SB Cap Issue 9, 7/22/2024

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SB Capital
July 22, 2024

SB Capital Insights

7/22/2024

Good morning. A massive tech outage caused by an update to MSFT’s operating system by CRWD disrupted critical infrastructure, grounding major airline carriers and delaying trades in financial institutions. President Joe Biden ended his reelection campaign Sunday after pressure and mounting calls from within his own party for him to step down. The Democratic Party will rush to support a new candidate. In the future we will explore each party’s proposed economic agenda.

Keep reading as we take a look at the state of cybersecurity in the U.S. and what the markets look like for this critical service. We will delve into why markets are in decline this week with the downturn being led by tech, and we will keep you up to date on a Chinese sell off of U.S. securities.

Markets 

  • Strong declines in the technology sector pulled down the Nasdaq over the course of last week. As stated in a previous issue it has been the top six companies, all tech based, that have pulled up the entire U.S stock market over the last year. Investors are closely monitoring these companies earnings as they have strong implications for the rest of the market. 

  • This past week the VIX rose 27.13% to the 16.52 level. The VIX is a real-time tracker of short term volatility on the S&P 500. Investors use the index to measure the level of risk and fear in the market. As fear rises in the market, many market participants look to hedge their positions through the purchasing of option contracts. This in turn raises the premium at which to purchase these contracts.

    • Volatility refers to statistically how far an asset's price can move in either direction. 

  • Above is a feature on the ThinkorSwim terminal that uses option pricing to determine volatility, similar to VIX. This graph shows the probability of the VOO (an ETF that tracks the S&P) moving to different price levels. By Friday the market is implying a 51.1% chance that it will close above the current level. 

  • Bitcoin surged this past week as Trump remains the first “Crypto President '' and as JD Vance was appointed to be his running mate, also a supporter of crypto. BTC posted an 11.7% gain since last Monday and remains a revolutionary store of value.

Cyber Security

  • This past week a faulty update to Microsoft’s Windows operating system caused outages in critical infrastructure. While an initial fix was quickly found, restoration of certain essential services will take several days, as a roll-out of new software will be necessary to resolve the bug. This outage was short-lived and not malicious, however it had significant consequences. It is estimated to be the worst IT outage ever, with billions lost in revenue. More precise estimates will follow in the coming days. This failure has made many question the large consolidation that has occurred in IT services. A small group of companies has significant market share in IT services. Any disruption in their services has a ripple effect as was seen this past week. 

  • As of 2024 it is estimated that the cybersecurity market is worth $194 billion and by 2032 will reach $563 billion, representing an estimated 14% compound annual growth rate (CAGR). (Fortune Business Insights)

  • A study conducted by McKinsey in 2022 estimated that the need for cybersecurity investments is much greater than the current level. They estimated that current market penetration is only at 10%, representing a $1.5 to 2 trillion opportunity. While this estimate is lofty, growth in this industry is undisputed. Companies and increasingly governments are turning to cybersecurity firms to receive vital security solutions.

China sell off

  • In May China sold $42.6 billion worth of U.S. securities, ranging from treasuries and stocks to corporate debt. 

  • Analysts suspect there are multiple reasons why this sale is accelerating.

    • Record high prices make it enticing to find returns elsewhere, as it is speculated that U.S. returns are at their max. Foreign markets are looking comparatively attractive due to more conservative pricing.

    • De-dollarization - This is a politically driven sale of U.S. treasuries by China in order to weaken demand and strengthen the case for alternative reserve currencies. In addition, as hostility between China and the U.S. grows, China will be looking to protect its reserves from U.S. sanctions. 

    • Risk reduction - As U.S. deficits grow and uncertainty increases regarding the presidential election, investors might be seeking less exposure to U.S. debt.

  • China is continuing to sell U.S. treasuries as its holdings of U.S. securities shrink. China is the second largest foreign holder of U.S. treasuries, with $768 billion. In 2013 China’s holdings reached a record high of $1.3 trillion. Today's level represents a 42% decrease from its record holdings. While this decrease should not cause hysteria, it could be a cause for concern. Increased sales from China could further weaken demand for U.S. treasuries, increase yields, and strengthen a potential transition away from the dollar as the global reserve currency.

- In cutting back on U.S. treasuries China seems to be alone among major holders, but this cutback on U.S. treasuries is important to watch. We will be watching how other foreign holders adjust their reserves. Demand for and trust in U.S. treasuries is crucial to funding U.S. deficits. Broader changes in holdings could signify a decline in faith in the ability of the U.S. to pay.

Inverse relationship between U.S. treasuries and gold reserves held by China

White line shows increase in gold reserves and blue line shows decrease in U.S. treasury holdings by China (Bloomberg)

It's important to take note of the inverse relationship between China's holdings of U.S. treasuries and cash versus China’s gold reserves. As mentioned there could be many reasons why China is embarking on a sell off. However we believe a transition away from U.S. treasuries for gold, which is a more favorable asset for China, seems most reasonable. The result is a rapid increase in gold reserves held by China that are untouchable by U.S. sanctions. This could signal that China is preparing itself to become more independent from the United States. Perhaps it could mean China is preparing for a potential invasion of Taiwan and planning to avoid sanctions similar to those imposed on Russia after its invasion of Ukraine. Regardless, it's an important relationship to watch that likely has politically driven motives which will have large implications for U.S. influence and the market for U.S. treasuries . (Check Issue #1 for more info on foreign gold reserves.)

What to look out for this week

  • Core PCE for June (Friday) - The Fed will be watching its preferred inflation gauge. They will be looking to see if inflation is continuing to grow at a slower rate. The Fed continues to require “more good data '' in order to be confident in lower rates. A reading that shows decreased growth in inflation could embolden the Fed to begin cutting rates.

  • Earnings to look out for! 

    • Tesla (Tuesday), Microsoft (Tuesday), Meta (Wednesday), Coca-Cola (Wednesday), Chipotle Mexican Grill (Wednesday), Visa (Thursday

We are two college students on a mission to immerse ourselves in the financial industry. We are eager to learn more and make new connections. Our goal is to share exciting and informative content that provides a broad picture of current events and offers valuable insights.

Authors: Ben Banchik, Zachary Singer

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