Novum Alpha - Daily Analysis 11 December 2020 (10-Minute Read)
TGIF and I hope you're looking forward to the weekend!
In brief (TL:DR)
In today's issue...
It's all about the jobs, but right now in the U.S., there just aren't a lot of them.
When lockdowns were first lifted, many businesses started hiring again under the mistaken impression that just because the economy was reopening, everything was heading back to normal.
Instead, a failure to wear masks and misinformation spewing forth from the Trump administration has seen a disastrous third coronavirus wave that has seen even cities like San Francisco returning into lockdown conditions.
And given that the lame duck U.S. President has all but signed off on doing his job since he lost the election, America is drifting rudderless into a coronavirus cataclysm.
When Joseph R. Biden Junior is sworn in as the 46th U.S. President, it won't be a silver bullet and he'll have his work cut out for him.
In the meantime, economic conditions in the U.S. look set to get far worse before they get any better.
In Asia, markets were mainly a mixed bag with Tokyo's Nikkei 225 (+0.22%) and Seoul’s KOSPI (+1.12%) up, while Sydne
1. Think Company Valuations Don't Matter? Think Again
Every seasoned pinball player knows that a slight nudge at the right time can help to put a bit of spin on the steel ball to get extra points, extra balls and a new high score.
But every pinball player also knows that if you push the pinball machine too hard, it "tilts", the flippers stop working and you lose the ball that you were playing with.
And that could well be happening for stocks.
As the coronavirus pandemic hit, central banks slashed interest rates and governments spent lavishly to prop up otherwise battered economies, but too much money may be pushing the markets to "tilt" as well.
Because so much hot money had to flow somewhere, the bulk of it found its way into the stock market with investors coining the term “TINA” – there is no alternative.
Remaining overweight in equities, especially U.S. tech firms, valuations have returned to levels not seen since the 2000 dotcom bubble.
And while every market crash is different, there are typically common themes preceding the inevitable turmoil.
Widely held beliefs that actually paper over genuine risks, multiple contributory factors and the layering of assumptions, have all generally preceded a market crash, and the current complacency when it’s come to stocks has many of those characteristics.
Investors are assuming that valuations no longer matter, that interest rates will stay low indefinitely, and that monetary and fiscal policy paired with coronavirus vaccines will return the world to the investment regime of the past five years.
But stock valuations do matter, just not necessarily in the short run.
Since 1950, whenever the preceding 12 months price-to-earnings ratio of U.S. shares has exceeded 30, the subsequent annualized returns for U.S. equities has rarely been above 5% and often has been below 5%.
Traditional measures of company valuation have been dismissed by many investors as being less meaningful given that future earnings are discounted by rates so close to zero.
But at some point, when unemployment falls and inflation starts to rise, central bankers will inevitably have to start considering the raising of rates.
And any tightening in policy could send shocks to the market.
The problem with relying on overvalued bonds to justify overvalued company valuations is that any volatility in rates, whether by central bank intervention or inflation, could very easily destabilize the positive feedback loop that those assumptions self-perpetuate.
And now that investors have turned their attention towards “value stocks” to outperform, as earnings become more plentiful and margins recover, they will inevitably start to ask “value-type” questions, and focus more closely on valuations.
Investors looking to buy cheaper “value” stocks will become more wary of buying “growth” stocks which have so far commanded a premium because of their higher potential earnings.
And that’s bad news for the investment themes of the past year, betting big on tech stocks, even if they’re not profitable, challenging many of the investment assumptions, particularly valuations.
The problem with ignoring valuations is that they can be ignored up till a point where they can’t and nobody knows for sure when that is.
2. What Goes Up, Can Only Keep Going Up?
Imagine a soccer match where you could only bet on both teams to win, not draw mind you, but win.
Is that even possible?
Yet that appears to be precisely what the South Korean authorities are seeking to do by planning to levy heavy fines and jail sentences on traders that bet against the country’s stock as part of a broader campaign against short selling.
The move has understandably irked hedge funds, who bet on stocks going up as well as down.
According to South Korea’s Financial Services Commission, investors who engage in so-called “naked” short selling, selling stocks of a firm without first borrowing or owning the underlying security, could be imprisoned for at least a year or face stiff financial penalties up to five times any profit made on a trade.
Whilst most investors buy stocks in the hope that they appreciate, short sellers bet on stocks going down and naked shorts make those bets without owning or borrowing the shares but sell them anyway.
The beefed-up punishments come hot on the heels of an extended ban on all short selling by another six months from August this year, which itself was implemented during a sharp sell-off in South Korean stocks earlier in the year due to the coronavirus.
But short selling in and of itself isn’t necessarily an undesirable activity in markets.
By adding a healthy dose of skepticism, investors are invited to more carefully scrutinize their one-way bets and short sellers have uncovered countless instances of corporate fraud.
The ban on short selling has tarnished the image of South Korea’s capital markets as it joins an exclusive club of just three countries with such a ban, the other two being Indonesia and Malaysia and raises questions about whether or not authorities are sincere about corporate clean up.
One of the key advantages of banning short selling is that it discourages more investigative investors questioning the valuations and books of a firm.
Cognizant of the fact that a prolonged ban on short selling could stymie the development of South Korea’s capital markets, regulators are considering lifting the embargo on the activity when it expires in March, although naked short selling will continue to be prohibited.
Ultimately it may not matter very much because South Korea’s equity markets have been on a tear of late, with foreign investors pouring into the country’s firms on the back of a weakening dollar and a widely held belief that Asia will emerge from the pandemic economically stronger.
In November alone, foreign investors poured in over US$4.4 billion into South Korea’s markets, snapping up shares in firms such as Samsung Electronics (-1.35%) and SK Hynix (-3.32%).
The ban on short selling has already seen South Korean stocks fall.
Foreign investors now own more than a third of South Korea’s stock market, which raises other risks.
As the Asian Financial Crisis clearly demonstrated, hot foreign money can leave a market just as quickly as it entered.
And while it’s completely understandable that South Korean authorities are keen to avoid a repeat of the 1997 Asian Financial Crisis, which saw the South Korean won devalued, simply putting a ban on short selling won’t achieve that.
3. Banking with Bitcoin, Literally
One of the biggest criticisms levelled against Bitcoin is that it generates no yield.
And last year, legendary investor Warren Buffett criticized Bitcoin as being nothing more than a “gambling device.”
Ahead of Berkshire Hathaway’s (-0.07%) annual meeting last year, the Oracle of Omaha told reporters,
“It (Bitcoin) doesn’t do anything. It just sits there. It’s like a seashell or something, and that is not an investment to me.”
But while Bitcoin may not be an investment to Buffett, a growing number of institutional investors are betting that just by sitting there, Bitcoin could potentially be an investment.
In the latest sign that Bitcoin is extending its institutional reach, Fidelity Digital Assets will now allow its institutional customers to pledge Bitcoin as collateral against cash loans.
But it won’t be Fidelity Digital Assets making the loans itself, instead, the firm will be holding the Bitcoin as collateral, and acting as a qualified custodian, working with BlockFi which will issue the loans.
With a growing number of Bitcoin-rich investors, many may be looking to turn their digital assets into spendable cash, without necessarily selling their precious Bitcoin.
Fidelity Digital Assets is said to be targeting hedge funds, Bitcoin miners and over-the-counter trading desks for its Bitcoin collateralized loans.
In an interview with Bloomberg, Fidelity Digital Assets President Tom Jessop said,
“As the markets grow, we’d expect that this becomes a fairly important part of the ecosystem.”
Fidelity Digital Assets noted that institutional investor interest in cryptocurrencies is rising.
To date, billionaire hedge fund managers from Paul Tudor Jones to Stanley Druckenmiller have publicly disclosed their investments in Bitcoin and listed companies such as Square (+4.92%) and MicroStrategy (+1.44%) have both invested in Bitcoin as well.
A survey by Fidelity Digital Assets earlier this year found that 36% of respondents held cryptocurrency in their portfolios and over 60% expressed interest in Bitcoin and other cryptocurrencies, well up from 47% in the 2019 survey.
Fidelity Digital Assets launched a Bitcoin custody service last year, but this is the first time that the firm is making the coins available as collateral for cash loans and to get a loan a customer will first need to have an account with BlockFi.
Jessop says he envisions the Bitcoin-backed loans to act similar to a typical repo trade, that many on Wall Street would already be familiar with adding,
“We want to develop a world-class brokerage capability for assets of all types.”
Considering the notoriously volatile nature of Bitcoin against the dollar, BlockFi will hedge that risk by offering cash worth 60% of a loan backed by Bitcoin initially.
But given that Bitcoin has fallen by as much as 80%, and in a relatively short period of time, the ability to effectively manage these Bitcoin-backed loans is no mean feat.
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Dec 11, 2020
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