RESEARCH
The Weekly Catch-up
What began as a tentative relief party in tradfi turned into a blowout last weekend in crypto. Positioning helped, with open interest to market cap high, the positive news around a potential September merge caused ETH to skyrocket. We are seeing short squeezes in select equity names as well. Positioning and sentiment have become more negative but equities are ignoring the bond market, call it a form of gaslighting. Corporates are getting the message, though, with everyone from Tesla to FTX beefing up their balance sheet for a rainy day. GASLIGHTING THE BOND MARKET Equities are ignoring bonds, with the spread between the 2 yr US government bond yield and the ten year at over -20 bps, the most negative since 2000. The equity market appears to have its head in the sand about the economic outlook and downside to earnings, betting for a stronger 2H.Summary:
Macro
In 2000, spreads remained negative for most of the year, which preceded a mild recession the following year. The Fed had raised the fed funds rate from 4.75% in early 1999 to 6.5% by July 2000 to try to cool the economy and a hot stock market, which led to the Nasdaq crashing by 70%. One key difference is that at the time, the Nasdaq 100 was trading at over 100x forward P/E, far from the 25x levels of today.
Sentiment has turned more negative recently, with the widely tracked Bank of America survey of fund managers the most downtrodden since the Covid shock.
Fund managers are the most despondent about the economy since March 2020
MANAGING EXPECTATIONS
We can conclude that positioning coming into earnings season likely played a part in the rebound, with investors now short the S&P, less long the Nasdaq and short select names such as Netflix and Tesla.
Earnings still have to fully play out but so far they are not comforting (+8% revenues, -7% earnings). Lower estimates and high short interest led to a short squeeze when Netflix reported a loss of almost a million subscribers instead of the 2 million feared, and guided for a gain in Q3 of 1 mn.
Another short darling, Tesla reported FCF of $621 mn, though this was not impacted by the sale of bitcoin. The sale was done at an average price of 30k to boost cash for a potentially tricky China outlook and may have played a part in the crypto selloff.
Earnings beat but they posted the first sequential EPS decline since 2020. Management is sticking to its 50% delivery growth for the year but warned it would be tougher to achieve.
Tesla eked out positive free cash flow and boosted cash reserves with the sale of BTC
EURO POPS ON A 50 BPS HIKE FIZZLES OUT AS RECESSION LOOMS
In Europe, the ECB surprised the market by raising rates by 50bps after having guided half that, leading to a short-lived pop in EUR/USD on Thursday. This takes rates to 0%, the first time they haven’t been negative since 2014. It is unlikely that the euro can stand up to more aggressive tightening in the US and a weakening economy, with the July PMIs dipping below 50 (contractionary).
Despite ECB president Lagarde’s plan to buy higher yield peripheral bonds, Italian yields rose again as technocrat and market favorite Mario Draghi resigned as PM. With debt to GDP at 150%, Italy is the most fragile nation in the region so a potentially populist candidate in the form of Georgia Meloni from the Brothers of Italy caused ripples.
The spread between German and Italian yields reflects stress in the Eurozone
FRONTIER MARKETS: THE CRYPTO OF TRADFI
Dollar strength will continue to wreak havoc on emerging and frontier markets, with Pakistan now in the headlines. Bond spreads and credit default swaps (CDS) across the asset class have spiked as people take on insurance against country defaults. Pakistan has $16 bn in financing needs over the next year, including a $12 bn current account deficit and $4bn in debt to be repaid, while reserves are less than $10bn.
An agreement with the IMF may release $1.2bn and allow access to another $4bn which would avert a default.
A one way bet? The Pakistan rupee
Crypto
MARKET WRAP
Digital assets are up 14% as of Friday for the week, driven by the outperformance of Ethereum on a tentative merge date proposed by devs for September 19. ETH (+30%) left BTC (+11%) in the dust after a period of heavy underperformance. Polygon and Avalanche were both up 29%, while further down the market cap list, Near rose 35% and Ethereum classic was up 74%.
Polygon, the Layer 2 scaling solution that runs alongside Ethereum, launched its first EVM-compatible scaling solution, zkEVM which would allow more users due to lower gas fees. Avalanche, an Ethereum alt blockchain, has seen robust development activity and network growth this month.
FAR FROM THE FLIPPENING
The entire crypto market has seen a significant rally this week but Ethereum has achieved particular gains, with prices rising 32% over the last 7 days. On Monday alone Ether futures saw $230m in liquidations ($137 million in shorts and $93m in longs).
In addition to a less stressed macro scenario, there was a fundamental reason for the move as developers shared a tentative timeline for the merge which involves Ethereum transitioning from a proof of work to a proof of stake consensus mechanism. The proposed date is September 19.
Two more public testnet merges need to be completed on Ethereum Goerli and Sepolia networks before the mainnet merge can be executed. Many are taking the dates with a pinch of salt given Ethereum’s past form on delays to the merge but a proposed date indicates confidence that it’s on the brink.
The ETH/BTC ratio was at the lowest levels since April 2021 at .054, erasing all of the outperformance until the weekend rebound. At its height, many hoped that ETH would flippen’ BTC.
ETH: Still a long way from the flippening
Fireworks: ETH Daily Total Liquidations spiked as ETH rallied on a potential September merge
STASHING CASH FOR A RAINY DAY
It’s not just Tesla and JP Morgan strengthening their balance sheets, FTX, the leading crypto derivatives exchange, raised $400 mn last January in a Series C round at a $32 bn valuation and its US operations raised an equal amount at an $8bn valuation. Now both entities are looking to raise additional funds at the same valuation after having committed $1bn in credit facilities to stem market contagion.
THREE ARROWS CAPITAL: PICKING UP THE PIECES
We were given further insight this week into the debt taken on by crypto hedge fund 3ac, who owe $3.5 billion to 27 different firms. Top of the list is Genesis, a crypto prime broker whose parent company is the Digital Currency Group, with $1.3 bn in funding and ownership of the Grayscale Bitcoin Trust, with almost $30 bn in AUM.
The broker has filed a claim for $1.3 billion. Voyager Digital filed a claim for $674 million but we do not yet know the identity of the remaining creditors. According to Genesis, their loan was under-collateralized with a weighted average margin requirement of 80% which 3ac fell short of by $462 million as of June 15. The collateral posted by 3ac was made up of shares in Grayscale Bitcoin Trust and Grayscale Ethereum Trust as well as AVAX and NEAR tokens.
Spot the issue. Collateral that was locked up and at a discount, and less liquid names that are harder to exit in a hurry. Exposure to low liquidity, in small cap equities, led to the downfall of famed investor, Neil Woodford, at Invesco.
LIDO LIQUID STAKING on L2’S
Lido, which has $6.5bn in ETH staked on its platform, making it one of the leading providers of stETH and second in DeFi TVL is launching its services on ETH Layer 2’s. People will be able to stake directly on L2’s and earn 3.9% annualized yields. They are betting that most economic activity will migrate to these solutions due to scalability and lower costs.
TVL on Lido is down from its $19bn peak but stETH has not depegged again from ETH as occurred during the Terra contagion when everyone rushed to convert their stETH back to ETH.
Until next week!
The Bequant Team
Martha Reyes
Emiliano Bruno
Callum Greaves
Artur Sakovich
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