📈 Weekly Market Update

[Dione]

[27 February 2023]

Broader markets continue on a risk-off trajectory as a new narrative takes hold: inflation is more entrenched than expected, and to bring it under control requires an economic slowdown. If the slowdown occurs naturally, the Fed will not need to raise rates further. If it does not, then the Fed will need to bring further pain. In other words, there will be a comparable amount of pain coming from somewhere before markets can look upwards again. Regardless of the details, expect further downside in the short term.

Concurrently, one of the current driving forces behind NASDAQ’s previous strength, the craze over AI and ChatGPT, is also past. As time passes, the limits of diffusion-based AI models are becoming more apparent to the layman, and the exuberant emotions around the issues start to fade. This means a further damper on the US’ major tech stocks.

Tension between China and the US and uncertainty within China itself also continue to cloud the global outlook. Although the EU has done poorly in the past year, the EU is at least a known quantity, while China’s data is much more uncertain, with potential policy changes presenting a much larger risk. Within the last week, we have seen signs of continued decoupling between China and the US, with China pushing firms to drop big 4 auditors, stirring rumours of more books being cooked. Propaganda and policy have also stepped up elsewhere to denounce and curb “Western influence”. China’s continued coziness with Russia has been a serious source of unhappiness for the West; these are essentially sanctions busting within the limits of international law but also outside of the Western-led consensus. It is quite possible that we are looking at the precipice of moving from a globalized world of international supply chains focused on economic growth, to one with another iron curtain. Once the credit between the two sides has been broken, changes can arrive exceptionally quickly and recovery will be next to impossible.

In light of this, our analyst will limit exposure to the Chinese market in all its various forms. Given that the crypto market has been somewhat decoupled from China at this point, the overall impact may be limited in the short term. However, the broader impact of how China moves onwards will be difficult to overstate.

Events of note: US home prices, retail and inventories on Tuesday. S&P global manufacturing PMI on Wednesday. EU inflation data on Thursday.

Full article at: https://marginx.io/weekly-market-update-27-feb-2023/

[Dione]

[7 March 2023]

Last week saw markets largely setting up for their subsequent moves, with bond, stock and crypto markets all largely trending sideways after breaking their momentum in the second half of the week. The bond markets’ continued upwards tick is placing pressure on institutions who see another round of possible sell-offs coming along. If rates continue to tick higher, we are likely to see further shocks as positions are forced to unwind, as we have seen last October when the Bank of England had to step in to secure its financial system due to a sudden spike in borrowing costs. For now however, things look largely steady across the board, with VIX readings heralding a calm before the storm as markets wait for the next sign from the central banks, data agencies and policy makers globally. The US Fed and the Bank of Japan with its new chief are the ones to watch in the coming week.

China continues to be in the spotlight, with rumours that the US is preparing sanctions on China with its allies if Chinese support for Russia deepens. While this does not mean that US will exercise such a decision, releasing public knowledge of such discussions is clearly meant to act as a warning. This is likely to increase China’s emphasis on self-sufficiency in the near future, them having observed the impact of coordinated sanctions on Russia’s economy, and wanting to draw a line in the sand. The latest China’s National People’s Congress has seen Xi further tighten his grip on the state apparatus as the technocratic and economy focused Li Keqiang exits the stage. In broad strokes, the relationship between geopolitical risk and centralization of power is clear, as is Xi’s more confrontational style compared to his predecessors. That said, the inward facing nature of this congress suggests Xi is more interested in securing his own power and sorting out the Chinese economy’s internal woes for now. Both have yet to recover from years of adhering to China’s aggressive zero-Covid policy. Consistent with this, the CCP has set for itself a growth target for this year at 5%, a tepid follow-up to last year’s 3%. To be clear, China is still an integral part of the global economy, and a slowly growing China means the world’s largest growth engine in the last few decades can no longer be relied on to bail out the rest of the world. On balance, both the SSE and Hang Seng continue to drift sideways in response as they await more substantial market policies.

In the cryptosphere, Silvergate’s woes have sent ripples through the markets, sending BTC sharply downwards on March 3, 2023. Silvergate’s finances have come under pressure despite BTC’s recent price recovery and having held on since FTX’s collapse, a sign of the stresses induced by borrowing costs marching ever higher. It remains to be seen if this was an aftershock of FTX’s collapse, another company falling to the chill we are currently experiencing, or a sign of things to come.

Events of note: Powell’s testimony to Congress on Tuesday and Wednesday. US Job data on Friday.

Full article at: https://marginx.io/weekly-market-update-7-march-2023/

[Dione]

[13 March 2023]

Last week has proven to be dramatic, with both foreseen and unforeseen events. Powell’s statements before Congress sent expected rates shooting up. Silicon Valley Bank’s (SVB) subsequent collapse sent rates markets the other way and exacerbated the selloff in crypto and equity markets. The markets are pricing in no further tightening on the next FOMC meeting in the aftermath of these bank collapses. Along with Silvergate and Signature, there have been three significant bank collapses in a week. We can see a pattern emerging from these collapses:

1. Institutions are holding onto a large amount of losses from a bad year amidst collapsing equity/crypto prices and rapidly rising rates
2. A liquidity crunch follows from realizing these losses, or from a loss of public confidence related to these losses leading to a run
3. Institutions are unable to recapitalize due to the overall liquidity shortage on markets even if they are sound in the longer term

Broadly, this is similar to collapses that have already occurred within the cryptosphere. In the case of SVB, the FDIC was forced to step in to make depositors whole, above the 250,000 USD per account as usual. This, along with HSBC’s acquisition of SVB, has halted contagion fears for now and is evidence that the post 2008 system is more resilient and responsive. However, systemic stresses are not abating unless liquidity becomes more available. With crypto markets being less regulated than traditional markets and less likely to invite government support, the potential downside ahead remains substantial should anything break. SVB’s collapse already resulted in a visible red warning in the form of USDC’s depegging. It is again a reminder that mechanisms that relate different parts of the financial system, decentralized or otherwise, both propagate stresses and can be broken. The road ahead is uncertain and it is worth reevaluating assumptions that can be taken for granted in more ordinary times.

SVB’s collapse also offers a final lesson. HSBC has been able to acquire SVB for a single pound by taking on potential liabilities, and is able to do so because of their ability to absorb the remaining risk. SVB was a victim of both hard times and markets that have decided to shoot first and ask questions later. This acquisition, impossible under normal times, represents a massive opportunity to expand HSBC’s network in tech and their footprint in the US. Should we see another major financial crisis develop, those who protect their capital and have remaining liquidity will be able to snap up assets at incredible discounts. Investors may be well advised to seriously consider this as a model rather than reaching for a falling knife. Caution now is space for greed later.

Full article at: https://marginx.io/weekly-market-update-13-march-2023/

[Dione]

[21 March 2023]

At this point, it’s becoming increasingly obvious that we have a full blown banking crisis on our hands, and the measures taken to contain it are becoming increasingly exceptional. The latest failures to add to the tally include regional bank First Republic and Swiss giant Credit Suisse (CS). First Republic was the latest amongst the US regional banks to come under pressure since Silvergate and Silicon Valley Bank heralded the start of banking panic in the US. The FED has seen its balance sheet swell from additional lending made to banks through both its newly opened BTFP and the traditional discount window. Meanwhile, Credit Suisse’s troubles are not exactly new at this point, with their CDS premiums being elevated for months now and only able to borrow at ~4% over risk free rates when it tried to raise cash for its internal restructuring back in January.

That these two banks are, in retrospect, clear candidates for the latest fault lines to crack under pressure should not be a good reason for consolation. The collapse of Credit Suisse in particular is a sign that systemically important banks, also known as banks that are “too big to fail”, may not hold under their own strength. The Swiss government was forced to intervene and arrange an acquisition by UBS, with the latter being a largely reluctant party forced to clean up after its rival. UBS’ own equity took a significant hit from the news, while the Swiss government had to put up 9 billion to absorb potential losses. It is notable that the merger also went ahead without shareholder voting and with only the approval of the respective boards.

Another important detail of the Credit Suisse UBS merger is that Credit Suisse’ 17 billion USD worth of Additional Tier 1 (AT1), also known as Conditional Convertible (CoCo) bonds, were completely wiped out. This is in stark contrast to shareholders who will be paid 3.2 billion USD for their equity. That equity is paid out before bonds is distinctly unusual even if AT1 bonds have a clause for wipe outs in the event of government intervention. With the AT1 now seen as potential junior to even equity, expect liquidity in AT1 markets to evaporate, along with AT1’s ability to fulfill its role as a buffer between equity losses and bonds at a time when global markets are already incredibly fragile.

The serial collapse in the banking sector and the unusual actions taken by both the Swiss and FED, even if successful in containing the immediate fallout of these banking collapses, only serve to emphasize how significant the underlying problems are. Expect more institutions to fail and contagion to spread. Financial crises tend to emerge in the aftermath of usually negative market conditions following a loosening of financial regulations. 2008 followed from the 1999 repeal of Glass-Steagall, and current events can be traced in no small part to the repeal of parts of the Dodd-Frank act in 2018, itself designed to prevent a repeat of 2008. The similarity is both uncanny and uncomfortable. Expect more trouble on the horizon.

Equity and Crypto

In stark contrast to the banking sector, both tech stocks and crypto have performed well, with BTC breaking out over 28000. Tech has come to be seen as a safe haven, while crypto is seen as an alternative to traditional finance as at large. While a point has clearly been made about the weaknesses of traditional financial markets, the assumption that tech or crypto do not seem well grounded. While tech is no longer the growth filled hype bubble of 2001, with mature behemoths such as Google and Microsoft, it is worth noting that many of the NASDAQ’s largest components such as NFLX and AMZN do not have particularly strong cash flows. Cash-on-hand for the sector as a whole has come under pressure lately and it remains to be seen what would happen if these tech behemoths are forced to raise additional capital.

Concurrently, crypto has already shown itself to be far less decentralized or divorced from traditional finance than maximalists would propose. To argue that the current rally is a reflection of crypto’s superiority rather than primarily a massive squeeze of short positions is to forget FTX and Silvergate. Imagine for a moment if Binance collapses, unable to process withdrawals due to a loss in confidence in its liquidity, or if its partner banks are unable to process transactions due to their own issues that are unrelated to Binance. Another scenario would be if major holders of crypto are forced to liquidate their BTC holdings in order to cover their losses elsewhere. With the long/short ratio of BTC becoming increasingly long favored, BTC and crypto as a whole remain exposed and in danger for all their apparent strength.

Events of Note

The FOMC announcement on March 22 is the calendar event to watch. Prior to Credit Suisse’ collapse, my view was that we are likely to see a 25 bp increase despite pressure on the banking sector. Inflation remains more than double of the FED’s target, while the FEDs can rely on its lending facilities to maintain banking sector stability. With things as they are now, it is clear that current events have overtaken whatever projections the FEDs have made and will likely continue to do so regardless of their decision in the upcoming meeting. Even if we see no increase, don’t celebrate too early. Historically, market bottoms have followed FED pivots, rather than come before.

Full article at: https://marginx.io/weekly-market-update-21-march-2023/