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Novum Alpha - Daily Analysis 5 March 2021 (10-Minute Read)

It's official then, the U.S. Federal Reserve has bigger fish to fry than to worry about the borrowing costs of the U.S. government.

 
And a fabulous Friday to you as the markets flail fecklessly while the Fed sits back and watches.  
 

In brief (TL:DR)

 
  • U.S. stocks chased Wednesday's wounds with a terrible Thursday and the S&P 500 (-1.34%), blue-chip Dow Jones Industrial Average (-1.11%) and tech-centric Nasdaq Composite (-2.11%) were all lower as U.S. Treasury yields continued to soar.  
  • Asian stocks followed U.S. peers lower after U.S. Federal Reserve Chairman Jerome Powell refrained from pushing back against the recent surge in bond yields.  
  • The benchmark U.S. 10-year Treasury yield rose to 1.560%.
  • The dollar strengthened against nearly all major peers. 
  • Oil rose with April 2021 contracts for WTI Crude Oil (Nymex) (+0.55%) at US$64.18 as investors became bullish on the economic recovery narrative. 
  • Gold dropped with April 2021 contracts for Gold (Comex) (-0.69%) at US$1,689.00 falling below US$1,800 as demand for safe havens waned. 
  • Bitcoin (-8.39%) fell to US$46,711 at its lowest in 24 hours before recovering to around US$47,000 as investors even as the benchmark cryptocurrency rallied momentarily to US$51,000 before pulling back sharply. Inflows to exchanges pushed ahead of outflows (inflows suggest that traders are looking to sell Bitcoin in anticipation of lower prices). 

In today's issue...

 
  1. From Lavishing Banquets to Burning Stock Funds - Kweichow Moutai 
  2. Fed Folds Its Arms Leaving Investors Feckless
  3. Million Dollar Bitcoin? 

Market Overview

 
It's official then, the U.S. Federal Reserve has bigger fish to fry than to worry about the borrowing costs of the U.S. government. 
 
A poker-faced U.S. Federal Reserve Chairman Jerome Powell barely gave the turmoil in bond markets a mention while speaking with the press, and disappointed many investors who were hoping that the Fed would ratchet up bond purchases to push yields down. 
 
Understandably, tech stocks, which are the most sensitive to Treasury yields suffered, providing investors with buying opportunities or marking the end of the rally in tech, depending on who you asked. 
 
Asian markets slumped on Friday morning, in line with U.S. stock futures and with the carnage in the bond markets showing no signs of abating, with Tokyo's Nikkei 225 (-1.68%), Sydney’s ASX 200 (-1.12%), Hong Kong's Hang Seng Index (-1.48%) and Seoul's Kospi Index (-1.48%) all down in the morning trading session. 
 
 
1. From Lavishing Banquets to Burning Stock Funds - Kweichow Moutai
 
  • Kweichow Moutai (+1.41%) has become to Chinese stocks what U.S. tech giants have become to the S&P 500 and the correction has been painful for many stock funds
  • Algorithmic trading which saw the bulk of Chinese fund flows pour into the sorghum-based liquor maker has now left investors nursing substantial losses as Beijing tries to reign in red hot asset markets at risk of bubbling over 
 
At a punchy 53% proof, the sorghum-based Kweichow Moutai was the spirit of choice for corrupt Chinese officials and the businessmen who were trying to court their favor.
 
But when Chinese President Xi Jinping came to power, the habit of gifting Communist Party officials with the revered Kweichow Moutai took a backseat, as thousands of Communist Party cadres were purged in an anti-corruption campaign.
 
Suddenly the fiery-clear liquor that could probably fuel rockets, fell out of favor amongst the Chinese elite, worried that such gifts would be misinterpreted and as lavish banquets, once the mainstay of Communist Party officials, started going underground, or went unorganized altogether.
 
Kweichow Moutai has since recovered, as a new generation of Chinese took to enjoying the spirit of their ancestors and up till three weeks ago, the surest way to make a quick buck was to buy stocks in the Middle Kingdom’s beloved tipple.
 
China’s US$3 trillion mutual fund industry was minting money buying into Kweichow Moutai and attracting bumper inflows of funds.
 
Stock of the firewater maker soared by almost a third year-to-date till February, after gaining an eye-watering 70% last year, and doubling the year before that.
 
Kweichow Moutai’s stock was getting as high as its customers, and many Chinese funds, flush with liquidity didn’t have much choice other than to keep buying stocks, to keep existing clients and attract new ones – buying Kweichow Moutai was the easiest way to do it.
 
But the hangover has been tough – with Kweichow Moutai tumbling after the Lunar New Year break in a fall that shows no signs of abating.
 
Now down some 22% from its peak, it fell by as much as 6% yesterday, shaving off some US$111 billion off its market cap.
 
Although China’s onshore market has over 4,000 different stocks, Kweichow Moutai is by far the most significant, with a market cap nearing US$400 billion.
 
And Kweichow Moutai’s crash hasn’t just affected Chinese funds and investors, it’s dragged the FTSE China A50 Index of China’s largest firms down by some 27% since the middle of February.
 
To be sure, as Chinese were knocking back clarets of Kweichow Moutai, some were also warning that the firm’s heady valuation might lead to a hangover the morning after.
 
And according to a gauge tracking consumer staples in China including liquor makers, Kweichow Moutai traded at a record 36 times projected one-year forward earnings last month – astounding for a firm that is more a piece of history than making it. 
 
But Kweichow Moutai has fended off bigger challenges before – in 2017, Chinese state-owned media Xinhua News Agency openly declared that shares of the moonshine maker were rising too fast, triggering a sharp selloff in the stock.
 
And even further back in 2013, Kweichow Moutai stock plummeted after Chinese President Xi Jinping came to power on a promise to clamp down on lavish spending by party cadres.
 
This time round Beijing is concerned about excessive frothiness in its markets, and China’s top banking regulator jolted markets with a warning about the need to reduce leverage as bubble risks started rising globally.
 
With Kweichow Moutai being the best-known proxy for liquidity-fueled bets and momentum trades among Chinese fund managers, investors will need to get their highs elsewhere, because the hangover could be very painful otherwise. 
 
 
2. Fed Folds Its Arms Leaving Investors Feckless
 
  • Anticipated intervention by the U.S. Federal Reserve to reign in soaring Treasury yields fails to materialize, with investors dumping pricey tech stocks 
  • Fed cannot be seen to be acting (even if verbally) in a knee-jerk manner to shifts in U.S. Treasury yields, otherwise it could be interpreted as working at the behest of the market, but nonetheless will intervene if borrowing costs for the U.S. government become excessive 
 
Oops, turns out that the markets have a fickle friend in the Fed.
 
As investors sat on the sidelines prior to U.S. Federal Reserve Chairman Jerome Powell weighing in on the selloff in U.S. Treasuries, disappointment was on the face of market bulls as Powell recommitted the central bank to an economic recovery whose pace was picking up, without offering more aggressive asset purchases to reign in Treasury yields. 
 
A theory hatched last summer that the only thing stopping the megacap tech rally would be a recovering economy is appearing increasingly prescient.
 
Economic optimism is pushing up U.S. Treasury yields, creating competition for dollars that puts stress on share valuations that have soared to bubble-era levels.
 
As the yield on U.S. 10-year Treasuries surged past 1.5% again yesterday, Powell did little to suggest that he’s in any way flustered by the runup in bond yields, let alone what that means for stocks.
 
And as more Americans get vaccinated, investors have been left scratching their heads to determine how to price online companies, whose business models have flourished when the world couldn’t come out.
 
Could the post-pandemic era result in a flurry in travel and physical retail from populations deprived of social contact for so long, or could some of the changes in consumer behavior because of the pandemic end up being durable?
 
For months, investors have had little choice but to bet on the likes of Apple (-1.58%) and Amazon (-0.91%) – the only shows in town when it came to earnings growth – but now it’s possible to punt on airlines, cruise operators and retail chains as well.
 
The other issue of course is that tech has become overweight relative to the rest of the market.
 
At 27% of the S&P 500, tech firms are double the next biggest industry component of the benchmark index.
 
Analysts have been warning for months that growth and tech stocks had gotten ahead of themselves – whether it was the economy recovering, or a return to normalcy – investors were paying a premium because they had no choice, but now they do.
 
But while the Fed may be nonplussed about tech stocks or the markets in general, they will want to ensure that the U.S. government is still able to access credit at a reasonable price.
 
And while Treasury yields have spiked in recent days, they have also showed reasonable restraint, pushing boundaries to test the Fed’s resolve.
 
Should yields continue to gallop higher, the Fed will at some point have to intervene, whether verbally or through ratcheting up asset purchases – especially given that the Biden administration looks likely to pass its US$1.9 trillion fiscal stimulus package.
 
For the plucky investor, this may be an opportunity load up on some of the stocks whose prices may have run ahead of their prospects.
 
Because while the figures on the coronavirus are improving, a return to the free-wheeling days before the pandemic may still be some ways away. 
 
 
3. Million Dollar Bitcoin?
 
  • U.S. cryptocurrency exchange Kraken CEO Jesse Powell tells Bloomberg Television that Bitcoin could hit US$1 million or higher
  • Investors being taken in by such high price predictions should look at what the lower bound on losses could be instead of focusing on unlimited upper bounds, otherwise they risk losing substantial amounts of money 
 
Could Bitcoin hit a million dollars? Maybe even more, if cryptocurrency exchange Kraken’s CEO Jesse Powell is to be believed.
 
Powell (not the Chairman of the U.S. Federal Reserve although the coincidence is uncanny) is bound to be bullish for Bitcoin – the fortunes of the business he leads are inexorably tied to the rise and fall of the world’s favorite cryptocurrency.
 
Cryptocurrency exchange Kraken makes money off transaction fees, and a soaring Bitcoin price bodes well for that business. 
 
But Powell is not just a Bitcoin maximalist, he’s projecting a disruptive future for digital assets that would stretch the imagination of even the most ardent cryptocurrency fanatics.
 
Speaking to reporter Emily Chang in a Bloomberg Television interview, Powell noted,
 
“We can only speculate, but when you measure it in terms of dollars, you have to think it’s going to infinity.”
 
“The true believers will tell you that it’s going all the way to the moon, to Mars and eventually, will be the world’s currency.”
 
It figures that Powell would speak in hyperbolic terms, especially as he let slip that Kraken is looking to go public as soon as next year, hot on the heels of the largest U.S. cryptocurrency exchange Coinbase’s listing this year.
 
But extreme predictions are nothing new in the Bitcoin world – in fact they help to drum up media attention to the speaker’s pulpit – how many can still remember Fundstrat’s Charlie Lee being mocked for his prediction that Bitcoin would hit US$25,000?
 
It wasn’t that Lee got Bitcoin’s price prediction wrong – it’s just that the timing was off.
 
Lee was roundly ridiculed after that, and he committed to making no further price calls, but had investors listened to him, they’d have more than quintupled their money since that time.
 
Powell on the other hand sees Bitcoin one day exceeding the combined market cap of the dollar, euro and other fiat-based currencies, which can’t help but make one wonder what he’s smoking and whether we can score some of that action as well.
 
The truth is that price predictions are precisely that – predictions.
 
And as we all well know, predictions can always be wrong.
 
The predictor can turn around and say, “sorry I was wrong,” if they even acknowledge they made a mistake (very few do).
 
As an unconstrained nascent asset class, it’s not incorrect to say that Bitcoin has no upper bound – it is worth as much as someone else will pay you for it.
 
As investors though, such ideological debates are of limited value – what’s more worth knowing is whether or not there is a minimum amount of dollars that someone will hand over for Bitcoin – in other words, is there a price floor?
 
Knowing there’s no ceiling just helps to lure in more speculation – knowing there’s a floor suggests there are fundamentals – and for now at least, there seems to be some evidence to suggest that there is one.
 
Given the increasing number of institutional investors getting into the Bitcoin game, there will be some segment of the investing market, particularly those who have been sitting on the sidelines when it came to crypto, who will come in when the price is low enough – driven by the measurably capped downside.
 
What that precise price for Bitcoin is however is far more difficult to say – the only thing that can be said with any degree of certainty is that that figure is a non-zero number.
 
But that already says a lot.
 
For a nascent asset class that has been derided as a fraud and “rat poison squared” that the price floor for Bitcoin is non-zero should be more than enough grounds for celebration by Bitcoin maximalists.
 
Whether Bitcoin could be worth US$1 million one day on the other hand is far more speculative – and the problem with speculation is that it’s driven by greed, not fundamentals. 
 

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Mar 05, 2021

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