Although financial markets are struggling in general, cryptocurrencies are suffering most. After the collapse of the Terra stablecoin in mid-May 2022, cryptocurrencies barely recovered their losses. Even before this crash, the market was down substantially. This development may indicate another ‘crypto winter’ as it was the case in late 2017 and early 2018. After this crash, Bitcoin needed until 2020 and other cryptocurrencies until 2021 to recover. Although the current ecosystem is certainly not favourable, the situation is not equivalent to 2017. There are numerous reasons for this. Firstly, the investor base has changed massively with many more institutional investors in the market. This is likely to reduce the volatility of the asset slightly, as the majority of capital in the market is still retail-based. Secondly, the principle of blockchain and the applications are a lot better understood than back in 2017 when most people held coins for the profit only. Nowadays, assets are also held out of conviction which should further limit the downside potential. Thirdly, cryptocurrencies tend to crash the hardest at the beginning of a crisis but also tend to recover ahead of other asset classes. One of the best examples of this occurred at the beginning of Covid-19 when Bitcoin recovered quickly and soon rose to a new record high. Currently, Bitcoin is trading relatively stable at the $30k mark. The development of Bitcoin during 2022 is shown in Figure 1. Ethereum is trading consistently trading below the $2k mark since the crash.
Financial markets are experiencing tremendous daily volatility amid an unprosperous outlook across the board. This is largely caused by the still increasing inflation, steep and continuous interest rates hikes and the ongoing war between the Ukraine and Russia. Outstanding bonds have substantially decreased in prices in 2022 so far and there is little hope that this is going to get better. For example, in the U.S., the Fed just recently started to increase interest rates to an interval between 0.75% and 1%. It is now widely expected that this interval will be increased by 0.5% in each of the following two meetings in June and July 2022. However, it is also being debated if the hikes could even reach 0.75%, if the inflation outlook should worsen. The latest inflation update did not help matters either, as the expected inflation was lower than the actual value. At the moment, U.S. inflation is at 8.3%, just slightly below the March’s numbers of 8.5%. When looking at the inflation level across the world, it is still increasing in most countries. Although inflation is low in China, it increased substantially from 1.5% to 2.1% in April. In the Euro area, inflation has now reached a level of 7.5%. The ECB told earlier in the year that interest rate hikes are unlikely to occur before the latter part of H2 2022. Currently, there are strong signals that ECB will begin raising its interest rates in July. This grim outlook has led to substantial sell-off of treasuries. Meanwhile, the 10-year U.S. Treasury has surpassed the 3% mark in early May. Aside from rising interest rates, central banks are planning to shrink their balance sheet, which will put further pressure on equities and the market in general. Equities have further suffered in May, even after one of the worst months in April 2022. In particular, technology stocks have substantially decreased, as they have been inflated the most since the central bank interventions following Covid-19. The Nasdaq Composite Index is down already 25% since the beginning of 2022. Figure 1 shows a comparison of the current tech valuation compared to their historical average.
Markets are continuing to struggle in 2022. Equity markets have suffered substantial losses after their stellar 2021 caused by a combination of inflation, (expected) interest rate hikes and the Russia-Ukraine war. After the strong selloff at the end of April 2022 which closed the worst monthly performance since the financial crisis, equity indices are down substantially. The S&P500 is down almost 14% YTD while the tech-driven Nasdaq index is down more than 21%. The development of the S&P500 since January 2021 is shown in Figure 1 below. After its record high from the end of 2021, the index is as low as one year ago. Although equities are still high from a historical perspective, the anticipated, and very likely, interest rate hikes from the Fed are on the horizon. It is anticipated that the Fed will increase rates by 0.5% in May and possibly another 0.5% in June. This has a substantial impact on still highly valued stocks which will put further pressure on equities. Central banks are feeling the consequences of their extensive interventions during Covid-19. It led to record inflation levels (at least of the last 40 years), and the imminent treat of recession if interest rates are increased. Nonetheless, if interest rates are not increased, inflation could spiral out of control, if it has not already. Given that inflation has reached 8.5% in the US and 7.4% in Europe, the necessity to intervene is obvious. These difficult times are another opportunity for hedge funds to prove their worth, as they have since Covid-19. Despite losses of the industry collectively during Q1 2022, the industry still sees continued inflows. The difficulties from the uncertainties at the current moment make hedge fund selection more important, as the gap between good and bad hedge funds widened. Given the current market situation, equity-neutral, global macro and commodity-based strategies achieved great results. In particular our Discretionary Global Macro strategy had a phenomenal month with a gain of more than 50% in March and a gain of almost 150% in Q1 2022. Our crypto- and equity strategies did well in March 2022 and could partially offset their loss from earlier in the year. Nonetheless, this is unlikely to continue in April, due to the selloff in both markets at the end of the month. Another great alternative to be partially shielded to current market volatility is private equity and venture capital. Although both markets benefitted greatly from the overheated public markets in the past two years, valuations have declined slightly. Regardless of the decline in valuations, there is still a huge interest in the space as money keeps flowing in and the deal activity is very high in the space. The large amount of capital in the space alongside the competition are also likely to prevent such large decreases as the public equity markets see currently. Both of these markets, hedge funds and private equity, are large drivers of alternative markets. According to research from Goldman Sachs and Preqin, the AuM will significantly increase, even in a suboptimal ecosystem. In a grey-sky scenario, they expect the industry to grow to $14tn in 2026, up from $10tn in 2021. In a more favourable blue-sky scenario, they expect the AuM to rise to $31tn in the same time frame. Figures 2 and 3 show their findings.
While the war in the Ukraine is going on with little progress towards peace, market participants are waiting for further moves from central banks and their announced interest rate hikes to combat inflation. Over the past months, the war had a substantial impact on the currency market, as the Russian Rubel has strongly appreciated against the US-Dollar since the invasion of Russia in the Ukraine. USD-RUB has stabilized at around 80RUB per USD, the same as it has been ahead of the crisis. This is remarkable as it spiked to more than 130 RUB/USD due to the severe sanctions imposed onto Russia. Figure 1 shows the development of RUB-USD since the start of 2022. Despite the sanctions of Russia and its currency, Russia can still control its currency well. They create artificial demand of the Rubel through different measures. For example, foreigners invested in Russia cannot sell their Rubels, they require European countries to pay Russian gas in Rubels, and they require Russian exporters to be paid to 80% of their income in Rubels. These measures all help appreciating the currency against the depreciation pressure from the sanctions. The role of the USD in the FX remains very important, as 88% of the FX transaction involve the USD as one of the currency pairs. It is also crucial in reserves for central banks as it makes up 59% in all currency reserves. This high relevance seems excessive given that it is only responsible for 25% of the world’s GDP. Nonetheless, these are consequences of a currency that is widely regarded as the world currency. An overview of this is shown in Figure 2. This is in particular relevant as for the first time sovereign currency reserves have been confiscated. This may lead central banks to diversify their reserves, increasing the relevance of other major currencies, emerging currencies and real assets, in particular gold. Gold has rallied since the initial threats were looming on the invasion of the Ukraine. It spiked at $2,052 per barrel but did not manage to hold onto this level. As the initial volatility faded, gold fell and is remaining between $1,940 and $1,980 per barrel. Figure 3 shows a summary of this development. Oil experienced substantial volatility, largely due to the invasion of Russia and Russia being a key supplier of oil. Oil started gaining since December 2021, when WTI crude was $70 per barrel. Amid geopolitical tensions and then the looming threat of the invasion, it rose to around $90 per barrel and spiked to $105 immediately once Russia effectively invaded the Ukraine. Since then, WTI rallied between $95 and $120 and has almost fallen to its lowest level since the invasion at $94 per barrel for WTI. Figure 4 summarizes this development. A similar development was observed in Brent crude, as it fell below the $100 mark for the second time only since the start of the invasion. Unlike oil, natural gas has risen to a 15-year high of $6.534 per MMBtu (metric million British terminal units), which poses a huge concern for Europe, as they are highly dependent on Russia’s gas. If Russia would decide to stop gas deliveries to European countries, this would cause a huge recession, as gas-dependent industries likely have to shut down operations very quickly. This is the case, as there are a lot more alternatives for the import of oil than there is for gas.
Russia’s invasion of the Ukraine certainly did not work as planned by Russia. They vastly underestimated the resilience of the Ukrainian people and the worldwide support they have received which included money, weapons, ammunition and even soldiers among others. The sanctions imposed by most countries also have hit Russia hard which supposedly is on the brink of defaulting. Russia has suffered substantial losses in the war and Putin had to impose severe measures to shield the Russian people from worldwide news coverage. The Russian government imposed a new law for news broadcasting which made nearly all international news stations leave the country. Moreover, Russia banned many Western internet companies similarly to China. Russians are facing the dire consequences of the war, as the country is starting to run out of certain goods as well as seeing significant price increases. Nonetheless, for Ukrainians the situation is even worse, as there have been more than 1,500 civilian casualties and more than three million already left the country. Due to the resilience of the Ukrainians and the sanctions from the West, it is questionable for how long the war can continue, as Putin is likely to face more pressure from the citizens of Russia. This leads to a dangerous situation, as Putin and Russia are likely to lose substantially even if they manage to take control of Ukraine. Putin threatened the use of nuclear warheads if the worldwide interventions should continue or the NATO would step in. This threat is especially concerning, if Russia’s defeat should become apparent, even from Russia’s perspective in which case Putin has “nothing to lose”. Amplified by the war, inflation is continuing to rise. In the US, inflation rose to 7.9% in February 2022, while Europe’s inflation increased to 5.8% and 5.5% in the United Kingdom. In order to combat this development, central banks started to raise interest rates this year. The Bank of England announced its second interest raise, while the Fed announced its first interest rate hike of 2022. Both banks are expected to increase interest rate several times in 2022. Oppositely, the ECB announced that there is still space before an interest rate hike is necessary and first interest rate hikes are expected in the latter part of 2022. Figure 1 shows a summary of several assets and their performance in 2022 which strongly differs across the assets. Top performers are commodities. Crude oil is up 35% in 2022 after being up more 65% earlier in March. Crude oil topped $130 per barrel at one point in March 2022 but substantially declined in value, as it was announced that supply will be increased. Since then, crude oil is hovering between $95 and $110 per barrel. Agriculture funds also gained substantially. Wheat was a major contributor to this development, as wheat doubled from the prices one year ago. Since its peak in March 2022, the asset lost around 10-15% in value. Gold is another asset that surged and regained its losses from the past year and is close to its previous all-time high from August 2020. Figure 2 shows a summary of the performance of selected commodities. Most profitable were the commodities that are reliant on the Ukraine and Russia. Russia is a key player in oil, gas and palladium, while the Ukraine is a large supplier of wheat. These assets have skyrocketed, while other commodities still increased but only slightly. Although the increases in gold and copper seem underwhelming, both assets are trading at record or close to record highs. Equities are a lot more volatile and the broad markets suffered a substantial loss once the war started and keep declining at a relatively stable pace. Nonetheless, the success is largely dependent on the industry. Unsurprisingly, energy stocks are doing incredibly well, as they are up 32% in 2022. Tech stocks face substantially more issues and are down almost 20% in 2022 so far. This development stems from the correction of the huge gains in 2020 and 2021 and their high upside potential which is great if the economy is stable. If the economy faces a lot of uncertainty, these stocks suffer most, as is evident in the current situation. Lastly, Bitcoin (BTC) that is frequently referred to as digital gold could not maintain this status, as it is down significantly since the start of the war. It experienced substantially more volatility than most other assets during this time. Since the first few days in 2022, BTC is continuously trading between -5% to -25% compared to the value at the beginning of 2022. The industry gained a couple of percentages following the EU parliament’s approval of a crypto legislation but quickly lost this gain again. Nonetheless, the asset class is well positioned in the current ecosystem, as inflation is still rising and institutional adoption has increased a lot. Currently, 99% of transactions in BTC are from institutions. The performance of cryptocurrencies currently largely favours the big and well-known cryptocurrencies. BTC and Ethereum (ETH) have lost relatively little over this time period, whereas many other smaller cryptocurrencies, e.g. Solana (SOL), dropped by more than 50% since the beginning of the year. This highly uncertain ecosystem also favours hedge funds. The AuM of the industry soared to a record $4.8tn at the end of 2021 and it is unlikely that interest will decline. In particular, macro hedge funds are posting huge gains and attract further capital. Additionally, due to volatility, more investors deciding to put money in hedge funds rather than stocks and bonds.
Central banks, inflation concerns, and geopolitical tensions dominate the market in 2022 so far. Inflation keeps rising in 2022. In the US, the CPI already hit 7.5%, the highest it has been since 1982. Energy remains the key driver of inflation at the moment. In Europe, inflation slightly increased from December 2021 to 5.1% in January 2022. In the UK, the increase in inflation is steeper than in Europe with +0.4% last month to 5.4% in January 2022. Unsurprisingly, energy is also the driving force in the UK. Central banks try to keep inflation under control, which they need to do by raising interest rates, which may have a substantially negative impact on the economy. Hawkish central banks are also responsible for the substantial volatility in the equity market. In particular more speculative sectors, such as technology suffered substantially. The two major contributor for the losses in equity markets were the meeting of the Fed at the end of January 2022, in which rate hikes in March 2022 were hinted, and the Russia-Ukraine crisis. Equities recovered slightly since the Fed-meeting, although markets are again bearish. This is largely caused by the substantial likelihood of the Russian invasion in the Ukraine, as meetings between Russia and the US among others have not yielded any results. The tension of these two major events had a substantial impact on the stability of financial markets, as the VIX index highlights in Figure 1. Both events trigger quite strong reactions in a very short time. The situation is far from over, as it is rumoured that a Russian invasion is imminent. Safe haven assets like gold are slowly increasing in value. Gold is trading at $1,850 per ounce, which is slightly higher than it has been on average since its all-time high back in 2020. Oil prices keep surging as well. US oil prices even reached $90 per barrel and are headed for the $100 mark due to the geopolitical uncertainties. Oppositely, Bitcoin (BTC) which is frequently called an alternative to gold cannot compete. Since it peaked in November 2021, it decreased substantially alongside the entire cryptocurrency market. As many currencies have lost more than 50% from their peak in Q4 2021, people oftentimes speak of another ‘crypto winter’, which refers to what happened in 2017/18, when the entire market completely collapsed.