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Novum Alpha - Daily Analysis 28 June 2021 (10-Minute Read)

Investors are chasing stocks to all-time-records but have one foot at the door just in case things don't pan out as planned.

 
A magnificent Monday to you as we're down to the mid-year and what a year it's been so far!  
 

In brief (TL:DR)

 
  • U.S. stocks ended last week mostly up with the blue-chip Dow Jones Industrial Average (+0.69%) and S&P 500 (+0.33%) in the green, and the tech-centric Nasdaq Composite (-0.06%) more or less flat as the reflation trade saw a resurgence. 
  • Asian stocks were steady Monday with investors weighing the pace of economic recovery against more potent Covid-19 strains and central banks mulling stimulus reductions.
  • Benchmark U.S. 10-year Treasuries spiked to 1.53% (yields rise when bond prices fall) as investors chased equities higher. 
  • The dollar edged higher.
  • Oil was steady with August 2021 contracts for WTI Crude Oil (Nymex) (-0.09%) at US$73.98.
  • Gold was flat with August 2021 contracts for Gold (Comex) (+0.04%) at US$1,778.50. 
  • Bitcoin (+3.91%) rose to US$34,440 as investors remained unfazed by the U.K. Financial Conduct Authority banning a Binance-owned entity from conducting regulated activity and as inflows continued to lead outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices). 
 

In today's issue...

 
  1. Not Profitable? No Problem, Just Sell Stock
  2. Tesla Trips Up in China
  3. U.K. Bans Cryptocurrency Exchange Binance
 

Market Overview

 
Investors are chasing stocks to all-time-records but have one foot at the door just in case things don't pan out as planned. 
 
Central banks continue to weigh the cutting of stimulus even as Covid-19 variants threaten to derail the nascent economic recovery. 
 
Whilst vaccinations have proceeded in earnest globally, early gains from vaccination exercises are now starting to meet with resistance from those who are not looking to get vaccinated under any circumstances, and this could prove challenging as the northern hemisphere heads into flu season. 
 
Asian markets got out the gates on Monday in mixed fashion with Tokyo's Nikkei 225 (-0.28%), Seoul's Kospi Index (-0.14%) and Sydney’s ASX 200 (-0.02%) all down slightly, while Hong Kong's Hang Seng (+1.40%) was up sharply as the Chinese Communist Party heads to celebrate its centenary. 
 

Did you miss us at the Super Crypto Conference 2021? Watch it here...

 

1. Not Profitable? No Problem, Just Sell Stock

 
  • Record number of unprofitable companies have had secondary stock sales successfully, raising more capital than profitable firms since 1982
  • While some investors are warning of bubble risks because of excess liquidity in markets, pandemic factors shouldn't be discounted and capital markets may provide embattled firms with solid business models a second lease of life post-pandemic 
 
Nothing quite divides opinion as much as where the market is now.
 
Michael Burry of “The Big Short” fame, who correctly called the subprime mortgage crisis, warns that investors should brace themselves for the worst crash in decades.
 
Yet his warnings may be falling on death ears as unprofitable firms, including GameStop (-1.32%) and AMC Entertainment (-4.66%), have raised more than double the amount of money that profitable companies have since the end of March, according to data compiled by Bloomberg.
 
But is the fact that unprofitable companies are raising money in and of itself an ominous sign of what is to come?
 
To be sure, troubled companies are simply doing the logical thing – tapping into insatiable investor appetite in a 16-month rally in stocks and using the opportunity to beef up their balance sheets.
 
If nothing else, the capital markets are functioning precisely how they were designed to.
 
Over the past 12 months, almost 750 money-losing firms have sold shares in the secondary market, exceeding those that make profits by the largest margin since 1982, according to data compiled by Sundial Capital Research.
 
The last time this happened was when the S&P 500 was either at the start of a bear market, or already in one.
 
In 2000, the dotcom bubble, thanks to loose credit conditions, lured money-hemorrhaging firms to sell stock and once supply overwhelmed demand, stocks with no fundamental support sold off in a crash that rippled across to the broader market.
 
But is this time different?
 
Yes and no.
 
Whilst the dotcom bubble was fueled by excessively loose monetary policy, it didn’t come off the back of a global pandemic, which shuttered the economy.
 
Today, many of the firms that are losing money, including theater operators like AMC Entertainment, saw their fortunes made worse because pandemic restrictions prohibited them from operating their businesses – there are few equivalents from the year 2000.
 
And with much of the business world yet to fully recover from the fallout of the pandemic, that corporate America finds it so easy to raise money via equity offerings bodes well for the U.S. economy.
 
With the boost in capital, many of these embattled firms may have a second lease of life and America is all about second chances.
 
So while it’s true that monetary and fiscal stimulus have created an unnatural set of circumstances, it’s also true that loss-making businesses which have sold stock to raise capital have an opportunity to do whatever it takes to become profitable again given the extraordinary circumstances. 
 
And perhaps that is the key.
 
For investors seeking to sieve the wheat from the chaff, it may be necessary not just to look at firms which have raised money in the capital markets just because, but to understand if their business models were only affected by the pandemic, or they are inherently flawed and propping themselves up with gratuitous share sales.
 
Ultimately, a good business running into bad times will still make it out the other side, but a bad business opportunistically looking to save a flawed business model is just throwing good money after bad.  
 

Did you miss us at the Super Crypto Conference 2021? Watch it here...

 

2. Tesla Trips Up in China

 
  • Tesla (-1.17%) faces challenges in China as regulators there have claimed safety issues which have forced recalls 
  • If Tesla is able to crack the Chinese market, it may be able to do what so many other U.S. companies have failed to, navigating complex geopolitics while attempting to churn a profit 
 
In China, it’s impossible to say for sure whether any move by authorities is motivated purely by economics or politics – often it’s both.
 
For the longest time, electric vehicle maker Tesla had been having a field day in the Middle Kingdom on the back of soaring demand for its electric vehicles.
 
While China had built the formidable Great Firewall of China to keep out U.S. tech giants like Google (+0.01%), Facebook (-0.53%) and Amazon (-1.38%), it has worked closely with Microsoft (-0.63%) and appeared to be embracing Tesla, despite itself nurturing its own organic electric vehicle industry.
 
But over the weekend, Tesla’s aspirations in China were dealt a major blow after the government ordered that almost all the cars it’s ever sold in the country, estimated at over 285,000, be fixed to address a safety issue.
 
In a statement, the Chinese State Administration for Market Regulation said that Tesla’s autopilot systems had the potential to be activated automatically, possibly leading to crashes from sudden acceleration.
 
Fortunately, in most cases, the fix should be able to be made remotely with an online update to Tesla’s active cruise control feature, which Tesla will provide as a free software upgrade.
 
Tesla investors can take some comfort from the fact that this will essentially serve as a “stress test” for Tesla’s business model when it comes to selling vehicles.
 
Whereas in the past, upgrades and recalls could cost an automaker millions of dollars, working with dealerships to facilitate swapping parts, because the issue is a software issue, the patch can be rolled out just like any other software update, remotely, and relatively cheaply.
 
Tesla has faced multiple setbacks as it’s expanded in China, including a spate of crashes and a protest at the Shanghai auto show which unfortunately went viral.
 
Like other tech giants, including Google and Amazon, Tesla is finding that the world’s second largest economy, while an enticing and lucrative market, is full of hazards.
 
And with geopolitical tensions between the U.S. and China set to rise, the odds of Tesla becoming collateral damage will rise as well. 
 
In March, Teslas were banned from some Chinese military complexes and housing compounds on concerns over its built-in cameras collecting and storing data, but Tesla immediately sought to reassure authorities that any data collected in China was stored locally.
 
Regardless, most investors are still bullish on Tesla, with Credit Suisse (+1.86%) saying in a note that its price target for US$800 for Tesla still remained, with the key downside risk being international demand and any issues with its brand new Model Y.
 
Tesla’s stock soared some 743% last year and is up about 5% since January.  
 

 

3. U.K. Bans Cryptocurrency Exchange Binance

 
  • U.K. Financial Conduct Authority bans regulated Binance Markets Ltd. from conducting any regulated activity in the United Kingdom 
  • FCA move is cynical especially given that the vast majority of U.K. residents trade with Binance.com and attempts by Binance to work within a regulatory framework will be discouraged given the recent ban of its FCA-regulated entity from even attempting to do business 
 
Where is Binance.com domiciled?
 
The answer may be a lot more complicated than you think.
 
While a website has a domicile insofar as it resides on a server in some geographical location, the domicile of its legal entity is another thing altogether.
 
Yet that lack of clarity as to where Binance.com lives has done little to stop it from becoming the world’s largest cryptocurrency exchange by trading volume.
 
Which is why the recent move by the United Kingdom’s Financial Conduct Authority to get Binance.com to declare that it does not conduct any regulated activities in the U.K. is so strange – the ban by the FCA strictly speaking only affects Binance Markets Ltd., a U.K. entity.
 
Acquired in May 2020 and yet to launch any business in the U.K., Binance Markets Ltd. has been banned by the FCA from conducing any regulated business in the country, one of the most significant moves against the cryptocurrency industry in the United Kingdom.
 
Binance Markets Ltd. however is a separate legal entity from Binance.com which is allegedly based in Malta, but has no corporate headquarters anywhere.
 
According to Binance and adding to the confusion, the FCA notice restricts, but does not remove previous permissions owned by Binance Markets Ltd.
 
The FCA move did little to roil cryptocurrency markets however, with Bitcoin gaining around 5% in Asian trading.
 
Cryptocurrency bulls have long seen tough regulatory action as a sign that the industry is maturing and see a more robust safety net as potentially drawing in more investors.
 
Binance Markets Ltd. is an FCA-regulated entity, acquired by Binance last June, along with plans for the launch of Binance.UK.
 
And a closer inspection of the FCA move to ban Binance Markets Ltd. from conducting any regulated activity may have more to do with the fact that the U.K. arm of Binance hasn’t yet complied with all of the regulatory requirements to start its operations.
 
Regulators globally remain concerned that cryptocurrencies are used for money laundering or other nefarious activities and according to an FCA spokesperson,
 
“A significantly high number of cryptoasset businesses are not meeting the required standards under the money laundering regulations, which has resulted in an unprecedented number of businesses withdrawing their applications.”
 
Of the firms assessed by the FCA for applications to conduct regulated activities, over 90% have since withdrawn their applications.
 
The FCA is hardly alone in its censure of Binance, with Japan’s Financial Services Agency issuing a warning against Binance recently, saying it offered cryptocurrency services without registration.
 
The recent move by regulators against Binance is somewhat cynical.
 
Binance has operated without permission for years now, right under the noses of financial watchdogs who have conducted enforcement activities piecemeal, without clear definitions for what constitutes cryptocurrencies, let alone what would qualify as a regulated activity.
 
And now that Binance and other cryptocurrency exchanges are attempting to work within the auspices of a regulatory framework, authorities like the U.K.’s FCA and Japan’s FSA may push Binance to go the other way.
 
For years, many stakeholders had lobbied lawmakers for clear legislation to govern the cryptocurrency industry and had been largely ignored.
 
Now that the industry has grown too big to ignore, instead of providing clear regulatory frameworks with which participants can work within, regulators are trying to adapt existing regulations to issue blanket bans on an industry that has almost never asked for permission.
 
Considering that the American laws against alcohol during Prohibition provided fertile ground for the birth of organized crime, trigger-happy regulators may do the same when it comes to cryptocurrencies. 
 
If authorities want to regulate cryptocurrencies, they would be better served by working with industry, instead of driving them to continue operating in the shadows. 
 

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Jun 28, 2021

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