Novum Alpha - Weekend Edition 26-27 September 2020 (8-Minute Read)
Welcome to your weekend and what a week it's been. Markets surged higher in the U.S. on Friday and are setting the scene for another interesting, but volatile week ahead.
In brief (TL:DR)
In today's issue...
The path of stocks last week would make a Six Flags roller coaster blush and retreat in shame, it's tracks between its legs.
On again, off again stimulus out of Congress kept investors on the edges of their seats, guessing what the next turn in stocks would be like an M. Night Shyamalan movie (the good ones).
But markets are really only reflecting the general investor sentiment - what next?
With negative real yields and stocks already inflated, what's the next act in this terrifying but gripping play?
Can the dollar keep testing new lows and rebounding?
Can tech stocks be worth any more money?
Which asset's turn is it in the carousel of fortune?
Because politicians don't know. Central banker's don't know.
And investors surely don't know.
And against such a backdrop, everyone can be right - just not at the same time.
Which is why we can expect volatility to persist for some time to come.
1. Investors Need Alternatives, Good Luck Finding Them
Over one of countless video calls with the bankers he worked for, Samuel Thong, an investment banker and structured product expert from Hong Kong, was nearing the point of exasperation,
“What you’re asking for it can’t be done – there just isn’t the market depth for these sort of
instruments, and even if I did it over-the-counter, there wouldn’t be any counterparties who would bite for that ticket size.”
As stock prices have soared to lofty valuations and with negative real yields, thanks in large part to unprecedented fiscal and monetary stimulus, and with interest rates near zero, investors of every stripe have been on the hunt for alternatives, but finding that they are few and far between.
Structured products, a burgeoning trade in uncertain times, are financial instruments which range from the bespoke to the pedestrian.
Banks and issuers typically create such structured products for their most well-heeled clients, but of late, finding counterparties to take the risks of their books has proved to be more challenging.
“The availability of hedging tools such as options and other derivatives simply hasn’t kept up,
especially for the more exotic structured products,” says Thong.
Over the past decade, investors have increasingly sought out less liquid areas to stretch their investment tentacles, including real estate, infrastructure, privately traded assets and even cryptocurrencies.
One way to cater to that demand has of course been through structured products which while opaque to the broader market, still benefits from the wrapper of regulated counterparties.
The problem of course has been that the demand for alternative assets has far outstripped supply.
With various asset managers expecting a middling single-digit performance for the next five years, which will look even worse in an inflationary environment, investors are naturally rifling through the couch cushions in search of yield.
Yet as more money flows into alternative assets, given the much smaller size of this market, compared to the public markets, there are limits to just how far such an approach can shift the needle for longer term performance.
If you don’t know who the market is, chances are, you are the market.
And given the opacity and lack of liquidity of many alternative asset markets, sizeable investments can be sufficient to swing the entire market’s direction and price – liquidity for these assets also cannot be assumed.
Returns from alternative assets will no doubt help portfolios, but ultimately, they are no panacea and a broader approach that seeks streams of income (whether via dividends or sizeable and dependable coupons) from stocks or structured lending, that are less influenced by market interest rates will be needed – provided of course that investors can find them.
2. Streaming Killed the Gaming Console
“Video killed the radio star, video killed the radio star, it’s in my mind, and in my car, we can’t rewind we’ve gone too far.”
- The Buggles, “Video Killed The Radio Star” from the album “The Age of Plastic” ©1980
Will we one day sing the same song for gaming console?
As an avid gamer, I’ve never been much of a fan of consoles – their purpose-built nature meant that outside of gaming and maybe watching the occasional Blu-ray DVD (go ask your grandfather), a console isn’t very good for anything other than gaming, whereas a personal computer can still disguise itself as an extremely powerful workstation.
Consoles have always experienced seasonality in their success, which has seen the fortunes of console makers rise and fall with the sales of their platforms, lead primarily by flagship game titles.
And while the coronavirus pandemic has seen the sales of consoles surge, with some analysts predicting that the age of the console is making a comeback – that would be a premature observation.
While the smartphone killed off the camera and film (thank you for the memories Kodak (+6.27%)), and streaming services killed the video store (you’ll be missed Blockbuster), so cloud gaming threatens the venerable video game console.
In the past, console wars were fought mainly along cult title battle lines – Mario or Sonic? Street Fighter or Halo? Final Fantasy or Forza?
Your choice of game would ultimately determine your choice of console.
But as game publishers sought to appeal to a wider audience, the monopoly that console makers used to have on where gamers could play what, has waned in the past decade.
Case in point? Microsoft (+2.28%) is releasing its new Xbox this year even though it’s seminal title Halo isn’t ready for launch yet.
In the past, such a travesty could put a serious dent on Xbox sales as well as Microsoft’s share price, but not anymore.
These days, investors (and gamers) treat such news with a collective yawn of indifference.
With gamers increasingly demanding the ability to play their favorite titles across multiple platforms seamlessly, advances in cloud computing and high-speed internet have now made it possible for firms to dole out subscription-based gaming services, ala Netflix.
Just this week, Microsoft spent over US$7.5 billion to buy creative content studio ZeniMax while e-commerce giant Amazon (+2.49%) announced the launch of its game streaming service Luna, in response to Microsoft’s Xbox Game Pass and Google (+1.14%) Stadia.
And while the console market is still the big driver of revenue per user, that may soon be set to change, with some of the biggest names in tech battling to win subscribers for game streaming services – which will necessarily drive demand for the technologies that support such services, including cloud infrastructure and mobile phone operating software.
To that end, Google, Microsoft and Amazon, which each have their own dedicated cloud computing divisions, may have a leg up on the competition.
But the main beneficiary from a shift to game streaming services as well as more dedicated gaming platforms such as the PC, is likely to be Nvidia (+4.26%).
Nvidia has been making huge investments in its cloud infrastructure technology and its GPUs, which already power a majority of dedicated gaming PCs, also powers Amazon’s Luna.
Another big winner is also likely to be the game publishers themselves.
Whereas previously, publishers had to decide which platforms they would choose to launch on, especially when it came to consoles, they now have a far larger addressable market.
For everyone else? It’s game on.
3. Think Your Cryptocurrency Gains are Tax Free? Think Again
If you’re an American citizen, one of the biggest bugbears has been how much tax you have to shell out, for what appears to be very little in return, especially in terms of healthcare and other public services.
Which is why the advent of cryptocurrencies, and the supernormal profits that some traders have been making off the trade of them, was initially thought to be a utopia for those who would rather Uncle Sam, didn’t take a piece of the action.
But because those nuclear-powered aircraft carriers won’t pay for themselves (have they ever?), a surprise change to 2020’s tax form suggests that crypto whales can no longer claim ignorance over their immense digital wealth.
The Internal Revenue Service (that most favored of all the three-letter federal agencies) plans to alter the standard 1040 tax form by putting in this dreaded question on the front page (no less),
“At any time during 2020, did you sell, receive, send, exchange or otherwise acquire any financial interest in any virtual currency?”
with the taxpayer having to check a box “Yes” or “No.”
While the cryptocurrency question first appeared on the 2019 version of the tax form (those were simpler times weren’t they?), it was in a section that not all tax filers had to answer.
But now cryptocurrency has moved up the ladder and the question appears near the top of the 1040 form, just below the taxpayer’s name and address.
You know you’ve arrived when you’ve climbed up the chart to the top of the 1040.
But celebrations aside, the IRS’s move is a strong warning to millions of cryptocurrency holders that just because their wealth may be digital, doesn’t mean that they don’t have to pay taxes on it.
Yet the crypto defiant, who would rather burn their digital wallets (one wonders how that would be achieved) then see their crypto wealth land up in the hands of the government would be ill advised to lie on their 1040.
Because filers sign tax returns under penalty of perjury (or pain of death), and since juries often side with the IRS when it’s clear that a taxpayer has lied, aforesaid crypto whales may want to come clean, or come up with alternatives.
And before the cryptosphere dismisses the IRS as a fuddy-duddy federal agency trying to congest their network, the IRS has provided key assistance in two high-profile cryptocurrency cases in recent times – one a North Korean theft and the other a child pornography ring run by a Dutch national – demonstrating its capability.
Cryptocurrency users are understandably up in arms about the proposed change, with many arguing that cryptocurrency is treated as property by the IRS, despite its use (at times) as a currency.
That may be the case, but the law on this area is as yet unclear and until Congress (which is suitably preoccupied at the moment) sees fit to change legislation on the matter, Americans holding bags of crypto may want to think twice about checking “No.”
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Sep 27, 2020