Risk-off but Friday rally salvages week
I am going to try a slightly different format this week, so please let me know what you think. I have included the usual tables in the second half of this update without commentary and will let the data speak for itself. In the coming weeks, I will create some more concise summary tables to present earlier in the update. Any other ideas to make this more useful?
Summary
Equities continued their decline this past week, with only a late-session rally Thursday in US equities that extended into Friday salvaging what could have been a considerably worse week.
Other global equity markets were largely mixed, with the European bourses following the US lead on Friday and recording solid gains, pushing both the FTSE 100 and STOXX 600 into positive territory for the week.
As has been the case for many months now, it was the NASDAQ that had the worst relative performance for the week in spite of solid gains on Friday. The tech-heavy index is now down 24.5% YtD, in spite of gaining 3.8% on Friday.
US CPI for April – released on Wednesday – was the most influential economic data released this week, making a bad situation at the time even worse. At 8.3%/annum, CPI was above consensus (albeit down from March) and remains sufficiently high to raise ongoing questions as to how soon inflation can be brought down to the Fed’s target rate of 2.0%, and just how aggressive the Fed must be to achieve this objective. The Bank of England and ECB face similar problems as far as inflation with significantly less manoeuvrability than the Federal Reserve.
Market risk indicators were elevated much of the week, both in terms of volatility and credit indicators. BBB (investment grade) credit spreads were 9bps wider WoW (through Thursday), but the real damage occurred in the mid- to weak-end of the high yield (non-investment grade) corporate bond market. High yield spreads were around 60bps wider WoW, with the spread on the (most risky) CCC-rated index gapping out over 100bps this week (to 10.13%).
With this malaise going on in risk markets, US Treasuries caught a flight-to-quality bid in spite of the April inflation print, with yields declining and the yield curve flattening. The yield on the 10y UST decreased 19bps WoW, ending the week back below 3% (at 2.93%), even though Treasuries lost ground on Friday as a more constructive tone returned to risk markets.
The US Dollar continued to strengthen, with the Euro feeling especially vulnerable as the drift towards parity with the Dollar is in sight.
The rapidly shifting sentiment finally ensnared cryptocurrencies, which were sharply lower on the week. Bitcoindrifted below $30,000 (intraday) mid-week for the first time since July 2021, eventually finding some support on Friday as equity markets rallied. However, BTC faded again into the end-of-day Friday, closing the week down 18.8% at $29,283. The benchmark crypto is now down 36.8% YtD. As an aside, gold also fared poorly during the week (-3.8% WoW), continuing its recent slide.
Oil prices were up modestly after experiencing a broad trading range during the week, with WTI crude ending the week at $110.16/bbl (+0.4% WoW), its highest closing price since late March.
Major events driving markets last week
US CPI for April: US CPI for April came in at 8.3%, down from 8.5% in March but above consensus. You can find the full report from the US Labor Department here. Core inflation (excluding food and energy) fell to 6.2% in April (YoY). One of the highest inflation components is – perhaps not surprisingly – airline fares, which were up 33.3% in April (YoY) as people resume travel with concerns over COVID slowly fading. Having just flown in and out of London Heathrow, the increase in passenger traffic is very noticeable.
Earnings: Most corporate earnings (S&P 500) for 1Q22 are now behind us, with 458 of companies now reporting. The aggregate results suggest that earnings were solid, but in reality, there were several high-profile misses that made things feel a lot worse this cycle than the last several quarters. As far as an update for the first quarter’s S&P 500 earnings, I suggest that you read the #Refinitiv weekly update which you can find here. Specific earnings this past week that seemed to most rattle markets were from #DIS and COIN, with the latter moving to a loss as crypto prices drifted lower and trading volumes plunged. (See my Twitter thread regarding #COIN here.) Valuations continue to revert towards a more reasonable level, with Refinitiv reporting that the forward P/E ratio (2Q22-1Q23) for the S&P 500 index has now fallen to 16.7x.
Crypto volatility: Cryptocurrencies were sharply lower this week, driven by risk unwinding alongside growing concerns over so-called stable coins. Cryptocurrencies are not my area of expertise, but my understanding is that many stable coins are either linked to the US Dollar or to a basket of other assets, including (other) cryptocurrencies. As the name implies, the idea is that stable coins i) will remain on par with the US Dollar (1:1) for dollar-linked coins, or ii) for non-dollar linked cryptocurrencies would have the underlying basket of assets linked to the digital currency rebalanced via an algorithm to preserve the value of the stable coin. It is the latter that seemed to be most in focus this week, with concerns surfacing around TerraUSD (UST) and the value of its underlying collateral basket. TerraUSD, which was last around $1.00 on May 4th, closed the week at $0.154. I also mentioned the results of COIN in the “Earnings” section, which was personally my proxy play for cryptocurrencies. However, it is clear now – having seen Coinbase’s shockingly bad 1Q22 results – that as the appeal of cryptocurrencies fade, so does the appeal of crypto exchanges.
UK economic data: UK economic data was far from encouraging this week. UK retail sales fell 0.3% in April (source: BRC-KPMG, report here), the first decline in 15 months (MoM). As UK consumers feel the pinch from inflation, they are spending less, one more indication that the UK economy is on thin ice. According to the ONS (report here), UK GDP shrunk 0.1% in March and was flat (revised down) in February, indicating both the general weakness and the trend. Weak economic data coupled with high inflation (recall that the BoE said CPI in the UK could reach 10% in 4Q22) is a cocktail for stagflation. The BoE has no choice but to tighten policy to curtail inflation, but unlike in the US, the UK economy is in a more precarious state, providing little room for the BoE to navigate. There are also concerns around a potential trade breakdown with the EU as the skeletons of BREXIT continue to haunt trade into and out of Northern Ireland pursuant to the Northern Ireland Protocol.
China: It is becoming increasingly clear that the Chinese economy will struggle to meet its 2022 growth target of 5.5%, with the most recent blow being the broadening of government-imposed COVID-related shutdowns of large cities across China. China has also done itself no favours through its “quasi-association” with Russia, since Russia’s invasion of Ukraine is proving to be a slow slog, and China needs to be extremely careful to steer clear of US sanctions. Behind all of this, we have the issue regarding the property sector in China, which was exposed by the Evergrande situation many months ago but has never really been resolved. If one Chinese property company is in trouble, the likelihood is that others are, too. All of these factors mean two things. Firstly, supply-chain disruptions involving goods and component parts coming from China are likely to continue, which are creating bottlenecks that are contributing to inflation around the world. Secondly, as the world’s second largest economy, weaker-than-expected economic growth will reduce demand for goods and services provided by US and European multi-national companies that operate in China or import into the country. This will dampen inflation and be a drag on global growth.
Twitter / Elon Musk: As much as I would like to ignore this, it is impossible not to mention the ongoing saga around Twitter. Recall that Elon Musk made a formal offer to buy TWTR on April 14th, and the TWTR Board agreed to sell the company on April 25th for $44 bln ($54.20/sh). Since April 14th, the NASDAQ has fallen 14.8% (May 12th close), whilst general market sentiment has worsened considerably, and the economic outlook has become increasingly cloudy. Mr Musk claimed Friday morning that his acquisition of TWTR was “on hold” due to concerns over user data, specifically the percentage of fake or spam accounts (which the company said in its most recent 10-Q is less than 5%). The deal has a break-up fee of $1 bln, so whether Mr Musk really wants to walk away or just wants to have leverage to negotiate a lower price remains to be seen. The real casualty here will likely be Twitter and the company’s shareholders, as the price Mr Musk is offering looks very full in retrospect give the direction of the general market since Mr Musk made his formal bid in early April. Although TWTR shares moved lower on the news (down 9.7% on Friday), Tesla shares rallied (increased 5.7% on Friday).
What’s Next?
With the corporate earnings season now largely behind us, focus will be on economic data in the coming weeks. The combination of tighter monetary policy, on-going supply chains disruptions, elevated oil prices, and COVID-related shut-downs in China will slow global growth and weigh heavily on investor sentiment in the coming weeks. This confluence of factors suggests that US Treasury yields might have reached their peak. As a result, bonds might deserve more consideration. I expect equities to at best stabilise and at worst continue to drift lower. Short-lived rallies might be an opportune time to lighten into strength if you are more concerned about what will happen in the next few weeks rather than the next few years. If you are investing in stocks, be selective. You are getting in at much better levels than at the end of 2021, but markets still might have further to fall. We will find out early next week if the rally on Friday has legs.
There is plenty of economic data coming our way next week, too. The UK will release retail price and sales data, unemployment claims and CPI for April. The EU and Eurozone will release preliminary 1Q22 GDP (noting that flash GDP has already been released). The US will release retail sales and initial jobless claims for April. Fed chairman Powell is speaking at a WSJ “Future of Everything” festival on Tuesday (beware!). Japan releases 1Q22 GDP and April inflation data, and China also has some economic data releases early in the week.
The Tables
Global equity indices
US equity indices
US Treasuries (yields)
Corporate bond yields
Corporate bond spreads
Safe have and other assets
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