Novum Alpha - Daily Analysis 20 January 2021 (10-Minute Read)
Top of the Thursday to you as markets were full of good cheer today!
In brief (TL:DR)
In today's issue...
It's just hours from now and Joseph R. Biden Junior, a man who has made not one, but several attempts at the White House, will finally be sworn in as the 46th President of these United States of America.
Biden's inauguration, surrounded by unprecedented levels of security offers both hope and a cautionary tale as the incoming President takes over a country that is deeply divided both politically and economically.
There is however some degree of bullishness over not just fiscal stimulus, but the hope that competence will facilitate the effective rollout of vaccines.
In Asia, stocks were a mixed bag with Tokyo's Nikkei 225 (-0.37%) and Seoul’s KOSPI (-0.25%), down on concerns that Biden will take a harsher stance on China, while Sydney’s ASX 200 (+0.52%) and Hong Kong's Hang Seng Index (+0.51%) were higher on Chinese growth.
1. Inflation Is Coming For Your Bond Yields
In the movie Memento, Leonard Shelby, an insurance investigator played by Guy Pearce, suffers from anterograde amnesia and uses notes and tattoos to hunt for the man he thinks killed his wife, which is the last thing he remembers.
And just like Shelby, investors too often forget what just happened recently, let alone what happened a long time ago.
Take for instance the selective amnesia in the markets over the fact that not so long ago, oil prices were negative.
At the time, few, if any, thought that the negative oil prices were a warning sign of future inflation, but any student of monetary policy will know that unprecedented monetary conditions such as the present, presage an economic boom when the pandemic passes that will result in higher prices.
Between March and November last year, M2, a broad measure of money supply, jumped by 24%, easily surpassing any previous record set in the one-and-a-half centuries for which such data has been available.
And while inflation deniers point to the lack of inflation in the aftermath of unprecedented fiscal and monetary stimulus in the wake of the 2008 financial crisis, there was a fundamental difference between then and now.
Almost all of the money created by the U.S. Federal Reserve during the 2008 financial crisis found its way into excess reserves in the banking system, with nearly nothing lent out to the private sector.
The reason banks held tight to the money the Fed rained down in the aftermath of the 2008 financial crisis was simple – they needed it to survive.
Before the 2008 financial crisis, commercial bank reserves with the central bank paid no interest and so the absolute minimum was held to satisfy reserve requirements and everything else lent to the money market.
But after the 2008 financial crisis, regulators imposed liquidity requirements on banks that could be satisfied with these reserves and the Fed started paying interest on them, so that another bank collapse could be avoided.
The result was that the banks could easily absorb the extra reserves paid out by the Fed, and fiscal and monetary policy only led to a modest increase in lending.
But this time is different because much of the fiscal aid is going directly into the bank accounts of individuals and firms in the United States, with the potential to spark off sharp inflation and undermine bondholders.
Even though U.S. Treasury yields have risen above 1% recently, yields remain low because Treasuries still serve a role as a short-term hedge if stocks or other risk assets should decline sharply.
But the cost of using Treasuries as a hedge will rise with inflation and undermine the purchasing power of these bonds, making it inevitable one day that yields will also rise, possibly far higher and faster than even the Fed can anticipate.
Consider that money isn’t “free” in any real economic sense - some part of the system needs to pay for keeping jobs and supporting households.
And if that money doesn’t come in the form of higher taxes or bond sales to the public, then it will reveal itself in inflation.
2. Chinese Banks Trump Tech Stars in Fortune Reversal
The Chinese tend to fall on extremes – they can save seemingly superhuman portions of their income, yet love to gamble and this is evident in their approach towards stocks and investments.
For many upwardly mobile Chinese, money sitting in the bank is not as good as money sitting in the stock market and millions of Chinese have ridden the success of their tech titans such as Alibaba (+8.76%) and Tencent (+3.21%) to fresh fortunes.
But Chinese banking stocks, perennial under performers with valuations now hovering near record lows, have largely been left out of the rally in Chinese equities.
That may be set to change however given that Chinese authorities are continuing their crackdown on Ant Group, the fintech arm of e-commerce giant Alibaba, with some suggesting that the move should provide breathing space for banks to win lost ground and market share.
Ant Group’s blockbuster IPO, pipped at US$37 billion, was scuttled after Alibaba co-founder Jack Ma made scathing comments criticizing the Chinese financial system and making unfavorable comparisons of the industry to “pawn shops.”
The crackdown against Ant Group has spooked both local and foreign investors and Alibaba has lost almost a quarter of its market cap since the time the comments were made by Ma.
To be sure, Chinese tech stocks were already looking somewhat expensive, with Alibaba trading at 25 times and Tencent at 43 times forward 12-month earnings, versus the four largest Chinese state-owned banks which trade for as low as 5 times.
China’s broader economic outlook is also buoying the fortune of its banks, with GDP growth at 6.5% last quarter beating figures in 2019, a pre-pandemic year.
Now that state-run banks have been relieved of their duty to ease the financial burden on the Chinese people, profits have been soaring, with some estimates of the sector growing by as much as 9.2% from a year earlier.
Chinese banks in general have a had a tough time since 2018, following a deleveraging campaign that had caused a “mini-credit crisis” in China at the time.
This time however, investors are worried over which tech giant Beijing will crack down on next, and given the rock-bottom valuations for stocks of Chinese banks, have parked funds there in anticipation of better prospects.
3. Burned by Bitcoin? Nothing a Dose of Ether Won't Cure
While Bitcoin has been making headlines, burning through fortunes as quickly as it’s minted them, Ether has been on a quiet ascent.
Although having failed to scale its all-time-high in 2020, the world’s second largest cryptocurrency by market cap, Ether, has put on gains this year that has far outstripped Bitcoin and now leveled with its all-time-high.
And while Bitcoin has so far been unable to clear US$40,000, pulling back each time it has come close, it has remained comparatively less volatile than in previous periods.
That uneasy calm in the world’s largest cryptocurrency by market cap, has led some investors to search for opportunities in other cryptocurrencies, especially Ether.
So far this year, Ether is up 90% compared to Bitcoin’s relatively more modest 27%.
Soothsayers are still reading tea leaves and goat entrails to divine the parabolic surge in Bitcoin to almost US$42,000 before its sharp pullback to below US$40,000 and while technicals suggest that animal spirits account for the bulk of the gyrations, some suggest that fears over inflation also played a significant role.
An incoming Biden administration is also reigniting concerns that more profligate spending habits from Washington could spark the embers of inflation.
But US$40,000 may be more than just a psychological resistance for Bitcoin, with strategists at JPMorgan Chase (-0.43%) highlighting the risk that if Bitcoin is unable to sustain above that key resistance level, it could risk further corrections.
Bitcoin is now over 8% off its all-time-high achieved earlier this year, but anyone familiar with cryptocurrencies will note that such a metric seems to suggest Bitcoin is becoming increasingly more stable as opposed to more volatile.
As a nascent asset class where intra-hour swings can exceed 20% regularly, a decline of just 8% for Bitcoin in slightly less than two weeks is hardly anything to call home about.
And while Bitcoin has started to drift sideways, Ether has been enjoying bullish prospects from a resurgence in decentralized finance applications built atop the Ethereum blockchain while taking great strides towards a network upgrade.
If successful, the use case for the Ethereum blockchain has the potential to far outpace Bitcoin’s role as a store of value and could see Ether rally to new all-time-highs.
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Jan 20, 2021