Top Things to Watch this Week
Market Behavior, Russia-Ukraine, Fed Policy, and More
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain
Intro Note on Market Behavior:
Last week, I talked about the famous sin(x) and cos(x) curves — the latter as a derivative of the former. Time and again, peak panic moments set the stage for a reversal as things just become less bad; not fully back to where we were, but less bad. It is a hard concept and extremely difficult to act on in the moment it’s required most. It is, however, the very reason why a disciplined investor will win out over a fear-driven tourist walking from one attraction to the next, always chasing what shines brightest.
During Wednesday’s reversals – equities up 2% after down 2% overnight; Palladium down 4% after up 7%, etc. – Mr. Market made it very clear again. Once one starts to conflate the wisdom of crowds with the madness of crowds, capital destruction is on the inbound. What happened that day is not to be confused with the long-term trajectory of the economy and the Fed; we do, however, think that one’s panic is another one’s opportunity. It takes decades to build wealth and only a few flawed decisions to erode it. With that, let’s dive into macro.
Macro Corner
Going from micro to macro and back again seems to have been the market’s reaction to all the events of the past week. While we can not predict the next development of the Russian invasion, we want to consider what it means for the macro backdrop and the reaction different central banks may have as a function of it.
Let’s turn to the essence of it and look at the factors that may drive things in the months to come:
A Regime Shift
As venture capitalist Josh Wolfe likes to say: failure comes from the failure to imagine failure. I agree. Recency bias leads market participants to believe that tomorrow’s markets are very much going to look like yesterday’s. Low volatility, negative real yields, and goldilocks economic numbers that keep the Fed just accommodative enough. It is fair to say that the recent volatility in markets has led to a sea change and a VIX near 30 is certainly an indication of more caution. The question has to be: is the market going to mean-revert in a sharp snap-back as has been the case, or will we see a more prolonged period of risk-off spurred by a tightening in financial conditions? We might be in for a time of re-adjustment; rotations between sectors as different parts of the market see favorable macro conditions at various points in time. While the jury is still out on where we are going to see inflation settle in, the consensus view appears to establish at a higher than pre-pandemic level. If that is going to mean tighter financial conditions, central banks that will provide less monetary accommodation, and fiscal policy makers steering clear of aggressive government support programs, we are indeed re-calibrating. We talked about the fiscal drag and much more last week: Fed Policy, Yield Curve, Fiscal Cliff, And More
Please reach out to info@Bluelinefutures.com or call +1(332)-278-0500 if you would like to go into more detail on this.
Financial Conditions Index
Source: Bloomberg
Since October of last year, we have highlighted the degree to which markets have been caught in a flood of liquidity. To keep accommodative conditions alive, it takes more and more extreme re-adjustments upward — it is all about the incremental dollar. The chances are we are moving in the opposite direction and the Fed may be more determined fighting high inflation prints than they are keen saving risk assets.
With that being said, the Fed has been playing a time game. One that keeps easy conditions alive for as long as possible and tries to smoothen the transition to a less friendly environment. Arguably, the recent developments around Ukraine have bought the Fed time and the probability for a 50bps rate hike scenario have dropped off drastically.
March Rate Hike Probabilities
Source: CME Group
Known Knowns
As tragic as the situation around Ukraine is, markets are getting a clearer picture of things by the day (discounting extreme tail-end outcomes that we can risk manage via asymmetric strategies, but cannot bet the farm on.)
Markets dislike uncertainty more than they dislike certain bad news one can adjust to.
More likely than not, the current crisis and the spillover effects that come with it are going to affect supply of certain commodities such as wheat, palladium, etc. . However, unless we see an escalation much beyond Ukraine’s borders and therefore more sanctions and a potential on-the-ground military involvement by the West, we are moving closer to certainty. These are hard calls to make in a time where nothing is off the table; it is, however, prudent and right from a risk management perspective to acknowledge what has driven markets and more importantly: what is going to drive them going forward.
Ukraine and Russia are major players in the air cargo market, and not jut because their locations put them on the most direct flight routes from Asia to Europe. – @typesfast
The cyber attack that has rendered the largest international logistics company in the U.S. totally non-operational since last Sunday seems under-reported. – @typesfast
Again: the certainty of bad news lets markets digest, weigh, and extrapolate outcomes much more so than uncertainty does.
Please refer to last week’s writing on the potential of an inflation-slowing window the Fed could use to smoothen the transition to higher rates: Fed Policy, Yield Curve, Fiscal Cliff, And More
After all, we are watching markets through a rate of change perspective.
Market Multiples
Last week, we talked about market multiples in a historical context. Given the Fed’s trajectory, how much of multiple contraction is warranted, and how should one think about the alternative between stocks and bonds with the backdrop of massively low real yields.
S&P 500 & Nasdaq 100 Fwd P/Es | 10yr Real Yield
Source: Bloomberg
Equity Market and Sector Sentiment
Short Interest vs. Float for Total US Market
Source: Bloomberg
Short Interest by Sectors | 2/15/2022 vs. 09/15/2021
Source: Bloomberg
Managed Money Positioning Across Asset Classes
Source: CME Group
Increasingly so, growth in passive as well as exotics has driven markets via money flows. The growth therein has led to massive swings, which is why a reversal in sentiment leads to ever faster intraday swings. Even institutional participants have adopted intraday options trading to protect themselves (with the need to close out positions at EOD.)
Keeping an Eye on High Yield
CDX High Yield
Source: Bloomberg
High Yield OAS Across Sectors
Source: Bloomberg
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Economic Calendar
U.S.
Data Release Times (E.T.)
China
Data Release Times (E.T.)
Eurozone(decreasing importance of events from top – bottom)
Data Release Times (E.T.)
Food for Thought
Geopolitics | Articles & Conversations
U.S. And Europe Take Aim At Russian Central Bank Reserves, Threatening Blow to Economy – Bloomberg
White House Statement: Joint Statement on Further Restrictive Economic Measures
- ‘Russia’s central bank had over $640bn in foreign exchange reserves as of Feb. 18, much of it held in the computers of Western central banks….the effort to freeze or quarantine that money will likely put tremendous pressure on Russia…it could lead to domestic turmoil, triggering a bank run, cratering the ruble and causing businesses to panic’
- ‘Richard Nephew, a senior research scholar at Columbia University, said if done in a coordinated fashion, “you would impose dramatic sweeping costs on the Russian state. This would in one fell swoop say all the reserves of Russia are locked down and no longer usable,” adding that “it could have a devastating effect on the Russian economy” ‘
- “SWIFT is short for the Society for Worldwide Interbank Financial Telecommunication, a global messaging network that connects banks around the world. The consortium based on Belgium, links banks in 200 countries and is used as money is transferred through the banking system.”
Breakdown on how the SWIFT system works by Sahil Bloom
How new sanctions could cripple Russia’s economy – The Economist
- “Many of the headlines in America and Europe have dwelled on the decision to cut off some Russian banks, probably Sberbank and VTB, from SWIFT, the global cross-border payments messaging system. In fact the SWIFT decision is incremental rather than a game-changer. It will make all counterparties, not just Western ones, wary of dealing with these firms. If they choose to do so, they will have to resort to using email and phone to communicate, adding a layer of hassle.”
- “Instead, the really big step is to target institutions at the heart of Russia’s fortress economy, the central bank. It holds $630bn of foreign reserves, equivalent to 38% of Russia’s GDP in 2021 (the sanctions may also cover a sovereign-wealth fund with further holdings). As part of the fortress strategy Russia has shifted the composition of its reserves away from dollars: as of June 2021, it held only 16% in greenbacks, versus 32% in euros, 22% in gold and 13% in Chinese yuan. However, it is likely that the majority of its holdings of securities, bank deposits and other instruments, regardless of the currency they are denominated in, are held in accounts with financial institutions or in jurisdiction that will enforce Western sanctions. That means some, or even much, of Russia’s national war chest can be frozen.”
Crude Oil, Gold, Palladium | Updated Chart from Last Week
Source: Bloomberg
Russia – Ukraine Updates | Twitter World
Second, we will paralyse the assets of Russia’s central bank. This will freeze its transactions. And it will make it impossible for the Central Bank to liquidate its assets. – @vonderleyen
The White House are saying energy sanctions are on the table – @Amena_Bakr
“Russians have been stunned at how quickly the economic impact of the war was felt.” They’re in shock…from how quickly prices are changing and how suppliers are stopping deliveries,” says a business owner. Another exec says prices are up 30% – @saletan
For the first time in 22 years, I am actually starting to believe that Putin’s hold on power may be on shaky ground. Not because some of Plpeople’s uprising – that’s a fanciful dream – but because there is now a small but non-zero chance of a palace coup –@DAlperovitch
MOSCOW (AP) – Protests against Russia’s invasion of Ukraine erupt in Moscow and other Russian cities amid ominous Kremlin threats. –@kylegriffin1
* bp will exit its 19.75% shareholding in Rosneft.
* Both bp-nominated directors to resign from Rosneft board with immediate effect.
* bp will no longer report reserves, production or profit for Rosneft
What Putin has done is going to be an absolute catastrophe for the Russian economy. I have no idea how he expects to withstand the fallout. Repression can only achieve so much. I think they somehow imagined winning quickly & easily, avoiding the harshest Western sanctions. – @KofmanMichael
Former top official at Russia’s Central Bank: “There’s going to be a catastrophe on the Russian currency market on Monday” – @BNONews
Russia’s government portal is facing cyberattacks on an “unprecedented scale,” ministry says; multiple websites, including Kremlin, are down – @BNONews
Unseasonably warm weather in Ukraine may become a problem for Russian tanks and supply lines. Definitely a big issue when Russians choose to retreat. Brings new meaning to ‘stuck in the mud’. – @BillAckman
Not easy but maybe time to wake up and realise that there will be costs to pay to avoid ww3. And similarly to covid, the sooner we accept the costs, the less we will pay overall. For oil, we have SPR, a little spare capacity in Gulf countries, and we can accept some lower demand – @AndurandPierre
We have been preparing for this for 40 years. The @IEA collective emergency stocks (not just the SPR) allow for incredibly massive oil emergency drawdowns. Combined stocks allow for sustained ~5m b/d drawdown for >12 months, according to IE modelling –@JavierBlas
Oil supply disruption easier than gas and coal, and hence European electricity. How do those markets balance. Easier for Americans to call for an embargo given energy independence. –@JohnArnoldFndtn
Putin/Russia getting completely isolated economically & diplomatically. The West is completely united. Even China is getting scared of secondary sanctions. The danger: Putin has very little to lose now. He is cornered. May go all out on economic and cyber retaliation –@DAlperovitch
This coming week, we will launch a multilateral Transatlantic task force to identify, hunt down, and freeze the assets of sanctioned Russian companies and oligarchs – their yachts, their mansions, and any other ill-gotten gains that we can find and freeze under the law. –@WhiteHouse
Azerbaijan’s state oil company, SOCAR, has confirmed that it will provide Ukraine firefighting and ambulance services with free petrol for the duration of the Russia-Ukraine conflict – @michaeltanchum
Earnings
Target (TGT) ahead of the open on Tuesday:
- Consensus: EPS est. $2.98; Revenue est. $2.86bn
Commentary on the following will be monitored:
- Retail activity as a measure of how strong the consumer remains (potential inflation fears shaking consumer confidence)
- Inflation pressures and follow through into consumer prices
- Retail space and how its role evolves
Salesforce (CRM) after the close on Tuesday:
- Consensus: EPS est. $0.75; Revenue est. $7.24bn
Commentary on the following will be monitored:
- Strength of network effects, including Salesforce’s ExactTarget, Demandware, MuleSoft, Tableau, and Slack
- Revenue and cash flow growth rates; the state of enterprise software
- The state of enterprise software | growth rates
- Unit economics
- Attrition
- Cost to Book
- Cost to Service
- Unit Economic Margins
Snowflake (SNOW) after the close on Wednesday:
- Consensus: EPS est. $0.03; Revenue est. $372.70mil
Commentary on the following will be monitored:
- Growth of data and the ability to monetize
- Growth metrics
- Data marketplace listings strengthening network effects
- Total number of customers
- Customers over $1m product revenue
Costco (COST) after the close on Thursday:
- Consensus: EPS est. $2.67; Revenue est. $51.29bn
Commentary on the following will be monitored:
- Customer appetite to spend and effects of inflationary business on consumer prices as well as input
- Membership part of the business and international expansion thereof
More earnings: Zoom (ZM) after the close on Monday; Sea Limited (SE) ahead of the open on Tuesday; Kohl’s (KSS) ahead of the open on Tuesday, SoFi (SOFI) after the close on Tuesday; Coupang (CPNG) after the close on Wednesday
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