interest rate for this year now from 1.5% to 1.75%, deeming it the most sizeable rate hike since 1994, with Powell adding that a hike of a similar degree is expected in July’s policy meeting as well.
Not so long ago, 75-basis-points was considered “super-sized” but evidently what that means is subject to interpretation as the Fed battles the fastest pace of price increases in four decades.
Backing another 75-basis-point hike, U.S. Federal Reserve Governor Christopher Waller reaffirmed that the Fed is ‘all in’ on regaining price stability.
Officials forecast interest rates are expected to climb to 3.4% by December and 3.8% by the end of 2023, with both being the highest levels seen since 2008, where the U.S. economy was on the brink of a financial crisis.
Conversely, Waller notes that the fear of a recession is exaggerated and feels that it is necessary to go beneath the “trend growth for at least six months to a year” and denotes the possibility of unemployment rising between 4 to 4.5%, playing down the worries harbored by many investors.
With the Fed behind the curve when it came to inflation, concerns that it will not be able to usher the “soft landing” for the U.S. economy that it has promised are increasing.
If nothing else, the U.S. Treasury yield curve appears to have priced in a recession within the next two years and there are forecasts of rate cuts by 2024.
With Americans feeling the burn of inflation, there is political pressure on the Fed be more proactive when it comes to reining in costs, but the odds of it being able to do so without causing a recession are slim, which means investors should consider selling on the small rebounds that they see, rather than bet on any durable rally in risk assets. 



2. The Great Chinese Junk Bond Selloff is Worrying

  • Sharp selloff in Chinese high yield dollar-denominated bonds is worrying because it has spread beyond real estate developers to encompass other industries. 
  • Selloff in Chinese dollar-denominated junk bonds could mean that offshore money will sour on Chinese high-yield assets for some time, especially as default risk grows. 
China’s offshore bond market has had a tough time this year but is about to face a fresh challenge in the record selloff in Fosun International’s (-0.95%) dollar-denominated bonds, reminding investors that the worst is not over yet for China’s heavily leveraged property developers.
With sentiment and appetite weak in China, a sharp selloff in the Shanghai-based Fosun International’s dollar bonds is spreading to other Chinese industrial firms and their offshore debt.
Hints of contagion are disconcerting, especially since the near-collapse of China Evergrande Group (+8.33%), was confined mainly to China’s real estate borrowers, having not extended the rout to other sectors.
Fosun International’s bonds are facing steep losses and coming at a time when Macau’s casino operators are enduring a fresh selloff, pushing China’s junk dollar debt market into a new phase as broader risks from its embattled property sector start to spread.
Much of China’s economy and GDP are closely-tied to the real estate sector, with some estimates putting it at 70% of the country’s economy and around 30% of GDP, thanks to the other industrial sectors that property development supports.
But years of over-leverage and a purge by Chinese President Xi Jinping of the borrowing that so deeply marks the sector, has seen a decline in the fortunes of property developers, but their fall has taken much of the broader Chinese economy with it.
Rolling zero-Covid lockdowns have also not helped sentiment as Chinese appetite for new homes and apartments wane and consumer sentiment remains sluggish with unemployment rising.
Many Chinese derive the bulk of their net worth to the value of their homes and as prices have declined, so has consumer sentiment and consumption, especially for discretionary items.
Some Chinese real estate borrowers have also demonstrated preference towards onshore bond holders, while stiffing dollar-denominated lenders, which reputationally, would make China’s junk bond markets off-limits for years to come. 



3. Crypto Startups Faceoff Austerity as Cold Winter Bites

  • Crypto startups attracting eye-watering valuations are now having to contend with years of austerity as the sector faces pullbacks from what appears to be a lengthy crypto winter. 
  • Nevertheless, opportunity may be present from laid-off employees starting their own new ventures and as smaller outfits gain access to a bigger talent pool. 
If you’re working at a well-funded cryptocurrency startup, congratulations, you’re one of the lucky few and let’s hope that management didn’t put their treasury into some centralized lending platform to generate yield.
In the aftermath of the 2017 ICO bubble and 2018 crash, many firms which had raised monies sought protection against the value of the cryptocurrency raised, to pay salaries and fund development and marketing.
But with the Crypto Winter now well and truly upon us, even the most well-funded crypto startups are having to tighten their belts and gird their loins for the difficult times ahead.
Venture capitalists who had dumped billions of dollars into the cryptocurrency sector, which has since rebranded somewhat to “Web3” in investment circles, possibly to shake the taint of token speculation and volatility, are now having to engage in a bout of soul-searching.
Layoffs at some of crypto’s most richly-valued companies have sent shudders through an industry that has only experienced a time of plenty.
Crypto lender BlockFi, which is suspected of having liquidity issues, recently raised capital on a down round (at a lower valuation compared to previous rounds), a worrying sign and suggestive of some desperation.
Even the big names have not been spared, including exchanges which are expected to make money no matter what, like Coinbase Global (+0.33%), Gemini Trust and, have all indicated layoffs.
To be sure, the hiring spree embarked on by cryptocurrency companies may have been excessive, especially given the volatile nature of the industry and the unpredictability of flows.
Not helping matters, a tightening U.S. Federal Reserve policy and the end of stimulus checks that has seen profligate speculative behavior that favors cryptocurrency trading, take a back seat.
Retail investors, which form the bulk of cryptocurrency exchange revenue from trading fees, have also been noticeably unenthusiastic as they grapple with the highest pace of inflation in four decades.
Large, leveraged and risky entities like Celsius Network and Babel Finance, as well as the rumored insolvency of a major cryptocurrency hedge fund Three Arrows Capital, has employees and investors concerned over which will be the next shoe to fall.  
Data from PitchBook suggests that VCs poured in over US$54 billion into cryptocurrency startups since the start of 2020, with many firms attracting eye-watering valuations, that are now being more closely scrutinized.
In such a hostile environment, survival may be wining.
But not all VCs see doom and gloom, and some have identified bright spots, because smaller companies may be able to absorb from a larger talent pool as the bigger players layoff staff.
Staff who have been let go by their cryptocurrency firms may also decide to pitch in and build out or bootstrap their own “Web3” offerings, potentially paving the way for new adoption, applications and growth.
To be sure, the entire cryptocurrency industry might have gotten ahead of itself by betting on growth in a time of easy money, but now that the liquidity taps have been turned off, those that deliver value at a good value, will be those that will ultimately persist in this space. 



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Jun 21, 2022

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