Novum Alpha - Daily Analysis 18 June 2021 (10-Minute Read)
Now that inflation is no longer a primary concern (the Fed has shown that it is willing to blink first on rates), the prospect of higher inflation eating away at the valuation of high flying tech stocks is in the rearview mirror.
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A fabulous Friday to you as the market returns to the familiar trading themes of the pandemic.
In brief (TL:DR)
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In today's issue...
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Market OverviewIs the reflation trade dead?
Now that inflation is no longer a primary concern (the Fed has shown that it is willing to blink first on rates), the prospect of higher inflation eating away at the valuation of high flying tech stocks is in the rearview mirror.
The tech trade isn't just periodic, it's reflective of a durable trend in bets on the future of the global economy, one that is dominated by digital doyens rather than cyclical stocks still stuck in 20th century industries.
Asian markets opened higher on Friday with Tokyo's Nikkei 225 (+0.31%), Hong Kong's Hang Seng (+0.48%), Sydney’s ASX 200 (+0.31%) and Seoul's Kospi Index (+0.08%), all up on the back of a rise in U.S. tech stocks and long-dated Treasuries.
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1. Re-Normalization of Markets Begins at Glacial Pace
“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”
– Winson Churchill, November 1942, after the Second Battle of El Alamein
To be fair, the U.S. Federal Reserve hasn’t tapered its US$120 billion monthly asset purchases and it hasn’t raised interest rates.
What the Fed has done though is started to pare down its holdings of bond ETFs, but the amount it held was so small as to not even cause a ripple in those markets.
But as any investor knows, trading and investment activity is based more on expectation and less on present objectively observed reality.
And while the Fed has been posturing for months that it will eventually look to end its pandemic-induced, ultra-loose monetary regime, the coronavirus was still lurking, the recovery too fragile and the uncertainty to prevalent.
But at the end of a Fed policy meeting on Wednesday, policymakers at the U.S. central bank started to provide a timetable for when the end of support would come, laying the ground for a return to some semblance of normal.
Not only did the Fed openly begin talking about eventually reducing the pace of its asset purchase program, economic projections of policymakers revealed that they now expect two 25 basis point interest rate hikes before the end of 2023, a year ahead of last month’s forecast.
Whether it was the 5% uptick in the Consumer Price Index last month, the fastest rate prices have risen since 2008, or evidence that the U.S. economy is recovering faster than expected that hastened an end to the Fed’s dovish stance is less clear.
What is perhaps more relevant is that the Fed is beginning the transition phase from really loose monetary policy to somewhat “less loose” whatever that means.
Bear in mind though, these are just forecasts and a lot can change in a Washington minute.
Retail sales have started to slow and employment data, while improving, is still well short of the full employment that the Fed is looking for, as a sign that the U.S. economy is well and truly out of the woods.
Alarmingly, the Fed appears to have flinched on its new monetary policy if not in action, then certainly in terms of psychology.
For months, the Fed has said that it was prepared to accept higher levels of inflation to make up for periods of lower inflation, and suggested that the last two months of elevated inflation were more a function of coming from a lower base because of the pandemic than any sustained price increase.
That expectation has been reflected in the Fed’s forecast for inflation, 3% for this year, but 2.1% for the next year – and that suggests that the Fed is reacting more from a concern of its intervention distorting markets indefinitely.
So the Fed didn't blink, sort of.
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2. The Pandemic Trade Part Deux
Given that the U.S. and large parts of Europe are reopening, the reflation trade that had marked most of 2021 would widely have been expected to continue, with more economically-sensitive stocks taking center stage.
Instead, the U.S. Federal Reserve’s shift towards a more hawkish stance longer term has seen tech companies and longer-dated bonds rallying hard.
But wait, isn’t that the pandemic trade?
During the height of pandemic panic, cash-creating tech giants and long-dated U.S. Treasuries soared, with yields on long-dated U.S. government debt falling and tech firms garnering eye-watering valuations.
Tech however had been on the decline this year, as many investors took the view that a reopening economy would favor cyclical stocks.
Instead, because the Fed appears to be taking a more proactive stance on inflation, cash-spewing tech giants like Apple (+1.26%), Nvidia (+4.76%) and Microsoft (+1.37%) helped to push the Nasdaq 100 (+1.29%) to a record high.
Commodity prices have also slipped after the Fed revealed that it was prepared to slow stimulus.
When inflation increases, purchasing power declines so each dollar can buy fewer goods and services.
Using a discounted cashflow method to value growth stocks, which have little to no cash flow today but are expected to generate future cashflows, typically don't fare well when inflation expectations are high.
Which is why when interest rates are expected to rise to combat inflation, growth stocks can be expected to be negatively impacted.
So why are tech stocks, which some investors classify as growth stocks doing so well?
Because a close examination of these clutch of tech companies that are doing really well aren’t really “growth stocks” in the traditional sense.
Just because tech is a “growth” sector doesn’t meant that all tech stocks are growth stocks.
Many of the storied names that rallied in the wake of the Fed’s apparently more hawkish stance, albeit in the future, are tech institutions which generate a lot of cash NOW.
As the U.S. reopens, businesses will advertise more, and where will those advertising dollars go?
To platform companies like Google (+0.80%) and Facebook (+1.64%) which capture our attention more than anywhere else.
Money is being put back into growth, but at a reasonable price and for cash-generating names.
U.S. Federal Reserve Chairman Jerome Powell downplayed the risk of any immediate rate hikes, but his comments can be seen as prepping the market for an inevitable and eventual hawkish tilt and tapering.
The rotating back into tech stocks then should be seen not so much as a pandemic-led trade, but part of a durable trend where the winners in the next epoch are digital platforms like the railroads and energy companies of the 20th century.
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3. Do we really need another Cryptocurrency Exchange IPO?
Investors in Coinbase Global’s (+1.14%) direct listing can’t be a happy lot.
Expectations were high that when America’s largest cryptocurrency exchange was listed on Nasdaq, it would usher in a golden age for digital assets.
If so, it’s hard to tell, with Bitcoin down some 40% from its all-time-high in the wake of Coinbase’s listing.
As one of a handful of cryptocurrency exchanges that are regulated, Coinbase which had an indicative direct listing price of US$250 (not to be confused with an IPO price, a listing price is just a guide to allow the market to have some form of reference), shares in the company rallied to US$342 at the open before continually plummeting.
But that’s the story for most listings isn’t it?
Because Coinbase wasn’t an IPO, it didn’t have the benefit of an underwriter or investor roadshows to help drum up investor interest or educate potential buyers about the company.
Nor did it have the support of bookmakers prepared to snap up the shares of Coinbase to keep its price up.
And IPOs are typically “underpriced” by investment banks to allow other clients a chance to benefit from an early IPO “pop.”
Coinbase didn’t have the benefit of all of that yet saw its shares rally out the gates, issuing no new shares and selling existing stock in the company.
Sure the Coinbase stocks is under water based on its last traded price in the secondary markets (OTC) of US$350, but without the crutch of an (expensive) IPO team, it hasn’t been a total washout.
So could Kraken do better?
It certainly is hoping to do so as Jesse Powell, who founded the San Francisco-based cryptocurrency exchange in 2011, told Bloomberg TV that the firm is doing “all the prep work” to become a public company, without going into specifics about a target valuation.
According to Bloomberg, Kraken was recently in talks to raise a new funding round that would value the firm at US$10 billion with an IPO potentially seeing it reach a market cap of US$20 billion, more than automaker Nissan (-2.22%) and the Royal Bank of Scotland (+0.15%).
Kraken has over 6 million customers in almost 190 countries, making it the world’s fourth largest cryptocurrency exchange by trading volume, according to data from coinmarketcap.com.
Powell has said that Kraken could IPO in the next 12 to 18 months, an eternity in the digital asset space.
But the move also portends a period when it’s make or break for institutional participation and to that end, it appears that Wall Street has leaned towards playing the cryptocurrency game.
Pressure to regulate the digital asset sphere has been mounting and the Biden administration is already on course to make progress in this area, with regulators from the various financial oversight agencies meeting to determine issues of jurisdiction and enforcement.
Kraken’s IPO could therefore be timely, especially as investors become more familiar and aware of the nascent digital asset class.
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Jun 18, 2021