Friday Wrap Up (4 November)

(Maksymilian Mucha - Investment Director of UCLIF & Lead Editor)

Welcome to the Friday Wrap-Up, our weekly summary of events from the financial world that have had the greatest impact across asset classes. This week, we're again including monthly summaries from our ESG, Macroeconomics, and Political & Geopolitical Specialists. So what's moving markets?

Markets

In the US equities,?S&P 500?dropped?-2.87%?while?DJIA?declined?-1.07%.?The Fed raised interest rates by 75bp, as expected by the market, however Jerome Powell worried markets with his hawkish comments. Additionally, NFP for October came at 261,000 vs. 200,000 expected, and unemployment returned to 3.7% in October, 0.1 p.p. more than expected after sliding to 3.5% in September.?US 10y Treasury?yield?rose 14bp?to?4.16%?this week.

In Europe, the?FTSE 100?rallied?4.07%?and?EURO STOXX 600?was up?1.38%. The BoE raised rates by 75bp, as expected, though markets rallied after it was signalled that the market is overestimating the terminal rate. In Eurozone, inflation hit record 10.7% YoY in October, up from 9.9% in September and above 10.2% expectation, while unemployment fell 0.1 p.p. to 6.6% in October, in line with expectations. Lagarde became more hawkish during her speech than last week during the policy meeting.?UK 10y Gilts yield?rose 7?bp?to?3.54%, while?German 10y Bunds yield?was up?20bp?this week to?2.30%.

In Asia, the?Nikkei 225?was up?0.38%,?the?SSE Composite?surged?6.14%?and the?Hang Seng?rallied?8.97% after China’s National Health Commission eased country’s zero-Covid approach.

Monthly Summaries

ESG (Gabriel Hussein Alakbarov)

In 1986, Ecologist Jay Westerveld first coined "greenwashing" in his essay criticising hotels' "save the towel" movement. Greenwashing refers to the corporate practice of purposefully making unsubstantiated claims related to positive environmental practices to advance a company's corporate image in the eyes of the public. In the 1980s, smartphones were yet to be invented, and the internet was still in the very early stages of its development. Thus the everyday consumer will have heavily relied on TV, the radio, and print media as sources of delayed, sometimes even incomplete, information. Recognising this asymmetry in information, corporations at the time had no issues engaging in greenwashing (in fact, the term emerged precisely because of the prevalence of this problem). For example, during the 80s, the fully vertically integrated oil and gas company?Chevron?(CVX) released a series of expensive ads highlighting its environmental dedication. Chevron was then found to be simultaneously?violating the Clean Air Act, the Clean Water Act, and spilling oil into wildlife sanctuaries… not very environmentally friendly if you ask me.?

Since then, the term greenwashing and other terms such as sustainable investing and ESG have skyrocketed in popularity. In particular, over the last year, greenwashing has become significantly more prevalent on the agendas of politicians and regulators. This comes following an eruption of sustainability promises and pledges from corporations as they seek to obtain greater financing from institutional investors through yet another channel. Demand for ESG products from institutional and retail investors has exploded in the past few years. A recent?PwC?(PWC) study found that demand for ESG products exceeds their supply. The study found that 84% and 81% of institutional investors in Europe and the US plan to increase their shares in ESG products over the coming two years. This demand explosion likely stems from the fact that, on average, ESG funds significantly outperformed traditional funds in 2020 globally.?

Moreover, smartphones and the internet have become common household items in the modern, globalised world. Today, the speed with which one receives new information from anywhere in the world is limited only by internet speed and the processing power of the chosen device. Therefore, the asymmetric information between corporations and the wider public has significantly declined. Thus, because ESG and greenwashing concerns and modern sources of information have become ubiquitous, firms now face far greater accountability for their actions and the actions of associated third parties along their supply chain. As a result, greenwashing has become a far riskier strategy for companies.

A perfect example of this is the advertising?ban?HSBC received in the UK on the grounds of greenwashing in October. To promote its environmentally conscious image, HSBC ran several ads in the UK highlighting its tree-planting and net zero greenhouse gas emission initiatives. The?Advertising Standards Authority?(ASA), the UK's advertising watchdog, banned HSBC from further running these ads claiming that they "omitted material information," namely the lender's financing of fossil fuel endeavours and its links to deforestation. According to a report published by a coalition of activist groups organised by the?Rainforest Action Network,?HSBC provided more than $100 billion in financing for fossil fuel projects between 2016 and 2021. This ban sets a very significant precedent, as it marks the first time advertisement was banned based on greenwashing.?

Similar regulatory action is now being proposed in the US too. Late in October,?SEC?chairman Gary Gensler proposed a reform on the names investment managers could assign to their funds. This is effectively a reform of permissible advertising in the investment management industry, as fund names are a primary tool for marketing. The reform suggests that if a certain style of investing is attributed to a fund through its name (for example, value, growth, ESG, etc.), the fund must be able to prove that at least 80% of its holdings satisfy this style. In the case of violation, the policy only allows a mere 30 days for compliance to be restored. The motivation of the policy is to increase the transparency of the asset management industry in general and, in turn, increase trust in the industry. Therefore, one undeniable facet of this policy is to prevent greenwashing by asset managers and, more broadly, discourage corporate greenwashing. Consider the following scenario. An asset manager has an ESG equity fund that it manages. Under the new reform, if 20%, or more, of the constituent companies, are found to have been greenwashing, the fund falls out of compliance. The asset manager must therefore bear additional costs, as it scrimmages to restore compliance before the end of the 30 days. It is clear to see, therefore, that this policy encourages more prudent and proactive stock-picking among active managers to avoid potential costs associated with non-compliance. Therefore, active managers in ESG funds will be strongly incentivised to identify companies that are genuinely fighting the fight against climate change, not just pretending to do so (i.e., greenwashing), to avoid unnecessary compliance risk. Hence, the market will reallocate funds and resources away from greenwashing firms, depriving them of financing for growth, to those with positive ESG practices. This effect will be particularly pronounced as the demand for ESG products continues to soar in the coming years.

The accusation of greenwashing has become a very powerful weapon for exposing companies with weak corporate cultures for whom fraudulent behaviour is acceptable. Equally, however, the fear of greenwashing has ushered in a new growing trend: "green hushing." Green hushing refers to companies withholding their climate targets/ disclosures for fear of them being scrutinised and accused of greenwashing.?"A quarter of the 1,200 companies in 12 countries surveyed said they would not publicise their science-based net zero emissions targets, a road map for reducing emissions in line with the goals of the Paris agreement…"?The emergence of green hushing is a clear signal of the greater regulation needed when it comes to ESG reporting. The fight against climate change starts with regulators, and they must expose such companies with poor ESG practices for whom ignorance truly is bliss.?

Macroeconomics (Pravin Pathmajothy)

USD/JPY

In what seems to be a horror year for the Japanese Yen, with the currency losing 28% of its value to the greenback, this week the Yen fell to its lowest level since 1990 at ￥150 against the dollar. This is in spite of the Japanese government’s?$20bn stimulus package?in September where the Yen briefly surged to ￥140.34 from ￥145.89 before the intervention. The value of the Yen then fell back down shortly after and continued to fall to ￥150 prompting a further $43bn package in October. The main driver of such a stubborn Yen is the Bank of Japan’s divergence of monetary policy from other nations that have moved their benchmark interest rates higher. The BoJ has also pledged to maintain an ultra-loose monetary policy and is the only central bank in the world to hold negative interest rates. This is in an attempt by the BoJ to shore up inflation and Japanese growth. In light of this, the 10-year yield on Japanese bonds is hovering at 0.2% compared to the US’s 3% yield on 10-year treasury bonds. This has allowed for dollar-denominated assets to be far more attractive to foreign investors.?

These circumstances of a weak Yen provided a ripe environment for more attractive exports and thereby allowed?large Japanese corporations to flourish?raking in historically high profits. Sales to the US and China (Japan’s biggest export market) get 26% and 10% respectively resulting in huge currency inflows to Japan. In theory, these robust inflows would prop up the Yen. But figures show that the Yen’s decline has been locked in by massive outflows by Japanese companies and asset managers.

Dollar

The dollar has risen 20% in the last 12 months and is unlikely to weaken due to the FED maintaining high interest rates so long as inflation remains above their mandate of 2%. This has pivoted US based companies like?Microsoft to cut revenue forecasts by $500mn. Moreover, the surging dollar is expected to wipe off more than $10bn off US corporate earnings in the third quarter.

The Pound

Following the turmoil that ensued from former Prime Minister, Liz Truss’s, aggressive tax cuts, the pound somewhat recovered from its nose dive in light of Rishi Sunak preparing for years of tax rises to plug the ￡50bn fiscal hole.?

This week, the Bank of England raised interest rates by 75bp to 3% in a further attempt to curb inflation which currently sits at a 40 year high. Shortly after this, it was announced by the BofE that further rate hikes to 5% were not necessary resulting in a sharp sell-off in the pound. As such, the?GBP/EUR has fallen 0.75% and the GBP/USD sits 1.3% lower.?

Shifting our attention to UK economic activity, the BofE predicts that inflation will stay above 10% up until at least May 2024. Evidence of the UK entering a long recession has already come to the surface with a sharp fall in economic activity. New data releases point to a fall in the manufacturing sector being the main culprit for this due to low confidence. Moreover, it is predicted that unemployment will rise from 3.5% to almost 6.5% by 2025. Given this, it will be interesting to see how the new PM and the Bank of England respond to this and the large fiscal deficit created by Trussonomics and copious borrowing during covid -19.

Politics & Geopolitics (Michael Best)

Chinese President Xi Jinping secured a third term in power at the 20th communist party congress on the 16-22 October. Xi’s decision to pass over pro-market candidates for his 7-man standing committee unsettled markets causing a 14.4% drop in the Golden Dragon index (HXC), which tracks US-listed shares in Chinese companies, in its largest one-day fall on record, bringing its decline to about 50 per cent this year (FT). Third quarter GDP numbers which came up short of expectations are said to have contributed to a record $2.5bn being pulled out of China’s stock market on the Monday following the congress (FT). The hardest hit sector was tech which, for the past 12-14 months has been enduring regulatory crackdowns of Xi as Chinese regulators have reprioritized national security over economic growth.?

In the first week of November, however, Chinese stocks in Hong Kong posted their best week in more than seven years amid rumours that the country could begin reopening to the rest of the world early next year and reports that US regulators had completed a review of Chinese audit papers earlier than expected. In what some suspect to be a dead cat bounce, Hong Kong’s Hang Seng China Enterprises index (2828) rose 6% on November 4th, while the CSI 300 index (2846) of Shanghai and Shenzhen-listed shares jumped 3.3%. The China Enterprises index (HSCEI) closed up 9% for the week (FT).?

The US will hold midterm elections on November 8th. While US politicians and policymakers on both sides of the aisle increasingly view any contact with China as suspicious, a Republican victory in would likely fast-track more measures against the country and create further selling pressure on Chinese equities (FT). A Republican victory could also trigger market turbulence if they follow through on their threat not to raise the US debt ceiling. American voters view the economy as the key issue with Covid-19 low on the list, making this the US’ first “post-pandemic election” (Pew Research). Donald Trump is expected to announce another White House bid shortly after the election (FT).?

The Russian economy could face more labour shortages and increased inflationary pressure due to the partial mobilisation of its armed forces launched last month according to Russia’s central bank which for the first time after months of successive cuts kept its key interest rate unchanged at 7.5%. Separately, President Putin has rejected claims that Russia intends to use nuclear weapons in Ukraine (FT). Russia also agreed to re-join a UN-backed initiative to allow exports via the Black Sea, ending a stand-off that threatened to reignite a global food crisis. After the announcement wheat futures fell 6.4% at $8.45 a bushel, while corn was down 2.4% at $6.81 a bushel (FT).

Despite these short-term de-escalations of the Ukrainian conflict, military tensions remain high globally as North Korea engaged in the most intense series of launches in the country’s history firing at least 23 missiles and 100 artillery shells into adjacent sees (FT). In response, the US is set to deploy more nuclear-capable warplanes around the Korean peninsula (FT). Pyongyang’s show of force contributed to an approximate $291.1 million dollar inflow, that's a 10.9% increase week over week in outstanding units, into the iShares U.S. Aerospace & Defense ETF (ITA) (NASDAQ).?

The very turbulent October in British politics culminated on the 20th with the resignation of Liz Truss after only 45 days in office. Some of the nervousness around the outlook for the UK economy was relieved by the confirmation of Rishi Sunak as the new PM on the 25th as both gilt yields and the value of the?pound?rallied back to their highest levels since before Liz Truss’s mini-budget (FT). At the close of trading, the pound was up 1.77% against the dollar at 1.148 and was 0.79% higher against the euro at 1.151. Sunak is expected to prioritize fiscal conservatism, trim spending where possible, not let debt rise as a proportion of GDP and look to have incentives for business (FT). To help decrease the ￡50bn fiscal deficit, UK chancellor Jeremy Hunt has asked officials to look at raising the dividend taxation rate as well as cutting the tax-free allowance for dividends. The option of a 1.25 percentage point increase in dividend taxation across the UK’s three tax bands is being explored (FT).

Electric cars are to be subject to vehicle excise duty for the first time under measures to be introduced this month by Hunt. The aim is to prevent a temporary tax vacuum equivalent to 1.5% of GDP which was found in a October 2022 Treasury review to be caused by the transition to electric vehicles by the 2040s (FT). Saudi Arabia’s Public Investment Fund has agreed a deal with Foxconn (FXCOF) to produce electric vehicles in the kingdom as a part of its efforts to diversify its oil-dependent economy. The joint venture is looking to attract $150m in FDI and will put the PIF and Foxconn in competition with Tesla (TSLA) and Chinese automaker BYD (BYDDF) for Middle East sales. (FT).

Germany set out plans to legalise cannabis which would make it one of the first countries in Europe to do so (Reuters). The Czech Republic aims to coordinate with Germany to share information and the best practices to regulate the legal industry and also plans on legalising cannabis in 2024 (Forbes). The announcements have rekindled the interest of US and Canadian cannabis companies to invest in Europe (Forbes).

Equities

Technology?(Hyunjun Park)

Information Technology (“IT”) was down this week, with the S&P Global 1200 IT Index down 6.85% and the NASDAQ Composite down 5.02%. Chinese stocks, including Shanghai Bright Power Semiconductor Co Ltd (SHA: 688368) Vobile Group Ltd (3738), were the highest performers after rumours of a reopening spread on social media. This allowed hardware-related stocks to have low digit returns, while software was down around 5.5%.

Rogers Corp (ROG) was the worst performer this week after Dupont scrapped plans for a $5.2BN buyout due Chinese regulators. Low Q4 guidance and poor returns have pushed stocks like Varonis Systems Inc (VRNS), Rapid7 Inc (RPD), Fidelity National Information Services (FIS), and Global Payments Inc (GPN) down below -20%. This is despite some having shown strong growth returns. Expectations of a recession after 2022 and continued interest rate increases have put investors in a risk-off posture regardless of strong fundamentals in IT stocks.

Consumer Staples and Consumer Discretionary?(Jinesh Bothra)

The Consumer Discretionary sector and Consumer Staples both fell over the past week. The?Consumer Discretionary Select Sector Fund (XLY)?posted a loss of?5.95%.?Similarly, a?2.95%?loss was witnessed in the?Consumer Staples Select Sector Fund (XLP)?from last week. The Federal Reserve hikes interest rates by another 0.75 percentage points. In addition, the US economy added 261,000 jobs last month, with the?unemployment rate increasing to 3.7%, just above its pre-pandemic low.

In company news, the American multinational conglomerate holding company?Hasbro, Inc. (HAS)?shares were down by?6.7%?in the past week. Hasbro shares tumbled to their?lowest level since 2015?after the toymaker and entertainment company reported a sharp drop in quarterly revenue and earnings results. Inflation and consumer sensitivity to price played a key role in the company’s?15% earnings slide?in the quarter ending September 30, compared with the year-earlier period, and the company is also battling foreign currency fluctuations, including the strength in the dollar and supply-chain issues. Revenue totalled?$1.68 billion, matching analysts’ consensus estimate, but?adjusted earnings per share fell 10 cents short?of Wall Street’s outlook, coming in at?$1.42.?

Finally, the company, whose brand portfolio includes Peppa Pig, Transformers, Monopoly, Nerf and Magic: The Gathering, is expecting?flat revenue?in the fourth quarter revenue, a crucial holiday season span when the company typically makes as much as?half its annual revenue.

Financial Institutions?(Gauri Varma)

The effect of Elon Musk’s $44bn takeover of Twitter on banks was prominent this week. Banks lent $14bn to Musk and are preparing to hold the debt until early next year when Musk reveals a business plan that banks can market to investors. The banks holding this debt have admitted they will ‘probably end up incurring huge losses on the financing package’. Banks are trying to test out what yields investors are demanding for debt by marketing a portion of debt they are holding to fund Apollo’s takeover of Tenneco.?

The European Central Bank has warned banks of a capital hit should they not tackle climate risk. The ECB has warned that banks are not tackling their financial risks from climate change, and if they fail to do so in the next 2 years, it will result in higher capital requirements and fines. This reflects the increasing pressure from the ECB on eurozone lenders to detect, manage and disclose climate risks on their balance sheets. Banks have to work out what will happen to clients who may not have sustainable revenue sources due to the green transition. When the ECB performed a climate stress test to forecast the impact of global warming and extreme weather on banks’ balance sheets, it was estimated that €70bn of losses could occur from this over 3 years, and the ECB warned this was still an underestimation.

In the UK mortgage market, banks and building societies will now cut the costs of UK fixed-rate mortgages, with a major UK lender suggesting rates of 1% or 2%. This owes to the financial markets reducing their expectations of future rises in the Bank of England’s base rate. The high fixed rates previously were caused by markets that expected aggressive future rises in the base rate in order to counter inflation. The BoE pointed to a more dovish approach for interest rates on Thursday when they issued strong guidance that rates would not rise much further in order to bring inflation back to 2%, partially due to the recession forecasted for the near future. Mortgage brokers predict a period of market stability will help fixed rates continue to fall. The costs for fixed-term mortgages are influenced by swap rates, which shot up following the mini budget that pushed up government borrowing rates. These rates have now fallen.?

For banks, this week HSBC has been in the spotlight. Their largest shareholder holding more than 8% of shares, Ping An Asset Management (headed by Michael Huang), has urged HSBC to be more aggressive in their cost reductions by cutting more jobs. Ping An has complained about underperformance and the cancellation of HSBC’s dividend during the pandemic, and so has pushed for greater allocation of resources to Asia among other measures in order to improve HSBC’s returns. Ping An has publicly revealed that the bank’s return on tangible equity has been around 7% for 5 years, which lags behind rivals, and said last year HSBC delivered returns of 8.3%, far lower than the 12.3% average of its peers. Huang also said their cost-income ratio is higher than average compared to competitors. HSBC has claimed they were on track to hit targets in 2023, including a return on tangible equity of at least 12%.

Utilities?(Tancrede Guyader)

After remaining stable for the first half of the week, the S&P 500 Utilities Index experienced a sharp drop between Wednesday night and Thursday morning, falling from 345.68 points to 334.50 (ie. 3.3% reduction). Other utilities ETFs such?as Vanguard Utilities ETF (VPU), Utilities Select Sector SPDR Fund (XLU), and Fidelity MSCI Utilities Index (FUTY) displayed similar behaviours this week. This phenomenon can be explained by the Bank of England’s decision to raise its treasury rate by 0.75% since most utility companies are debt-heavy and thus severely impacted by increases in interest rates. However, the future of utilities might not be so dark as the Bank of England hinted that rates may not have to rise much further.?

The current situation is however greatly damaging to utilities and energy companies. Indeed, likewise many other utilities and energy companies, the Danish giant ?rsted released disappointing third-quarter results on Thursday. The firm’s share price has lost almost half of its value over the past two years and its net debt should rise from less than 2 times EBITDA this year to 3.4 in 2025 (Bernstein estimates).??

Fixed Income

Rates & Credit?(Eugene Chan)

Inversion in the Yield Curve Once Again

October’s labor market data showed no signs of slowing down in contrast to the property market, making the Fed’s job even more conflicting. However, Jerome Powell mentioned that the job-market conditions are yet to cool in an “obvious” way. Additionally, after the Fed’s sixth rate hike this year to 3.75%-4%, Powel reiterated that the terminal rate (interest rates in the long term) may be higher than expected due to inflation staying elevated. Traders did not take this well, and as a result, the two-year yield peaked at 4.80% this week. This resulted in yet another yield curve inversion–the deepest one we have experienced recently. This week, the spread between the 2-year and 10-year Treasury yield reached as much as 62 bps. Yield curve inversions can imply that markets are expecting rate hikes in the short-term to lead to a recession, which in turn leads to lower interest rates in the long-term.?

Another interesting piece of news was that the US Treasury decided to keep the rate of its debt sales steady. For around 8 years, the US Treasury has been slowing down its issuance of debt in order to reduce its fiscal deficit. However, the treasury plans to sell $96 billion of long-term securities in order to fund its borrowing needs. This is worrying, as the US treasury has a debt limit of $31 trillion. If they hit this debt ceiling, the Treasury would have to resort to other measures to pay off its obligations. One of the reasons the Treasury’s borrowing needs are higher than expected is due to the Fed’s quantitative easing, in which they are constantly buying USTs.?

Commodities

Oil, Gas & Precious Metals?(Joshua Boreham)

Crude Oil

With markets dominated by macroeconomic news this week, Crude Oil is no exception, and prices have paid close attention to the dollar index. Notably, as a result of the U.S nonfarm payrolls report published earlier this week, a weaker dollar has powered price gains as it boosted Crude Oil demand. Lingering crude oil supply risks have also played an important role in this rally. Specifically, U.S. Commercial crude oil inventories fell about 3.1-million-barrels (compared with market expectations of a 0.367-million-barrel increase) as refineries picked up activity ahead of the winter heating season – all while inventories are about 3% below the five-year average for this time of year. Whilst demonstrative of stronger demand, this has worried analysts who believe that the impending end of releases from U.S. strategic reserves will remove a source of supply that will further tighten markets. The possibility of China easing some COVID restrictions also supported markets. Overall, on the week,?Brent crude?futures settled 3%?up, to?$98?a barrel whilst U.S. West Texas Intermediate?(WTI) crude?rose?almost 5% to?$92.

Natural Gas

Natural gas futures linked to Dutch TTF were headed for a gain this week, supported by estimates of lower nuclear power output in France and maintenance at some gas export facilities in Norway. While front-month prices have since pared gains after this jump in early trade – trading around the €120/MWh mark on Friday, down from a peak of €137/MWh earlier in the week, contract prices were still poised for a weekly gain. Looking forward, some analysts have predicted European Natural gas prices to drop another 30% in the coming months. On the week, Dutch TTF front-month contract prices have risen by a moderate 2%

Alternatives

Digital?(Marco Fontanesi)

Keeping track of project earnings can prove to be useful information if one wishes to invest in a crypto project token. Not all protocols are meaningless speculation, some projects actually create value for them and their token holders in one form or another. Most of these protocols are Decentralised Exchanges (DEX), and today some of them generate hundreds of millions of dollars in daily trading volume, earning revenues that in some cases exceed 1 million dollars. The dominance of DEX among the protocols that generate the most cash flow is related to the most basic need that DeFi users demand the exchange of tokens. The most direct way to generate revenues for a DeFi protocol is charging a small commission for this exchange. Opensea, the largest exchange marketplace for non-fungible tokens (NFT), use this mechanism of earning, by charging a service fee of 2.5%. In recent months, Opensea's earnings have dropped dramatically due to the collapse of interest in NFTs. GMX is definitely the protocol with the highest growth in terms of earnings, the recent listing on Binance and FTX has given the project a further boost. Metamask earns from swap commissions, management fees and the sale of products through its online shop. Launched in 2016, Metamask has become the world's leading Ethereum wallet. It is used by more than 21 million people worldwide.??