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Novum Alpha - Weekend Edition 9-10 July 2021 (10-Minute Read)

Markets are on the mend in a broad-based rebound on Friday that saw stocks rising across the board, suggesting that any episodes of anxiety over where the global economy is headed, are precisely that, episodic instances of uncertainty. 

A wonderful weekend to you as stocks took a turn for the better on a broad-based rebound. 
 

In brief (TL:DR)

 
  • U.S. stocks reversed losses on Friday to bounce back sharply with the blue-chip Dow Jones Industrial Average (+1.30%), S&P 500 (+1.13%) and the tech-centric Nasdaq Composite (+0.98%) all higher as momentum was regained on the economic recovery narrative. 
  • Asian stocks continued to be weak on Friday following Thursday's gains in U.S. Treasuries and on China's central bank cutting the amount of cash commercial banks needed to hold, a sign that the Chinese economic recovery may be slowing down.
  • Benchmark U.S. 10-year Treasuries surged higher to 1.360% as investors bet on stocks and concerns over inflation waned (yields rise when bond prices fall).
  • The dollar slipped against a basket of major currencies. 
  • Oil was higher with August 2021 contracts for WTI Crude Oil (Nymex) (+2.22%) at US$74.56 as optimism over the economic recovery was met with reducing stockpiles in the U.S. and a failure to come to an agreement by OPEC+ on production. 
  • Gold was higher with August 2021 contracts for Gold (Comex) (+0.58%) at US$1,810.60. 
  • Bitcoin (+2.11%) was higher into the weekend, briefly testing US$34,000 before settling at around US$33,681 (Saturday, July 10 at 0600 GMT) as investors turned course on risk and started to bid up the benchmark cryptocurrency and with inflows still ahead of outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices). 

In today's issue...

 
  1. Stocks & Bonds Have No Cut & Dried Correlations 
  2. FAANG Trade Still Has Plenty of Teeth
  3. Could Binance be the Decentralized Company of the Future? 

 

 

Market Overview

 
Markets are on the mend in a broad-based rebound on Friday that saw stocks rising across the board, suggesting that any episodes of anxiety over where the global economy is headed, are precisely that, episodic instances of uncertainty. 
 
Analysts remain bullish on the general trajectory of the economy and while there are bound to be bumps along the way, expectations are high that the economy and by extension, stocks, will tend higher. 
 
Asia ex-China however remained in a somber mood as the Chinese central bank cut the amount of cash most banks had to hold in reserve, suggesting that things are not as rosy as the Chinese Communist Party would have investors believe. 
 
Sydney’s ASX 200 (-0.93%), Seoul's Kospi Index (-1.07%) and Tokyo's Nikkei 225 (-0.63%) all closed lower while Hong Kong's Hang Seng (+0.70%) benefited from the prospect of more Chinese money flowing into its market. 
 

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

 

 

 

1. Stocks & Bonds Have No Cut & Dried Correlations

 
  • Longer term, investors should be less concerned over correlation between stocks and bonds
  • Past year (short term) has seen stocks and bonds more positively correlated than at any time over the past two decades, undermining the value of Modern Portfolio Theory in asset allocation in short timeframes 
 
It’s an oft heard adage that “correlation does not imply causation,” but not everyone appreciates what that means.
 
Humans are wired to see patterns, which is why we do things we consider “lucky” before heading to the casino, and even Olympic athletes have rituals before heading out to compete.
 
Was Olympic gold a result of bringing along a stuffed bear from home?
 
Probably not, but it can’t hurt to have all the bases covered.
 
And nowhere is this more apparent than in the tricky business of investing.
 
Modern Portfolio Theory ("MPT") has contributed in no small part to why so many retirement portfolios today look the same.
 
Because MPT assumes that investors are risk averse, if offered two portfolios with the same expected return, investors will prefer the less risky one, and thus only take on increased risk if compensated with higher expected returns.
 
And that’s why to “balance” portfolios, many investors have maintained a mix of both stocks and bonds to act as ballast to each other over the last two decades.
 
Yet the negative correlation (in other words moving opposite to each other) between stocks and bonds has been under pressure for almost a year now and some are suggesting that the era of the stock and bond balancing act may finally be over.
 
Or is it?
 
When analysts discuss correlation, negative or otherwise, they are really looking at shorter periods.
 
Over longer periods, it makes senses that stock and bond returns are positively correlated – they’re ultimately competing investments and each generates a stream of income – dividends (hopefully) for stocks and coupon payments for bonds.
 
If stocks start to get pricey, investors move out into bonds as a cheaper alternative until that rebalancing makes bonds more or less equally expensive.
 
To be fair, economic conditions are the biggest determinant of whether stocks and bonds do move in the same direction – inflation for instance may be worse for bonds than it is for stocks.
 
But because inflation has been a nonissue for the past two decades or so, investors have paid more attention to economic growth.
 
Strong growth does wonders for stocks, but nothing for bonds and that’s why stocks and bonds move in different directions depending on these expectations.
 
So should investors concentrate their bets?
 
The reality is that unless you’re an active investor who has their finger on the pulse of the market, a diversified portfolio is probably still your safest bet.
 
Let’s face it, most of us just don’t have the time to be scanning charts and reading the news (especially when there seems to be a flood of it these days) 24/7, not especially if we have day jobs.
 
Nobel laureate William Sharpe’s capital asset pricing model says that for the average investor, it’s a good idea to spread your money between stocks and bonds even if they don’t necessarily hedge each other.
 
Ultimately, Sharpe’s recommended portfolio will deliver average returns, but that’s precisely what it’s promising.
 
And as for correlation? If you’re invested for the long term, it’s probably not worth losing sleep over. 
 

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

 

 

 

2. FAANG Trade Still Has Plenty of Teeth

 
  • FAANG stocks are proving resilient as the global economy shifts to different markers of value
  • Value investors should take a leaf out of Warren Buffett's own investing handbook and fill their portfolios with the companies whose products they actually use  
 
You wake up to login to your Google (+0.38%) Mail account on Apple’s (+1.31%) Macbook Pro and then complete a spreadsheet on Microsoft’s (+0.19%) Excel.
 
In the evening you watch Netflix (+0.98%) to unwind but not before keying up your Amazon (-0.32%) orders for tomorrow’s groceries and essentials.  
 
So why would your investment portfolio be filled with industrial, financial and energy companies?
 
If even legendary value investor Warren Buffett expounds the value of investing in companies that you’re already a customer of, it’d be somewhat ironic to have a Tesla (+0.63%) in the driveway and Zoom (-0.24%) on your desktop, while holding the shares of Haliburton (+3.56%) and Boeing (+1.19%).
 
And while the rally that lifted financial and energy companies made headlines and offered brief respite for value investors, the so-called reflation trade has barely registered a dent in the so called FAANG universe – Facebook (+1.38%), Amazon, Apple, Netflix and Google.
 
With U.S. Treasury yields plummeting this week on concerns over the economic recovery, the short-lived reflation trade is all but dead.
 
But it’s not all rainbows and unicorns in the tech space either.
 
On Friday, the Biden administration unveiled a wide-ranging executive order that would seek to reduce the concentration of big, dominant firms in certain sectors, one of which is technology.
 
But Biden’s lieutenants who are looking to bust up big tech may have their work cut out for them.
 
Last month, a federal judge dismissed an avalanche of antitrust litigation against Facebook in 46 states without it ever going to trial, and revealing just how far behind legislation is in reigning in technology companies with novel business models.
 
In many ways, American tech firms are like hydras, making it difficult to cut off their multiple heads.
 
A global minimum tax may go some way for governments looking to at least cash in on some of the tech giants’ success, but breaking them up, as enforcement agencies are realizing, may be far harder to do. 
 
For investors though, the bigger question is what threats lie ahead for tech firms, but whether the companies they've stocked their portfolios with are the ones that they care most about to use on a daily basis. 
 

 

3. Could Binance be the Decentralized Company of the Future?

 
  • Regulators may be better off working with Binance instead of against it  
  • Binance has proved that it can operate effectively everywhere while being regulated nowhere, and its openness to working with authorities should be seen in a positive light instead of being dealt with harshly and arbitrarily 
 
Global regulators are finding themselves in a bind – they’re trying their best to close in on the world’s largest cryptocurrency exchange by volume Binance, and finding that they aren’t having any real impact on its activities.
 
Earlier this month, the United Kingdom’s Financial Conduct Authority moved against Binance’s U.K. branch, Binance Markets Limited, to prevent it from conducting any regulated activity, but Binance.com, where most of the action takes place operated as per normal.
 
Binance is one of those companies which can effectively exist off the grid.
 
It pays its employees in BNB, a cryptocurrency of its own creation and its headquarters is wherever its founder Changpeng Zhao or “CZ” as he prefers to be known, happens to be (increasingly Singapore), meaning that it doesn't have a pressing need for banking services or an office to house employees who've almost always worked remotely. 
 
Binance’s history reads like the experience of every other cryptocurrency company trying to get a bank account.
 
Founded in China, it was forced to flee to Japan before being exiled to Malta, Binance as a legal entity finally uploaded itself into the cloud. 
 
Binance Holdings Ltd. which supposedly manages Binance.com is alleged to be domiciled in the Cayman Islands, but officially the Cayman Islands authorities claim they do not supervise it nor authorize its activities.
 
But a global regulatory crackdown on Binance is counterintuitive because it will force CZ’s hand to do what he and Binance have been good at all this while – minimizing government oversight while existing everywhere.
 
From the U.K.’s FCA, to the U.S. Justice Department and Internal Revenue Service, Thailand and Japan are the latest to join a growing list of authorities worldwide that are trying to tighten the dragnet around Binance.
 
Yet for its part, Binance has tried to work with regulators.
 
In Singapore, Binance Asia Services Pte. Ltd. is in line to apply for a Payment Services License, issued by the Monetary Authority of Singapore to run a digital token exchange.
 
Before the U.K. FCA’s most recent action, Binance Markets Limited was regulated and overseen by the FCA.
 
CZ himself has repeatedly come on media outlets to reinforce that Binance is committed to following the rules and strives to partner government agencies in routing out misconduct.
 
But does Binance really mean it?
 
Regulatory agencies are well advised to assume that it does and should take Binance up on the offer instead of trying to beat it back into the wilderness.
 
A cross between a hydra and an eel, last year a U.S. federal judge dismissed a lawsuit filed by a disgruntled Binance contractor in Portland, Oregon, on the basis that it lacked locus standi to adjudicate the case because Binance had neither offices nor managers there.
 
To make matters worse, Binance has plenty of cash and isn’t afraid to spend it the American way – on lawyers and lobbyists.
 
Binance is being advised by former Democratic Senator for Montana, Max Baucus as its policy adviser and government liaison and it has hoovered up previous administration officials for their clout, network and influence. 
 
Former Obama administration official Roberto Gonzalez serves as Binance’s lawyer of record, and Binance.us, the American arm of the cryptocurrency exchange, just hired Brian Brooks as its CEO, the Trump administration’s Acting Comptroller of the Currency.
 
Presumably these Binance hires are being paid in dollars, but you never know.
 
In a blog post last week, CZ conceded that Binance hadn’t “always got everything right, but (we) are learning and improving every day.”
 
Significantly, the founder of the world’s busiest cryptocurrency exchange actually welcomes more regulation so that people can feel more safe participating in the market.
 
Consider that in 2019, when cryptocurrency prices were far below where they are today, Binance was hacked for around US$40 million worth of cryptocurrency at the time, and made good on the losses for its users, no questions asked.
 
Binance could have just said “too bad” to its users and moved on, but it didn't. 
 
Instead, Binance was not only incredibly forthcoming about the hack, detailing its impact, it also said it would cover the entire incident “in full” and no user funds would be affected.
 
No courts needed to step in, there was no lengthy litigation and Binance didn’t rely on any of the myriad disclaimers that are embedded in almost every user agreement for software anywhere in the world.
 
Cryptocurrencies were stolen on their watch and Binance users were made whole, plain and simple - it’s hard to say if a regulated financial institution would do the same or deny responsibility while hiding behind a wall of lawyers and exception clauses. 
 
If regulation is about consumer protection, then arguably, Binance has already passed the smell test, but perhaps that’s not foremost on the minds of enforcement agencies. 
 

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Jul 10, 2021

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