Novum Alpha - Daily Analysis 4 February 2021 (10-Minute Read)
I hope you're having a terrific Thursday as markets drift rudderless in the absence of clear macroeconomic direction.
In brief (TL:DR)
In today's issue...
Investors are drifting rudderless in a sea of liquidity, even as U.S. President Joseph R. Biden Junior looks to make history by ushering in a fresh US$1.9 trillion stimulus package that would see an additional US$1,600 put into the pockets of most Americans.
Data out of the U.S. shows that January was not as bad as expected with more jobs added than forecast and stock markets have regained their swagger after terrific volatility in the past few weeks largely blamed on retail traders.
Over in Asia, stocks were mostly down in the morning trading session with Tokyo's Nikkei 225 (-0.47%), Hong Kong's Hang Seng Index (-0.14%) and Sydney’s ASX 200 (-0.74%) down while Seoul’s KOSPI (+0.22%) was up marginally.
1. No Such Thing as Zero Fee Trading
Although retail investors were drawn to the likes of SoFi and Robinhood because of their zero-fee trading accounts, trading isn’t free.
Just as how users “pay” social media with their data to use these platforms, zero-fee traders on apps like Robinhood are also “paying” – they’re the product.
Democratizing access to the markets sounds like a good idea – the devil is in the execution and a race to zero commissions meant that the more people get price updates the more they're likely to trade with the frictionless nature of playing the market warping behavior.
Consider that in 2008, an average of just 10.9 billion shares changed hands across all of U.S. exchanges every day, while last week a whopping 24 billion shares were traded in a single day – the most on record by a long shot.
The real cost of those trades has been noise in the market.
More than ever before, quantitative trading algorithms are having to work doubly hard to filter out signal noise.
And a study published this week by researchers at Emory University and Oklahoma State University showed that commission-free trading on Robinhood not only contributes to greater volatility in stocks bought by retail traders, it also provides no predictive value on returns.
So how do brokerages charge zero fees?
The no-fee business model relies primarily on what’s known as “payment for order flow” – market makers make money off of order spreads (the difference between the bid and ask price for a stock) so they’ll pay brokerages to send orders their way.
Because stock markets are generally more efficient than say cryptocurrency markets (i.e. the spreads are thin), market makers need tremendous amounts of volume to make money off the spreads and that’s where zero-fee brokerages like Robinhood come in.
Robinhood isn’t giving away free trading – the customer is the product, they just don’t know it.
Which means that platforms like Robinhood or the other brokerages who have all been cornered into zero-fee trading don’t care as much if investors are profiting or losing, they just care that they’re trading and that’s where the misalignment in interests comes in.
Just like social media firms only care that users are constantly coming back to use their platforms, brokerages only really care that traders are trading – the more people trade, the more money they make, it’s just that it’s not obvious how that money is made.
The same way that the past four years have demonstrated the distortive effects of misaligned interests when it comes to social media, last month demonstrated how a misalignment of interest between traders and their zero-fee trading platforms can wreak havoc on markets.
If you're not sure who's paying, chances are it's you.
2. Jack Ma Proves That Ants are Hard to Kill
Anyone who’s ever had an ant infestation will know that you can kill as many ants as you want, but they’ll always come back.
And investors who had written off Jack Ma’s Alibaba (+1.46%) and its fintech arm Ant Group, after Beijing moved to censure them, may not have realized that clues to the group’s resilience was always there - it's in the name - ants survive.
In a major coup for Ant Group, the fintech will put all of its major businesses, including its technology units, into a financial holding company to comply with a new regime implemented last November by the Chinese central bank.
The change, which is likely to be announced before the Lunar New Year holiday, will leave Alipay, China’s largest mobile payments company, subject to stricter capital requirements, making it more like a bank than a tech firm.
Despite the likely increase in compliance costs, Ant Group's wild profitability means that there is some buffer.
With over 700 million monthly users, Alipay is used to make payments, take out loans, insurance as well as manage money and Ant Group earned an estimated US$2.25 billion in profit in the third quarter of last year before its listing was suspended.
A main driver of Ant Group’s profitability of course has been the ability to behave and provide the services of a bank, without the capital and compliance costs.
In the end, Ma’s Ant Group will likely need to raise capital to satisfy the People’s Bank of China rules for financial holding companies and requirements on capital adequacy, risk control and governance.
But on the flip side, cooperation with Beijing may also allow Ant Group to raise additional funds through the public markets as its IPO gets restarted.
The extent that the rule changes will affect Ant Group’s valuation is less certain, with estimates anywhere from 10% to as high as 50%, and harsher regulations potentially weigh more heavily on the funds raised from a resuscitated IPO.
What’s certain though is that Ant Group and indeed Jack Ma’s Alibaba will survive this episode, bruised but not defeated.
3. What's the Future of Ether?
While Bitcoin makes headlines, the world’s second largest cryptocurrency by market cap has at best enjoyed bylines.
But that may be set to change as an eightfold rally in Ether has now led to an impending launch of CME Group’s Ether futures.
The CME Group’s Ether futures are set to debut next Monday and may stoke memories of 2017 when the launch of Bitcoin futures coincided with a peak ahead of a spectacular bust.
CME Group’s Bitcoin futures are cash-settled and back in 2017, provided a means for investors to bet on a fall in the price of Bitcoin, which they did.
And some are wondering if Ether futures could precipitate a repeat of the crypto winter.
If so, Ether’s most recent rally indicates that investors don’t seem to believe that’s the case.
To be sure, the circumstances for cryptocurrencies now are markedly different from back in 2017.
While cryptocurrency markets continue to remain speculative, use cases that did not previously exist have now developed, including decentralized finance on the Ethereum blockchain, which skirts traditional intermediaries such as banks.
And because CME Group’s Ether futures allow investors to go long as well as short, there’s no guarantee that investors will opt for the latter any more than for the former.
Add to that a far more developed derivatives market for both Bitcoin and Ether outside of the institutional forums such as CME, and the availability of cash-settled futures in and of itself should not be seen as a bearish move.
Ethereum has also progressively been upgrading its blockchain to process more transactions using a method known as “proof of stake” which also has the effect of curbing the supply of Ether tokens and potentially providing even more upside for the cryptocurrency.
Nonetheless, in 2018, the Federal Reserve Bank of San Francisco noted that the rapid rally and subsequent collapse in Bitcoin prices after the introduction of Bitcoin futures on CME “does not appear to be a coincidence,” adding that the contracts “allowed pessimists to enter the market, which contributed to the reversal of the Bitcoin price dynamics.”
But given the unprecedented levels of liquidity flooding markets, near-zero interest rates, loose monetary policy and quantitative easing, the macroeconomic climate that CME Group's Ether futures are being released into, is also significantly different from back in 2017.
If nothing else, there is a higher probability of greater interest in bullish long Ether futures than the other side.
Whether that's the case or not though lies very much in the future, which is why investors buy them.
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Feb 04, 2021
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