Easter Egg Hunt
In the wake of Taiwan's president visiting America, China is letting their presence be known.
Market Overview
Good morning all, and happy easter to those who celebrate. Rather than taking the weekend off, we’ve decided to go forward with this week’s newsletter. The last week in the markets was flat relative to previous weeks, with minimal action. However, the week upon us will be another one for the books. In the upcoming week, many economic events will rock the markets. In addition to the plethora of events happening this week, China has decided to take their military exercises one step further and is now rehearsing the “encirclement” of Taiwan. We believe this is a direct response to the President of Taiwan, Tsai Ing-wen. Hours before the start of the exercises, she returned from her trip to the United States, where she spent time meeting with various house speakers and speaking on the potential invasion of Taiwan. China has repeatedly warned Taiwanese officials about visiting/communicating with the U.S. government, threatening a full-scale invasion. These military exercises also come after BRICS nations recently overtook G7 countries in contributions to global GDP, making them more economically powerful.
Looking into the week ahead, apart from the scariness of a potential invasion of Taiwan, a few events will surely move markets significantly.
Multiple Fed speakers on April 11th
Fed members like Kashkari and Harker both speaking
This happens after the market closes, so it shouldn’t have too much effect on the market unless some outrageous statements are made. Still worth a listen.
They will likely speak about upcoming CPI prints.
Core CPI and CPI print on April 12th
Core CPI is likely to stay the same.
CPI forecasts are expecting a significant drop from 6% to 5.2%
Deviation higher from expectations will impact markets negatively as we are still curious about the Fed's path.
PPI on April 13th
PPI is expected to go positive after being negative last month due to commodity prices falling.
Retail sales on April 14th
Retail sales are likely to stay the same. Unless there is a drastic deviation, this will seldom affect markets much.
Equities
A slightly volatile week ended with stocks closing slightly flat as the S&P500 lost roughly 4bps since its opening last Monday. Given a halt on trading because of Good Friday, less overall trading volume meant less overall movement as global markets returned quite mixed outlooks. Job markets have seemed to come to a slowdown as March only printed 236k jobs, 3k lower than expected and a significant decline from the 311k print in February. However, unemployment rates remained relatively stable at 3.5%, while wage growth increased ~0.3% for March, representing a deceleration in growth compared to February. While a weakening labour market may seem worrying at first, continued slowdowns can help ease inflationary pressures and support core trends.
More economic slowdowns have also been shown through manufacturing and services activity as the US ISM Manufacturing PMI recorded at 43.6 in the month of March, representing a near 3-year low and 1.4 point reduction compared to February. On the other hand, the US ISM Non-Manufacturing PMI (services index) fell to 51.2 in March, well below the consensus of 54.5 and significantly decreasing from February levels. While an index measuring above 50 still represents expansion, the reduction in growth still implies slowdowns due to cooling labour markets and a reduction in overall demand.
In more exciting news, earnings season is just upon us as banks look to report 2023 Q1 statistics in the upcoming week. While this presents some nice opportunities for trading, expectations are set quite low given continued economic tightening and geopolitical turmoil. To ensure safety against upcoming volatility, investors should watch for continued economic data, sector trends, and broader political developments. For more experienced traders, option premiums will likely rise as earnings edge closer, meaning plays with stronger conviction should be undertaken to benefit from underlying movement.
Commodities
The commodity market displayed a mixed performance over the past week, with energy having by far the most eventful week.
Energy
Over the past week, the energy sector has seen some significant announcements. This all started with an announcement by vice president Kamala Harris that an executive order for community solar power was on the way. Fossil fuel commodities seemed unfazed, with a mix of results being seen. There is a high likelihood that a push by the Biden administration will be made toward renewable energy sources as they seek to fulfill promises that could better their chances of re-election. This will cause downward pressures on unsustainable energy pricing. The mover of most significance this week was coal (up 9.62%), a bounce following fears from Western nations that OPEC+ and Russia energy supply cuts would need to be partly counteracted by coal.
Metals
This week's main story in the metal markets was the acquisition offer by global mining giant Glencore to acquire Teck Resources. The bid was 23 Billion dollars which represents a 20% premium to Teck’s current market cap. As a result, the stock price skyrocketed by over 15% as investors priced the odds of acquisition and questioned their long-term outlook. As it stands, it seems as though the deal will not go through as executives at Teck value the macroeconomic outlook of the market and the recent restructuring in their corporate structure. Lithium and Iron Ore continued to perform poorly (both down 5%+), while precious metals kept building on their impressive start of the year. Silver led the way and is up 3.15% for the week.
Agriculture
Over the past week, the agriculture industry has experienced some noteworthy developments, with various factors influencing prices and overall performance Coffee was the primary mover (up 8.13%) as poor weather in crucial supply areas made headlines. Within livestock, egg prices dropped almost 10% after being at all-time highs over the past few months.
Fixed Income
If you’ve been paying attention, since the beginning of the banking crisis, we have seen extremely unordinary volatility in fixed-income, much so that every wealth manager worldwide is screaming that the 60/40 portfolio is back. However, this is alarming due to the lack of ferociousness in equities as well as the lack of liquidity in bonds, so much so that we are currently seeing the largest gap between bonds and equities volatility in 15 years.
Although bond volatility is high, liquidity is falling extremely far behind. This is due to the “rush for the exits” that we have seen in equities due to the banking crisis. This is significant because traders and investors are significantly underplaying the chance of a United States recession. As the future of rate hikes and the economy becomes more uncertain due to the banking crisis, OPEC oil production cuts, and now increased militarization around Taiwan, it’s becoming more and more apparent that traders cannot afford to get stuck in a bad position in the bond market because it will be tough to get out. Any instant shock to hurt bonds significantly may cause a timely mess. On another note, a rise in the VIX may be on the horizon extremely soon because the MOVE index and the VIX are highly correlated in the long run. The bond market has an extremely accurate track record of signalling what’s to come for equities. Think of the bond market as the “plumbing” for the equities market.
Alternatives
The hot topic in alternatives this week is, yet again, real estate. Big names ranging from Bill Ackman and Elon Musk to Morgan Stanley predicted that this threatened sector would be where the next cracks appear in the U.S. financial system. According to Morgan Stanley, more than half of the $2.9 trillion in commercial mortgages will be up for refinancing in the next couple of years. “Even if current rates stay where they are, new lending rates are likely to be 3.5 to 4.5 percentage points higher than they are for many of CRE’s existing mortgages,” wrote Morgan Stanley Chief Investment Officer Lisa Shalett in a recent report. In addition, small and medium-sized banks account for as much as 80% of commercial real estate lending. This has led to the belief from Morgan Stanley analysts that commercial property prices could fall as much as 40%, “rivalling the decline during the 2008 financial crisis,” This catastrophic outlook is, however, not shared by an industry-leading competitor, Goldman Sachs "The risk of a vicious circle of large leveraged losses and undercapitalized balance sheets that would pose a threat to financial stability is still limited," strategists Lotfi Karoui and Vinay Viswanathan said in a research note published Monday. While Karoui and Viswanathan anticipate massive issues in the office sector – an area that other strategists have expressed concern about, they believe that apartments, manufacturing plants, warehouses, and other types of commercial real estate are better capitalized and won't suffer a huge crash.
The risk to the commercial real estate market is not limited to a single region of the world and instead poses a threat to any developed markets with reliance on the banking sector.
Analysts at Citi warned clients late last month that European real estate values had still not fully factored in rising interest rates and could fall by up to 40 percent by the end of 2024. Moreover, the European Central Bank has warned of “growing vulnerabilities” in property markets “The commercial real estate sector is considered vulnerable to the impact of the pandemic, while medium-term risks of price corrections continue to grow in the residential real estate sector,” the central bank said in a supervisory report in February. However, most analysts think a rerun of 2008, where troubled loans against commercial property undermined banks’ capital, in some cases fatally, is quite unlikely. They predict instead a long period of painful adjustment rather than a sudden, severe shock.
Interesting Articles of the Week
U.S. Tensions with China on Display as McCarthy Hosts Taiwan’s Leader - New York Times
Saudi maintains crude supply to Asian refiners despite OPEC+ cuts - Reuters
Even a Recession Might Not Tame Inflation - Bloomberg Opinion