[LD Capital] Weekly Report 9.4: Bad News Boosts U.S. Stocks, China Stabilizes, Last-Minute Surge in 30Y Bonds, BTC exhibits a ‘flash boom-bust’ pattern

Key Points:

• Over the past week, weaker employment data has fueled sentiment that interest rates have peaked. Stocks in developed countries and China, gold, and short-term bonds all rose last week, while only long-term bonds and digital currencies declined.

• On Friday, long-term bonds surged without an apparent reason, indicating future potential pressure as there remains room for both long and short bonds to fluctuate.

• E-commerce companies like Alibaba and Pinduoduo outperformed expectations, showing that latent demand could accumulate momentum and support the initial recovery of the Chinese stock market.

• China’s PMI unexpectedly surged to a six-month high, indicating that stimulus policies are effective.

• The positive news of Grayscale winning its lawsuit is not substantial enough as the SEC can appeal again. However, GBTC recorded a 6% increase for the week, outperforming the crypto spot market, signaling better risk-reward for such investments.

Last week was a joyful one for the majority of global investors. Not only did stocks in developed countries perform well, but the recently lackluster Hong Kong and mainland China stocks also rebounded. The S&P 500 index rose 2.5% last week, marking its best performance since mid-June, thanks to economic slowdown expectations which fueled bets that the Federal Reserve might delay further rate hikes.

Furthermore, the tech-heavy NASDAQ 100 index soared 3.8%, while the small-cap Russell 2000 index increased by 3.6%. The U.S. dollar remained flat for the week, while gold, suppressed by the dollar and interest rates, rebounded for the second consecutive week, up 1.3%. WTI crude oil surged 7.8%, mainly driven by Russia agreeing to further OPEC+ cuts and the lowest U.S. oil inventories since last year.

The S&P 500 sector performance is distinctly aggressive, with technology and energy sectors being the strongest, while utilities and consumer staples are the weakest.

However, digital currencies remained weak despite macro tailwinds. Bitcoin and Ethereum fell by 1% and 1.4%, respectively, indicating that industry-specific positive news is needed to reverse this trend. This kind of divergence requires some positive industry-specific news to reverse. For instance, last week, when Grayscale won the lawsuit, the possibility of the introduction of ETFs increased, and the market originally intended to correct its valuation. However, this good news was not substantial enough because the SEC can continue to appeal or reject it for other reasons, leading to an inconclusive situation in the end.

The two most critical data points were:

On Tuesday, JOLTS job vacancies dropped to the lowest level in two years, consistent with Friday’s non-farm employment report showing a rise in the unemployment rate. Market participants are invigorated by these figures, suggesting that the overheated labor market is finally showing signs of fatigue. The effects of the Federal Reserve’s aggressive tightening measures are becoming apparent, and the market hopes these reports are sufficient to persuade the Fed to halt its rate hikes. However, contradicting this sentiment is the fact that initial jobless claims have decreased for the third consecutive week.

Many are puzzled why the unemployment rate rose despite better-than-expected non-farm employment numbers. This scenario has occurred more than once this year. The primary reason is the overall expansion of the workforce (also related to the depletion of savings), leading to increases in both the labor participation rate and working hours. Although wage growth has slowed, considering the increase in working hours, the total income continues to grow at a certain level, preventing any negative impact on the economy.

Other important but limited-impact data include:

The July Core PCE price index rose 0.22% month-over-month, marking the smallest consecutive increase in over two years. Real disposable income fell by 0.2%, and the personal savings rate dropped to 3.5%, indicating that the recent pace of consumer spending may not sustain in the coming months.

U.S. manufacturing improved in August: the Standard & Poor’s Manufacturing PMI final value was 47.9 vs an initial value of 47.0, while the ISM Manufacturing PMI was 47.6 vs an expected 47.0. The manufacturing sector has been contracting for a while, but there has been some recovery in the past two months. However, we suspect this survey will deteriorate again in the coming months, given the looming auto workers’ strike.

Global Manufacturing PMI generally improved in August, but there are significant differences among countries. Overall, emerging market countries performed better than developed ones. Among the developed countries, North America and Japan outperformed Europe.

Strong USD and Yield

Throughout August, the US dollar exchange rate rebounded strongly, with the DXY dollar index rising about 2.2%. It peaked when Powell spoke at Jackson Hole on August 25th but retreated in the last week of August, ending its four-week rise. The trend of the dollar is highly correlated with market interest rates. The two-year yield was close to its annual high last week, once exceeding 5.1%, but it plummeted more than 25 basis points in the last three days of August. With changes in the futures market pricing, it confirms the market has almost entirely given up on a rate hike in September. This is mainly due to volatility brought about by August labor market data, led by JOLTS.

In August, BRICS countries held a summit discussing currency or trade settlement tokens backed by gold, but no substantial results were achieved. Ironically, as the discussion of de-dollarization is widespread, the weight of the dollar has further increased. This is not only evidenced by the strong exchange rate price but also its use in SWIFT, which reached a historic high of 46% in July. The increase in the dollar’s share came mainly at the expense of the euro, which fell to a record low of just under 25%. The yuan’s share is slightly more than 3%.

On Friday, long-term U.S. Treasury yields surged, with the 30-year yield recovering all its losses from the past three days. The stock market remained calm about this, but gold and Bitcoin were notably affected. During this period, BTC plummeted from 26,000 to 25,400, while gold fell from 1,950 to 1,936.

Given the dovish data of the day, it’s hard to explain why bonds were sold off, but the trend is worth noting. Currently, the inversion between long and short terms remains severe. Without a crisis, if the short end drops faster, it’s good for the market. But if the long end rises faster, the market will face pressure for some time.

In the first half of August, long-duration bonds led risk-free yields to surge, with short bond yields catching up from August 22nd to 28th, causing a pullback in long bonds. As for the strong yields, economic activity was stronger than expected, supply surged, and Fitch’s downgrade of the U.S. rating was a triggering factor. But fundamentally, the inversion between long and short bond yields for over a year was unreasonable.

Some believe that Japan’s adjustment of the yield curve control at the end of July is responsible for the global bond sell-off in early August. However, the Ministry of Finance’s weekly investment portfolio liquidity report shows that Japanese investors have been buying foreign bonds. In fact, since the 10-year Japanese government bond yield cap doubled from 0.25% to 0.50% in December of the previous year, they have mostly been net buyers of foreign bonds. The following graph shows the net flow data of foreign bonds by Japanese investors over the past two years (in billions of yen):

There are also rumors that China’s intervention in the foreign exchange market put pressure on U.S. bonds. This is possible, but due to data lag, we cannot currently know the situation in August.”

China Stabilizes

Concerns about China’s debt, especially in the real estate sector, were one of the macro themes in August. However, with the introduction of new stimulus measures almost daily in the past two weeks, including the first reduction in stock transaction stamp duty since 2008 and a decrease in existing mortgage rates, the panic sell-off sentiment seems to have temporarily stabilized judging from exchange rates and stock market performance. The Nasdaq Golden Dragon China Index rose by 7.4% over the week, the Hang Seng Index increased by 1.9%, and the CSI 300 fell nominally by 3%, mainly due to a significant opening on Monday, actually rising by 2.2% from the previous Friday. The yuan fluctuated narrowly below the crucial 7.3 level last week.

Aside from the real estate sector that hit bottom in July, China’s tech and consumer stocks have performed well during the earnings season, showing some resilience.

E-commerce companies like Alibaba and Pinduoduo reported earnings generally above expectations as they successfully met the pent-up demand of consumers after COVID restrictions were lifted. Massive spending on food, tourism, and movies boosted optimistic sentiments, with commentary suggesting that latent demand might gather momentum supporting a preliminary recovery in the Chinese stock market after the government’s recent measures.

Additionally, last week’s Caixin August Manufacturing PMI unexpectedly expanded to a six-month high, indicating that targeted economic stimulus policies are having an effect and suggesting that the manufacturing downturn might be nearing an end. The construction industry has seen significant improvement, with local government special bonds and government financing platform bonds accelerating, and corresponding public infrastructure investments increasing.

Currently, the CSI 300 index has a PE ratio of 11.8 times, sitting at 29.7% of the past 10 years range, indicating a relatively low valuation.

Last week, U.S. Commerce Secretary Gina Raimondo met with Chinese officials. Being the fourth high-level U.S. official to visit China this summer, she stated that the visit aids in establishing open communication channels. While she claimed that the U.S. is not seeking to decouple economically from China or hinder its economy, she also emphasized that export controls are for national security. Overall, both sides showed some concessions and goodwill, resulting in a cautiously optimistic outcome.

Grayscale’s Win and Not-So-Win

Grayscale won a federal court ruling that the SEC must revoke its refusal of Grayscale’s request to transform the Grayscale Bitcoin Trust into a Bitcoin Exchange-Traded Fund (ETF). The SEC had previously believed that their product failed to meet anti-fraud and investor protection requirements.

Grayscale Bitcoin Trust’s stock price surged by 19%, and Coinbase’s stock price jumped 15% on this news. However, we commented at the time that this positive news was not substantive since the SEC could appeal again and decline with a different reason.

Indeed, when the SEC delayed decisions on physical Bitcoin ETFs for all applicants, including BlackRock and Fidelity, BTC and ETH fell sharply, retracing all gains from the beginning of the week (though we don’t believe the two events are closely linked since Grayscale’s ETF transformation is different from new product releases by other fund companies).

The former SEC chairman indicated that despite the delay, approval of a physical Bitcoin ETF is “inevitable.”

Later on, Bitwise filed a request to withdraw its Bitcoin and Ethereum market-cap-weighted strategy ETF application, a surprising move. Initially submitted to the SEC on August 3, Bitwise’s withdrawal added a hint of uncertainty for the prospects of a physical ETF.

Still, thanks to the optimistic sentiment in the U.S. stock market last week, GBTC recorded a weekly increase of 6%, ETHE +2.4%, and COIN +4.6%, outperforming the performance of the crypto spot market, showing that investing in such U.S. stock market crypto-related assets could offer better risk-return ratios.

The market last week was reminiscent of the situation in mid-June when BlackRock unexpectedly submitted a BTC spot fund application to the SEC with the Bitcoin price at approximately $25,000. In the following weeks, the price surged by over 20%. However, as the wait extended and market interest rates rose, overall interest in cryptocurrency waned, with prices dropping back to pre-BlackRock application levels by mid-August.

Upcoming Date of Interest: After the postponement last week, the U.S. Securities and Exchange Commission (SEC) has 45 days to respond to the issuer again. This means investors can expect a response from the agency by mid-October, but hopes remain dim.

Furthermore, the listing of Ethereum futures ETFs, possibly around October 10th, is on the horizon. Almost a dozen companies, including Volatility Shares, Bitwise, Roundhill, and ProShares, have applied to launch ETFs. Insiders suggest that regulatory authorities are unlikely to block these products.

Capital Flows and Portfolio Changes

Last week, investors refocused on stock funds, especially in the U.S. and emerging markets, as well as the tech sector. Discretionary investors increased their positions, while systematic strategy funds decreased theirs.

According to Deutsche Bank metrics, since the end of July, discretionary investor positions dropped sharply to just below neutral but rebounded slightly last week, returning to slightly above neutral, currently at the 53rd percentile historically. Systematic strategy positions, after rising steadily since mid-June, have declined over the past two weeks and currently stand at the 61st percentile historically.

Stock funds recorded their largest net inflows in five weeks, totaling +$10.3 billion, mainly from the U.S. (+$4.5 billion) and emerging markets (+$4.9 billion). Bond funds saw a net inflow of +$1.7 billion, slightly up from the previous two weeks. Money market funds had a net inflow of $6.5 billion, with the U.S. netting $10.7 billion and Europe seeing an outflow of $4.5 billion.

The sector with the most inflows for stock funds was technology, while the energy sector experienced the most outflows despite rising oil prices.

Data from the CFTC indicates that the overall net long positions in the U.S. stock market remained steady last week, mainly due to a decrease in net long positions for the S&P 500 being offset by an increase for the Nasdaq 100. Meanwhile, net short positions for Russell 2000 and DJIA decreased. Outside the U.S., long positions in emerging markets decreased, possibly reflecting investors’ cautionary stance.

In the foreign exchange market, the net short position of the U.S. dollar decreased, suggesting a more optimistic view towards the dollar by investors. In the commodities market, net long positions for oil remained steady, while those for gold and silver increased. Net short positions for copper decreased.

Investor Sentiment Indicators

Last week, the AAII investor sentiment survey showed little change in bullish and bearish views, with a slight shift towards optimism.

The CNN Fear & Greed Index rose from 48 to 56, entering the positive zone.

Stablecoin Flow

The overall on-chain stablecoin volume increased for the second consecutive week (+$660 million), marking the first back-to-back growth since February. This is mainly attributed to the issuance of TUSD.

Stablecoin balances within the exchange decreased for the second consecutive week (-118 million USD), marking the largest outflow in the past four weeks.

Future Focus Points

This week marks the U.S. Labor Day holiday, and significant data releases are limited. Let’s look at some medium-term concerns:

Savings accumulated during the Covid period are decreasing, the labor market is cooling down, delinquency rates are rising, and student loan interest is set to resume in October. This might undermine consumer momentum from September onwards. Despite this, data so far indicates a strong recovery in U.S. consumption over the summer. Some retailers expressed similar concerns in the recent earnings season, remaining cautious about the future.

Regarding student loans, Goldman Sachs estimates that fully resuming payments will amount to approximately 70 billion USD, or about 0.3% of disposable personal income, reducing the Q4 PCE (Personal Consumption Expenditures) growth by 0.8%. The impact may be smaller than anticipated as some borrowers might not immediately resume payments, and others may qualify for benefits under the income-based repayment plans recently announced by the Biden administration.

Budgetary debates in the U.S. are back in focus. With the new fiscal year starting on October 1st, budget spending authorization is needed. The two parties in Congress remain divided, and there’s been little progress. Additionally, authorization for several programs expires in September, including extended unemployment benefits. Unlike the threats of default due to the debt ceiling dispute, failing to grant spending authorization could result in a partial government shutdown. Market commentators generally believe there’s a significant chance of the federal government shutting down later this year, although past market reactions to such shutdowns have been relatively muted.

On September 14, contracts for the United Automobile Workers Union in the U.S. will expire, posing a looming strike threat.

Institutional Opinions

From BlackRock to Pacific Investment Management Company, bond investors bet that the Fed’s rate hikes are over.

Recent employment data has bond market participants believing the Fed is unlikely to raise rates in the short term, potentially ending the current economic cycle of hikes. As focus shifts towards when the Fed might ease policies, short-term bonds will outperform long-term bonds. Seasonal trends also play a role: companies typically rush to offload debt after the U.S. Labor Day, putting pressure on long-term bonds. BlackRock’s Jeff Rosenberg calls it a “screaming buy.” Michael Cudzil, a portfolio manager at Pacific Investment Management, believes the rate hike cycle is over, and the first rate cut will steepen the bond duration curve.

CICC Overseas: How much savings do Americans have left?

CICC’s calculations, based on methods similar to Aladangady and others, show an excess savings of 770 billion USD, lasting until 2Q24. The lower-income group might have depleted it by the end of last year. The San Francisco Fed estimates excess savings will be exhausted by 3Q23. The lower-income group faced a deficit, exhausting excess savings last year. The middle-income group’s income and expenses are stable, retaining more excess savings. The higher-income group is depleting their excess savings at a faster rate. The support of excess savings for consumption will gradually weaken.

Morgan Stanley: Maintain a late-cycle, defensive approach.

Michael Wilson: Over the past week, stock prices have rebounded strongly, once again led by growth stocks. With weaker economic data pressuring treasury yields, market participants seem willing to raise their valuations based on the belief that the late economic cycle environment is extending. In summary, price momentum is a key emotional driver, especially in a late-cycle environment when uncertainty is high. We continue to advise a more defensive strategy in portfolios, especially as we enter September, a month where growth concerns or financial pressures could resurface at any time.

We suggest that investors maintain a cautious stance towards the prevailing consensus that economic growth will re-accelerate. We recommend continuing with a late-cycle economic mindset, which means investing in growth stocks and defensive stocks rather than cyclical stocks or small-to-mid-cap stocks.

As we enter the second quarter earnings season, we believe it will be a “sell on the news” event, primarily because stocks had already risen before mid-July. Nevertheless, this year’s earnings results have not kept pace with the economy, except in a few areas primarily driven by cost reductions. This further reinforces our view that we are still in the later stages of the economic cycle.”

LD Capital is a leading crypto fund who is active in primary and secondary markets, whose sub-funds include dedicated eco fund, FoF, hedge fund and Meta Fund.

LD Capital has a professional global team with deep industrial resources, and focus on develivering superior post-investment services to enhance project value growth, and specializes in long-term value and ecosystem investment.

LD Capital has successively discovered and invested more than 300 companies in Infra/Protocol/Dapp/Privacy/Metaverse/Layer2/DeFi/DAO/GameFi fields since 2016.

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