Summary

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From the entire Turing Capital team we would like to wish you a very happy holiday season and a good start to the year 2023. In this week's newsletter we will be a little shorter, the market at this time drastically lowers its trading volume and is exempt from major macroeconomic events. The year is done, it is time to look ahead to 2023, which, at first glance, looks set to be another complicated and turbulent year for the markets. The Fed and the rest of the central banks have been clear in their last message of the year, they are going all out to fight inflation. Too bad it was so late and so poorly managed, now the cure is almost worse than the disease.

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Macro analysis and news

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Relevant data for this week:

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Wednesday: Pending home sales USA

Thursday: US Unemployment

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In previous newsletters we have addressed various macroeconomic issues: earnings, employment, real estate, the energy sector, economic activity indicators and, finally, a detailed analysis of the year-end actions of central banks. It is important to keep all these issues in mind in order to face the new year correctly. The general macro context is worrying to say the least due to the deterioration of economic activity practically worldwide, a drastic reduction in company earnings seems inevitable and a major credit event is very likely.

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Sovereign yield curves are once again becoming highly stressed, indicating that inflationary pressures still outweigh the lengthening shadow of recession.

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Liquidity in the bond market as well as in the SPY is at lows, which contributes to even more volatility.

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The U.S. curve is almost completely inverted, which has always been an unmistakable sign of a recession.

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Once again, we want to focus on company earnings. The Federal Reserve's meteoric path of rate hikes is causing lower corporate earnings, hurting consumer spending and business investment. The materialization of these issues is not immediate; in the real economy things require different timing than what the market demands, thirsty as ever for positive catalysts after losing its mainstay over the past decade, accommodative central banks injecting trillions of liquidity and keeping rates at zero. It seems that all this will lead to a significant reduction in corporate profits and margins, which will have a major impact on share prices by 2023.

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Perhaps the highlight of the week comes from the East. Japan, a country historically gripped by deflation, gets serious about combating inflationary pressures. Japan's consumer inflation hits a 40-year high as companies increasingly pass on higher energy, food and raw material costs to households. Core CPI jumped to 3.81%, the biggest increase since the 4% jump seen in December 1981, when inflation was still high due to the impact of the 1979 oil shock.

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All this has led Japan's central bank to intervene again as a matter of urgency, this time trying to control the yield curve by setting wider bands.

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From China important news, it seems that the strict zero covid measures are being relaxed, opening the door to the long-awaited "re-opening".

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These are the measures announced:

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• quarantine requirement eliminated, including rules for inbound travelers.
• Covid management downgrades to category B from the top-level category A.
• close contacts of covid cases are no longer identified.

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Truly surprising measures when the Asian giant is experiencing an unprecedented wave. The Financial Times reports that 250,000,000 people in China have contracted Covid in the last 20 days, with more than 5,000 deaths per day.

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It seems that Beijing has had to make a radical shift in its zero covid stance as there are many indicators that the Asian giant is heading off a cliff.  

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A large-scale reopening in China is undoubtedly great news, as China is one of the locomotives of the world economy. However, a re-opening implies a thirst for raw materials and energy resources. We will be watching closely the impact on inflationary pressures in the already depleted Western economies.

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To conclude this macroeconomic section, we will take a look at the German chemical, agri-food and pharmaceutical industry as the market continues to seek short-term bullish stimulus while ignoring economic reality. Be warned, the data is very serious.

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The German chemical industry is collapsing, high gas costs prevent it from being competitive. This industry employs 500,000 direct workers in Germany, 70% of its production are intermediate goods that are used as inputs for other industrial sectors. This is the case of agricultural costs, which rose by 37.9% in October.

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The agri-food industry is being hit hard by the sharp rise in the cost of fertilizers, which in turn is directly dependent on the cost of manufacturing ammonia.

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Relationship between gas prices => ammonia costs => fertilizer production.

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Germany was using 20 TWh of electricity per year to make green hydrogen that will be used again to make ammonia.

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The President of the German Medical Association invites people to share their medicines at home with other sick people. The lack of medicines in Germany is already a reality due to the collapse of the chemical industry.

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Chemical production has fallen by -14.1% and pharmaceutical production -5.5% compared to the third quarter of 2021. But the worst thing is not the falls in production but the closure of companies that produce intermediate goods for other industries. The current gas costs make them unviable companies and their chemical products that are produced jointly and chained to other products are difficult to import. A desperate import would only cause bottlenecks in the already depleted global supply chains, there is neither the required quantity on the market nor the necessary logistics. Wolfgang Große Entrup, President of the German Chemical Industry Association, declared last week that this was the end of industrial Germany.

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The lack of intermediate goods due to cost overruns or supply chain failures produces delayed effects in time throughout the industry (remember the lack of semiconductors in 2020 due to supply chain bottlenecks). It is unfeasible for German industry to save 20% of gas: manufacturers of intermediate goods will close down and these intermediate goods cannot be imported due to lack of logistics and international suppliers.

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In blue, the balance of goods, in red the balance of energy.

Merchandise balance deficit recorded record deficit = -64.7 billion eur in August

First 8 months 2022 = -309.6 billion EUR

First 8 months of 2021 = +91.8 billion EUR

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If Europe's locomotive fails, European industry as a whole will be in serious trouble, which unfortunately no central bank will be able to save with further monetary measures. Unfortunately, energy cannot be printed today.

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Cryptos: spot, derivatives and on Chain metrics

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Bitcoin

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The market in absolute lethargy, without moving from the Vpoc of $16800. Balance of forces in this value area, we are still waiting for a clear operational event that will show us which hand is in control.

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20/12/22

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27/12/22

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However, observing the price dynamics around the value area, we do not like at all this abrupt return to the vpoc after rejecting the relevant previous high of $18000. Just as it broke and consolidated above the vpoc, it now finds itself the other way around, breaking and consolidating below. The control of the market seems to be in the hands of the sellers, who have prevented, already for several days, to take off from $16800.

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The order book remains strongly protected at the bottom, with no relevant changes at the top.

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The skew, which measures the difference between the IV (implied volatility) of OTM puts and the IV of OTM calls, again reflects markets in extreme complacency after a week spent on the other side of the coin, total panic. Market of extremes, clearly undecided market.

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skew 20/12/22

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skew 27/12/22

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The volatility curve at the money returns to normal contango, after the remarkable backwardation of two weeks ago. We observe a notable jump in the IV of near maturities, specifically up to January 13, 2023.

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ATM IV 20/12/22

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ATM IV 12/27/22

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On December 30, we face the last important expiration of the year in Bitcoin options on Deribit (centralized exchange that gathers most of the volume traded in options). The "max pain" (level where most options end up with no intrinsic value, i.e. worth zero) is around $18500.

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After an intense last week in terms of bullish flow, highlighting bull call spreads very out of the money and some bull diagonal spreads, this week the institutional activity has been lacking.

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In our opinion, the main driver to keep an eye on is the evolution of the SPY and the Nasdaq. Risk assets are in a situation of clear weakness after the Fed and ECB meeting, sales in these markets could cause contagion to the crypto ecosystem, a trend that has been occurring since the beginning of this year. More details in the specific section on stock markets.

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Ethereum

Like bitcoin, in an absolute state of lethargy with no change from last week. The price remains anchored from the Vpoc of the $1200 volume composite.

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20/12/22

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27/12/22

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Classic markets

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The market after touching the gamma call wall of 4100, leaving a bullish imbalance failure on it, has gone through the entire value area with a lot of verticality, this in the Wyckoff methodology is known as "sow" (sign of weakness). Last week we were at the moment of the imbalance of the whole upper structure, the well known "break and test". Our main scenario is still an effective bearish imbalance. Clearly the most important level for the market now is 3800 points.

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SP500 Futures 12/20/22

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SP500 Futures 12/27/22

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The 3800 points as a line in the sand of the market. Generally, the more times a level is tested, the weaker it is. If buyers stop having momentum in this area, the market could clearly get into serious trouble and therefore infect the rest of the risk assets.

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A bullish scenario would necessarily require the recovery of the vpoc of 3960 points. Buyers would have a lot to prove to materialize such a scenario.

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Gamma profile 20/12/22

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Gamma profile 12/27/22

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The market gamma profile shows a lot of interest in the 3800, 3750 and 3700 puts, which have increased their gamma notional significantly after the past Opex. The 3835 put strike, which comes from the JPM collar, is giving some support to the market. This gigantic position is about to expire and be "rolled", therefore, its associated flows will no longer be present. In short, the door is open to look for lower levels and let the market follow its natural course.

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