The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

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)

Invest with smart knowledge and objective odds

THE DAILY EDGE: 23 MAY 2022: Getting Sentimental?

SENTIMENT WATCH
Late Rally Lifts Stocks After S&P 500 Skims Bear Market

We just keep making history! Up and down.

(…) At one point, the S&P 500 slid so far it was on track to close at least 20% below its January peak—what would have been considered a bear market. A comeback in the final hour of the trading day pushed the index higher (…)

It has been decades since stocks have fallen for such a prolonged period. The Dow industrials notched their eighth straight weekly loss, their longest such streak since 1932, near the height of the Great Depression. The S&P 500 and Nasdaq had their seventh straight weekly loss, their longest such streak since 2001, after the dot-com bubble burst. (…)

This week, the pain spread well beyond the technology sector, alarming many investors. Major retailers reported their profits being hurt by rising costs and supply-chain disruptions, driving a selloff that led to Target and Walmart’s worst one-day decline since the Black Monday crash of 1987. As investors took stock of how inflationary pressures and slowing growth could weigh on corporate profits in the coming months, shares of everything from banks to real-estate investment trusts to grocery store chains fell, too. (…)

On Friday, even shares of energy companies, which have benefited from surging oil prices, fell alongside the broader market. (…)

Until the Fed convinces investors it can tighten monetary policy and reel in inflation without triggering a downturn, it is unlikely markets will stabilize, analysts said. The central bank’s job will be made more difficult by factors outside of its control that have added to inflationary pressures this year, including China’s zero-Covid policy and Russia’s invasion of Ukraine. (…)

The yield on the benchmark 10-year U.S. Treasury note fell to 2.785% Friday from 2.854% on Thursday. [And 3.12% on May 6] (…)

Bloomberg:

For the record: the S&P 500 fell all the way to 3,810 during Friday’s session, or roughly 20.6% below its record close of Jan. 3, then rebounded to cut the loss to 18.7%. The levels could be dismissed as trivial except for a nagging fact: history holds an improbably large number of examples of such rebounds lasting. In 1998, 2011 and 2018, the benchmark slid either below the 20% level or very near it on an intraday basis — only to reverse itself and never test the bear-market waters again.

Another fact to recall from those near-death experiences of the past: how bullish they ended up being. Consider the 19.4% drop from April 29 to Oct. 3, in 2011, for instance. At that bottom, the gauge experienced three days of gains greater than 1.5% — and continued on to its best month in 20 years. The recovery paved the way for the longest bull market ever recorded, the one that ended in the Covid crash.

Something similar happened in 1998, when the benchmark suffered a drop greater than 19%, bottoming on Oct. 8, before a 2.6% rally spared it from oblivion. From October’s start to the end of January the following year, the gauge surged nearly 25%.

In 2018, the bull market got within points of a 20% plunge on Dec. 24 before turning on a dime right after Christmas. Six days later began a year in which the S&P 500 surged 29% and the Nasdaq 100 rose 38%.

Julian Emanuel, chief equity and quantitative strategist at Evercore ISI, says 2018, 2011 and 1998 have been on his mind. “These three episodes notably occurred around periods of Fed tightening and did not accompany US recession,” he wrote in a note. His firm doesn’t predict a recession to happen this time, either.

And John Stoltzfus at Oppenheimer is reported saying:

I’ve been doing this for 39 years, and my gut is telling me right now this looks a lot like early 2009, before things straightened out. It looks like 1994. It looks like the fourth quarter of 2018. These things, if you projected negatively on that point, you missed the rally that followed after things were basically right-sized.

And today, the WSJ’s James Mackintosh also points out that “In the past 40 years, the S&P 500 has bottomed out with a 20%-or-so peak-to-trough decline four times, in 1990, 1998, 2011 and 2018.”

What the above commentators do not mention is that at the 1990, 1994, 2009, 2011, 2018 and 2020 bottoms, valuations were also at their lows, quite unlike presently:

                            P/E     R20 P/E    FOMC at low

  • 1990:     13.0       18.4           easing
  • 1994:     15.7       18.6        tightening
  • 2009:     12.7       14.5      done easing
  • 2011:     12.3       14.3             QE
  • 2018:     14.6       16.8  stopped tightening
  • 2020:     13.9       16.2          easing
  • now:       18.1       24.0      tightening 

James Mackintosh adds that

The common factor in the 20% drops was the Federal Reserve. Each time, the market bottomed out when the central bank eased monetary policy, with the stock market’s fall perhaps helping push the Fed to take the threats more seriously then it otherwise might.

That was exact in 1990 and 2020. But in other instances, the Fed was either tightening (1994), was done easing (2009 and 2011) or signaled it would stop tightening (Powell Pivot, Jan. 4, 2019). So far, Mr. Powell’s only apparent pivot is toward a Paul Volcker incarnation.

As to 1998, the Greenspan Fed decided to ease amid a strong economy, a 4.5% unemployment rate and stable 2-2.5% inflation, launching the second leg of the dot.com froth that Alan Greenspan himself labeled “irrational exuberance” in December 1996. But if you faded that rebound at 22+ P/Es, you could buy again 4 years later 15% cheaper.

I have been doing this for 50 years and I have learned that my gut is not always dependable. Objective risk/reward measurement has proven more rewarding, and less stressful.

I am often told that forward earnings would be more appropriate for P/E multiple calculation. I would only say that the Rule of 20 discipline is working very well with actual trailing earnings and also warn that, of the last 14 bear episodes, only 3 (21%) did not the precede a recession during the next year. These generally come with 10-15% earnings contractions, sometimes much more…

Quincy Krosby, chief equity strategist at LPL Financial, is totally right: “There’s zero certainty on where the economy is heading. You have a ‘recession’ camp, a ‘soft landing camp,’ and everything in between.”

But the world’s biggest hedge fund seems solidly camped:

(…) Jensen, who serves as co-CIO with Bridgewater founder Ray Dalio and Bob Prince, also warns that investors also shouldn’t expect the central bank to step in to save them. Instead the Fed will be hamstrung by its need to tighten financial conditions in order to bring inflation under control. This idea that the Federal Reserve is not afraid of a stock market selloff — and in fact may actually welcome one — has been expressed by the likes of former NY Fed President Bill Dudley in a Bloomberg Opinion piece from April.

“They want the asset prices to fall to a certain degree. And even if they fall more than they want them to, they’re weighing the inflation picture against that. So all of a sudden you’ve got a much bigger dip possibility before you get relief from policy makers,” Jensen said. “And in fact, the dip has to become disinflationary in order to do that.”

Jensen estimates that roughly 40% of the US equity market “can only survive essentially with new buyers entering the market because they’re not cashflow generating themselves. And that’s near a historic high, that’s like basically right in line with ‘99, 2000.” (…)

“The assets that need liquidity the most, that don’t themselves have cash flows are getting killed because liquidity is being withdrawn from the aggregate system and those assets that require kind of Ponzi-like ongoing purchases to support the assets, are getting hit the hardest,” he said.

That said,

  • bearish sentiment is getting near its extreme highs as Ed Yardeni illustrates with Investors Intelligence data:

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  • volatility, a measure of fear, is also near extremes (via Ed Yardeni):

image

  • this contrarian indicator is in buy low range…although it can get worse:

  

  • deleveraging is well underway:

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But we haven’t got the final capitulation yet:

“Watching”, but not selling out yet.

EARNINGS WATCH

Analysts must have been shaken by last week shocking revelation that inflation is hurting demand and boosting costs. The string of upside revisions has broken last week.

image

image

But it is a slow process among disbelievers. Q2 estimates are for EPS to rise 5.4%, down from 5.7% last week but Q3 and Q4 estimates are unchanged at 10.8% and 10.7% respectively.

Corporate guidance remains cautious but given that April seems to have been a particularly difficult month for revenues and margins, more negative surprises may be in store for Q2. Note that the N/P ratio totals 3.6 for Industrials and consumer centric companies.

BTW: Despite higher sales of small farm machinery during the three months ended May 1, Deere said its quarterly profit fell by 20% as its operating margin shrank by nearly 5 percentage points. Quarterly profit from large farm equipment rose 5% from a year earlier, but the profit margin contracted. Deere said it expects to continue raising prices on its equipment. Deere raised its net income forecast for this year by $300 million to a range of $7 billion to $7.4 billion. Deere’s shares fell 19% from $385 on Wednesday to $313 on Friday.

THE GOODS ECONOMY LESS GOOD

On May 15, the Chase consumer card spending tracker was 1.1% above its pre-COVID trend. That’s before adjusting for inflation. Actually, the tracker is 7.3% over its 2019 level. Total CPI since December 2019: +11.6%; CPI-Durable Goods: +22.1%; CPI-Nondurable Goods: +15.9%.

  • End of April: Walmart and Target inventory jumped by 32% and 43%, respectively. Kohl’s was up 40%.
  • Kodak now holds around six months of inventory, compared with three months before the supply-chain challenges began, Mr. Bullwinkle said. During the first quarter, the company reported $247 million in net inventory, up more than 12% from the prior-year period. (…)
  • [Olaplex], The Santa Barbara, Calif.-based company went from having four to five months of supply in the first three months of 2021 to holding six to seven months of inventory by the end of last year’s third quarter. Inventory levels will remain elevated until supply-chain conditions show signs of improvement, according to Mr. Tiziani. (…)
  • Other companies, including energy drinks maker Monster Beverage Corp. , microcontroller chip maker Microchip Technology Inc. and medical equipment company Steris PLC, also said they are carrying higher levels of inventory. (WSJ)

From April’s Senior Loan Officer Survey: “Among the most cited reasons for strengthening demand, major net shares of banks cited increased customer needs to finance inventory and accounts receivable, as well as higher customer investment in plant or equipment.”

Voluntary or involuntary accumulation?

Bespoke finds much business pessimism in the Philly Fed’s latest survey, suggesting involuntary inventory accumulation:

Expectations indices meanwhile are generally more depressed with some readings even near record lows.  As such, the average normalized distance between the current conditions and expectations categories throughout the report have broken out to the highest level since February 1988 and mid-1975 before that. Put differently, there have rarely been times in which the region’s manufacturers have reported such a dramatic difference between healthy current conditions while also holding a pessimistic outlook.

Spread between current conditions and expectations

image image

(Bespoke)

Meanwhile, we know that housing is facing strong headwinds:

(Bespoke)

The Loan Officer Survey revealed “weaker demand for all RRE loans over the first quarter.”

This is happening when the supply side of the equation is swelling:

(Bespoke)

  • On Monday, the industry group representing Canada’s real estate agents said a key metric measuring the balance of power between buyers and sellers — the sales to new listings ratio — was about to tip from favoring sellers to an equal footing. Metropolitan Toronto is already a buyer’s market, Bank of Montreal research shows. Buyers no longer appear eager to purchase properties now to avoid increased prices in the future, the mindset that helped drive Canadian home values up by 50% since the start of the pandemic. (Bloomberg)

Hence:

FIBER: Industrial Commodity Prices Continue to Decline

Despite the recent improvement in U.S. factory output, many industrial commodity prices have weakened. The Industrial Materials Price Index from the Foundation for International Business and Economic Research (FIBER) eased 0.2% last week. It was the fourth consecutive weekly decline and pulled prices 7.1% below the peak in the second week of March.

Prices in the metals group have been under extreme pressure, tumbling 17.0% during the last four weeks. This decline was led by a 23.9% four-week decline in steel scrap prices. The price of zinc, which is used in batteries, fell 19.6% during the last four weeks while aluminum prices were down 13.9% in the last four weeks. Copper scrap prices fell 10.0% in the last four weeks, while tin and lead prices also fell sharply.

Prices in the miscellaneous group also have been under pressure and fell 1.0% last week (-10.0% y/y), led by a 5.6% decline in framing lumber prices. They have fallen by roughly one-half during the last year. Natural rubber prices eased 0.1% last week and have weakened 6.5% during the last four weeks.

Offsetting these weekly declines was a 4.3% increase in prices in the crude oil & benzene group, which have risen by one-quarter during the last year. Crude oil costs alone rose 6.4% last week and were up by roughly three-quarters y/y. The per barrel price of crude oil of $111.75 compared to the $115.64 per barrel high in the second week of March. The price of the petro-chemical benzene rose 10.2% last week and stood 10.8% higher y/y. Excluding crude oil, industrial commodity prices eased 0.5% last week and have fallen 7.3% during the last ten weeks.

Textile group prices recently have trended sideways, near thirty-year highs. Cotton prices increased 2.6% last week and rose 81.4% y/y. The cost of burlap, used for sacks, bags and gardening, eased 0.2% last week and remained near its record high.

 image image

commodity

Bloomberg: “Financial conditions have tightened at the fastest pace this far into a hiking cycle since at least 1987. The financial conditions index, as tracked by Goldman Sachs Group Inc., has fallen 1% since the first rate increase two months ago. The pace of tightening at this stage exceeds all previous five hiking cycles, data compiled by Bloomberg show.”

Financial conditions tightening at fastest rate in decades this far into a hiking cycle

Germany Warns Falling Euro Could Push Inflation Even Higher The comments add pressure on the European Central Bank to reverse its negative rate policy despite concerns about a recession.
Business leaders warn that three-decade era of globalisation is ending
The world’s car buyers are ready to go electric

52% of respondents to EY’s annual Mobility Consumer Index who are looking to buy a car want an EV, according to the survey of 13,000 people in 18 countries.

  • That’s a leap of 22 percentage points in two years, and the first time that EV interest exceeded 50%, the company said.

Consumer interest in electric vehicles has hit a global tipping point, with more than half of car buyers saying they want their next car to be an EV, new research from Ernst & Young shows.

  • Yes, but: Americans still aren’t as enthusiastic as consumers in Europe and Asia.
unnamed - 2022-05-23T070854.590

Data: EY Mobility Consumer Index; Chart: Axios Visuals

  • …. and EVs are shoving aside real volumes of oil

Electric vehicles displaced roughly 1.5 million barrels per day of oil last year, new analysis shows, an amount slated to grow as EV sales keep rising, Ben Geman writes in Axios Generate. (…)

  • The amount EVs have displaced doubled over the last six years, BloombergNEF said.

Reproduced from BloombergNEF; Note: Includes a small number of fuel-cell vehicles; Chart: Axios Visuals

  • “Two- and three-wheeled EVs accounted for 67% of the oil demand avoided in 2021,” the report notes, citing rapid adoption in Asia.
  • Buses were next at 16%, followed by passenger vehicles at 13%, though BloombergNEF adds that they’re the fastest-growing segment.

BloombergNEF said last year’s displaced oil demand amounts to roughly one-fifth of Russia’s pre-invasion exports.

TECHNICALS WATCH

My favorite technical analysis firm’s most valued indicators still reflect an
unhealthy and still-deteriorating market
condition.

Biden Says U.S. Would Intervene Militarily if China Invaded Taiwan President Biden said the U.S. would get involved militarily to defend Taiwan if China tries to take it by force, issuing a stark warning to Beijing during his first trip to Asia as commander in chief.

High five The White House rowed back the comments, saying he simply meant the US would give military equipment to Taiwan, not send troops to defend it. China was angry and warned him not to send the wrong message.

Pointing up Biden also said he’ll review Trump-era tariffs on Chinese imports.

Meaning review and cut.

THE DAILY EDGE: 10 MAY 2022: Digital “Bank” Runs!

HOUSING SLOWING

From John Burns’ @RickPalaciosJr: April homebuilder survey results are here. Top themes: 1) Demand is slowing, namely entry-level due to payment shock. 2) Investors are pulling back. 3) Ripple effect of rising rates starting to hit move-up market.

  •  #SanJose builder: “Quality traffic has significantly decreased.” THE END
  • #Sacramento builder: “Seeing trouble qualifying for entry-level buyers as they are priced out by rates.”
  • #Cleveland builder: “Once we reach home closings, about 5% of our current customers on the books will be forced to bust out as they originally qualified at a 3.25% rate and won’t be able to stretch beyond this.”
  • #Fresno builder: “Finding an increase in cancellations due to the rate increase. The majority of cancellations are resulting from fear vs non-qualification.”
  • #Reno builder: “Cancellation rate last month more than doubled from 6% to 16%. We attribute this to buyers that did not lock interest rates early in purchase process. Also seeing many buyers put buying decision on hold.”
  • #KansasCity builder: “Our lower end product has paused or slowed dramatically.”
  • #Indianapolis builder: “Traffic has significantly declined and people have paused on moving forward with purchases.”
  • #Tampa builder: “We’ve seen a significant shift in buyer behavior in the last 30 days. Florida was on fire and pricing has really come to a high point, and people are not willing to pay the prices anymore.”
  • #Philadelphia builder: “Between higher interest rates and higher sales prices, along with high gas prices and a volatile stock market, we’re seeing a pullback in our sales.”
  • #Denver builder: “Sales are slowing due to higher prices and rates. Backlog of buyers have remained but we are seeing new prospects priced out with interest rates and anticipated payments. Conforming loans quoting over 6%.”
  • #LosAngeles builder: “Buyers who are stretching to purchase have become more cautious.”
  • #RiversideSanBernardino builder: “Cancellations are starting to creep up due to loan declines and job losses. Waiting lists are certainly smaller. Saw an immediate change in buyer behavior when rates climbed over 5%.”
  • #Seattle builder: “Pause by a large population of buyers. To achieve our desired [sales] pace, we had to make price adjustments. Rates starting to knock people out of qualification.”
  • #WashingtonDC builder: “Traffic half what it was in March. Worried about first time buyers. Many fewer REAL buyers than number of people collected on interest list last 6 months. Certainly more attempts [from buyers] to negotiate.”
  • #Provo builder: “Investors are evaluating the investment more critically than in the past.”
  • #Raleigh builder: “Investor activity has slowed dramatically.”

There’s more but you see the point(s)…

But I don’t see this next point, from the NY Fed’s Survey of Consumer Expectations:

 image image

Hence:

 image image

Tesla halts most output at Shanghai plant, April sales dive

Tesla Inc (TSLA.O) has halted most of its production at its Shanghai plant due to problems securing parts for its electric vehicles, according to an internal memo seen by Reuters, the latest in a series of difficulties for the factory.

The automaker’s sales in China had already slumped by 98% in April from a month earlier, data released by the China Passenger Car Association (CPCA) showed on Tuesday, underscoring the hit from China’s hard COVID-19 lockdowns. (…)

Tesla planned to manufacture fewer than 200 vehicles at its factory in the city on Tuesday, according to the memo, far below the roughly 1,200 units per day it had ramped up to shortly after reopening on April 19 following a 22-day closure. (…)

The company had been aiming to increase output at the plant to 2,600 cars a day as soon as next week, Reuters reported previously.

Overall passenger car sales for China, the world’s largest auto market, dropped almost 36% in April from a year earlier, the CPCA said. However, sales of battery-electric vehicles and plug-in hybrids – a category China targets for incentives – rose more than 50%, boosted by particularly good performances by BYD (002594.SZ) and SAIC-GM-Wuling (GM.N), (600104.SS).

Another auto association estimated last week that overall auto sales in China had dropped 48% in April as lockdowns shut factories, limited traffic to showrooms and put the brakes on spending. (…)

U.S. producers undo years of efficiency gains in fight for supplies

Industrial companies reporting earnings over the past few weeks have described steps they’ve taken – from acquiring trucks to move their own goods to building products that sit around on factory floors waiting for missing semiconductors – to deal with delays and shortages that have dogged them over the past year.

“We want to optimize our supply chain to its fullest,” said John Morikis, chief executive of Sherwin Williams Co (SHW.N), describing to analysts last month how the Cleveland-based paint maker has started using its own trucks – a much costlier route than using third-party services – to get around bottlenecks in transport systems.

Morikis admitted this is “less efficient,” but necessary to meet surging demand. Over time, he said, he hopes “the efficiency will work its way back.” (…)

Many companies focused on how they were responding to these problems in their earnings calls. In many cases, the moves add to costs and complexity in their systems.

Rockwell Automation Inc (ROK.N), the Milwaukee-based maker of factory software and automation equipment, said one response to shortages has been to build more products that had to wait for scarce semiconductors to be finished.

“That’s one reason we saw our working capital increase in the (latest) quarter – as we had a higher amount of product being built in anticipation of getting chips,” Blake Moret, Rockwell’s chief executive told Reuters. Moret said he considers many of the efficiencies created by shortages to be part of a new normal.

(…) Generac has worked on finding second and third suppliers for more of its parts – seeking them in multiple regions of the world – more costly than relying on one source but, he said, more secure.

“What we’ve learned is that we need a buffer,” said Jagdfeld. “The way we’ll create that is by carrying more inventories of the component supplies we consume.”

Companies currently don’t mind higher costs which they can easily pass on. ING on today’s NFIB report:

Looking to tomorrow’s inflation data the NFIB report shows a net 70% of companies raised their selling prices in the past 3 month – down from last month’s 72% balance, but this is still the second highest reading in the survey’s 47-year history. Moreover, a net 46% of firms plan to raise their prices further over the next three months (down from 50%, but this is still the 6th highest reading in the survey’s history). This reinforces the message that despite concerns about where the economy is heading, businesses continue to have pricing power and highlights the breadth of inflation pressures in the economy. The ability to raise prices is seen across all sectors and all sizes of businesses.

NFIB price indicators show no sign of a turn in inflationunnamed - 2022-05-10T082340.585

New York Fed: Longer Term Inflation Expectations Rose in April Respondents see prices rising by 3.9% three years from now, up from a rise of 3.7% they predicted in March.

Meanwhile, respondents believe inflation one year from now will rise by 6.3%, down from March’s 6.6% level. (…)

The expected rise of gasoline prices a year from now hit 5.2%, a sharp drop from the 9.6% rise seen in March. Food and medical care costs 12 months from now were seen up by a smaller degree relative to the prior month, while the 10.3% increase seen for rent was the highest reading in a report that goes back to 2013. Home-price increases a year from now held steady at an expected 6% gain. (…)

In the report, the New York Fed said survey respondents “remained positive about their labor market prospects, with earnings growth expectations stable at its series high and job loss expectations hovering near its series low.” It said household spending expectations hit a new high in April, even as expectations about future access to credit worsened to its worst reading since the survey started in 2013.

Royal Bank of Canada is raising base pay by 3 per cent for its lower-paid employees as part of a $200-million spending package that aims to fend off fierce competition for talent by improving salaries and benefits.

The unusual increase takes effect on July 1, and applies to all employees in a range of entry-level and less senior positions, including at branches, call centres and other divisions. Collectively, the employees receiving raises make up nearly half of all RBC staff, and chief executive officer Dave McKay said in a company memo that the raises are intended “to address the market pressures and the rising cost of living that is having a greater impact on colleagues in lower salary bands.” (…)

Mr. McKay has said that a “massive” imbalance between demand and supply for labour is emerging as a top concern for business leaders. (…)

Last month, Toronto-Dominion Bank – which is RBC’s largest competitor in Canada – promised a 3-per-cent pay raise to most of its employees in July, and $1,500 cash bonuses to some other staff.

On Monday, RBC also said it will contribute more to employee pensions over two years, enhance benefits for fertility and surrogacy services and adoption, and add a paid sabbatical program for staff when they reach employment anniversaries. (…)

Inflation, Sharp Rise in Rates Pose Financial Risks, Fed Says Central bank identifies near-term threats in Monday’s Financial Stability Report

(…) “Further adverse surprises in inflation and interest rates, particularly if accompanied by a decline in economic activity, could negatively affect the financial system,” the central bank said in its latest semiannual Financial Stability Report.

Near-term risks highlighted in the report reflect a survey by staff from the Federal Reserve Bank of New York with a range of contacts, including academics, community groups and domestic and international policy- makers, the Fed said.

A combination of higher inflation and rising interest rates could weaken the balance sheets of households and businesses, leading to an increase in delinquencies, bankruptcies, and other forms of financial distress, the Fed said. Households could be affected by job losses, higher interest payments, and a reduction in house prices caused by higher mortgage rates and decreased housing demand.

Meanwhile, business credit quality could be eroded by a steep rise in rates that would increase business borrowing costs, which in turn could have negative consequences on employment and business investment, the Fed said. (…)

The Fed said that vulnerabilities from business and household debt are moderate. The financial position of many households continued to improve since the previous stability report in late 2021, supported in part by a strong labor market, high personal savings, remaining pandemic relief programs and rising house prices, the Fed said.

The report also warned that a prolonged conflict in Russia could have adverse consequences to U.S. financial markets, particularly through exposures to tumult in commodities markets, the Fed said.

Russia’s war in Ukraine has spar only when too lateked large price movements and margin calls in commodities markets and highlighted a potential channel through which large financial institutions could be exposed to contagion, Fed governor Lael Brainard said in a written statement. “The Federal Reserve is working with domestic and international regulators to better understand the exposures of commodity market participants and their linkages with the core financial system,” she said.

At present, financial market stresses don’t appear to have significantly disrupted broader economic activity or created substantial pressure on key financial intermediaries, including banks, the Fed added. (…)

“At present”, and from what is known. But there are unknowns, even known unknowns, that often reveal themselves only when it’s too late. The tide is receding fast and we shall soon know who was swimming naked as Warren Buffett says. Watch commodity and FX markets when complex leverage schemes are often used. Also watch that, below. It’s black swan season!

One type of cryptocurrency, a so-called stablecoin, is meant to keep its value at $1. But on Monday, the third-biggest stablecoin, TerraUSD, fell as low as 69 cents, causing a flood of investors to sell their holdings.

Stablecoins get their name from their being tied to the value of government-issued currencies, such as the dollar. These $1 pegs are usually backed by Treasurys, cash and other dollar debt that is easily sold in times of market stress. (…)

But unlike traditional stablecoins, TerraUSD is an algorithmic stablecoin. These pseudo dollars aren’t necessarily backed by any assets at all, instead relying on financial engineering to maintain their link to the dollar.

Such designs have been criticized by market observers as risky because they rely on traders to push the value back to $1 rather than having assets that continuously support the price. If traders aren’t willing to buy them, coins can go into a so-called death spiral. TerraUSD has mostly maintained its dollar peg, but it has been broken in bouts of heavy volatility.

In TerraUSD’s case, if its price falls below $1, traders can “burn” the coin—or permanently remove it from circulation—in exchange for $1 worth of new units of another cryptocurrency called Luna. That reduces the supply of TerraUSD and raises its price. Conversely, if TerraUSD climbs above $1, traders can burn Luna and create new TerraUSD. That increases supply of the stablecoin and lowers its price back toward $1.

The break in the peg, which began over the weekend, started with a series of large withdrawals of TerraUSD from Anchor Protocol, a sort of decentralized bank for crypto investors, said Ilan Solot, a partner at crypto hedge fund Tagus Capital LLP. Anchor Protocol—which is built on the technology of the same Terra blockchain network that TerraUSD is based on—had been a major factor in the growth of the stablecoin in recent months, by allowing crypto investors to earn returns of nearly 20% annually by lending out their TerraUSD holdings.

In tandem with the big withdrawals, TerraUSD was also being sold for other stablecoins backed by traditional assets through various liquidity pools that contribute to the stability of the peg, as well as through cryptocurrency exchanges.

The dislocation of TerraUSD from its peg caused some traders to panic and sell. To reinstate the peg, others began selling ether and buying TerraUSD, weighing on the dollar value of the second-largest cryptocurrency by market value. Some traders also sold bitcoin over the weekend in anticipation that the platform would need to sell its bitcoin reserves to support the peg, Mr. Solot said. Bitcoin fell 10% Monday to about $31,076 amid a broad selloff in the crypto markets. (…)

Panic selling also hit the related Luna cryptocurrency, which plunged 50% from Sunday to Monday, wiping out more than $10 billion of market value, CoinMarketCap data show.

The Luna Foundation Guard, a nonprofit supporting Terra, said it voted to support TerraUSD by lending $750 million of bitcoin to trading firms to protect the stablecoin’s peg and lending out an additional 750 million in TerraUSD to buy more bitcoin. (…)

One has to be a “lunatic” to follow the flow…but Bitcoin Mag warns us: “Now the main risk to the market is that the biggest buyer of bitcoin over the last couple months will now become the market’s biggest forced seller.”

President Truman had a sign on his desk: “The buck stops here”. Let’s see where that sign is now…Hopefully nothing spelling like “tether” which, according to CoinMarketCap, has a market cap of $86.7B and traded $164B in the last 24 hours. Who’s nervous?

BTW, the Financial Stability Report also warned of

(…) deteriorating liquidity conditions across key financial markets amid rising risks from the war in Ukraine, monetary tightening and high inflation in a semi-annual report published Monday.

“According to some measures, market liquidity has declined since late 2021 in the markets for recently-issued U.S. cash Treasury securities and for equity index futures,” the U.S. central bank said in its Financial Stability Report.

“While the recent deterioration in liquidity has not been as extreme as in some past episodes, the risk of a sudden significant deterioration appears higher than normal,” the report said. “In addition, since the Russian invasion of Ukraine, liquidity has been somewhat strained at times in oil futures markets, while markets for some other affected commodities have been subject to notable dysfunction.” (…)

And a rising USD…

Another risk off move:

Global Banks Flee the Monster SPAC Market They Helped Create

Goldman Sachs Group Inc. is ending its involvement with most of the special purpose acquisition companies it took public and pausing new U.S. SPAC issuance, Bloomberg reported on Monday. Bank of America Corp. scaled back work with some SPACs and could retreat further as it evaluates its policies surrounding the deals, people familiar with the matter said. (…)

The banks’ recent concerns center around liability risks stemming from the new rules, which are aimed at tightening oversight on a market after it set back-to-back yearly records. The proposals would require SPACs to disclose more information about potential conflicts of interest and make it easier for investors to sue over false projections.

They also would require underwriters of a blank-check offering to also be underwriters of the SPAC’s subsequent purchase of a target firm, known as the de-SPAC. That expansion of underwriter liability poses a greater risk for investment banks, prominent law firms have cautioned. (…)

It’s unusual for a bank to withdraw from an active blank-check firm because it typically works on the de-SPAC as well. The move risks leaving the sponsor of the SPAC — its client — in the lurch and unhappy.

The sentiment also weighed on shares, with the De-SPAC Index — which tracks 25 companies that have gone public through a merger with a SPAC — plunging 10.4% on Monday. (…)

MORE RISK OFF!

Yesterday was a 90% down day on very heavy volume. Truly breadth taking as just about every asset class and most things in each asset class was in the red.