Novum Alpha - Daily Analysis 12 July 2021 (10-Minute Read)
A magnificent Monday to you as investors are back in force in the markets and as reporting season gets underway.
In brief (TL:DR)
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In today's issue...
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Market OverviewMarkets are shrugging off not just the prospect that growth may be slowing, but the confidence that even if there are signs the economic recovery may not be as robust as anticipated, governments and central banks will be able to stimulate a bounce-back.
Shares ended noticeably higher in the U.S. last week and Asian trading was brisk on Monday's morning trading session.
With the U.S. earnings season getting underway and expectations high that profits will be robust, even concerns over coronavirus variants and potentially slower Chinese growth has not managed to dampen sentiment.
In Asia, stocks were higher in Monday's morning trading session with Sydney’s ASX 200 (+0.77%), Seoul's Kospi Index (+0.72%), Tokyo's Nikkei 225 (+2.12%) and Hong Kong's Hang Seng (+0.92%) all up despite concerns over coronavirus variants and slowing Chinese growth.
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1. China's Pandemic Recovery is Fading and What That Means for The World
Central banks may want to keep their hands on the liquidity taps, ready to turn them back on at a moment’s notice and governments may want to prepare for another round of stimulus because just like long-Covid, the economic fallout from the pandemic may also be long drawn.
In signs that China’s economic recovery post-pandemic may not be as robust or as resilient as hoped for, the People’s Bank of China (“PBoC”), the Chinese central bank, slashed the amount of cash most banks must hold in reserve last Friday, in order to boost lending.
The move by the PBoC came as a surprise especially as Beijing appears to be allowing even larger state-owned giants to default on their debt, and after moving towards tightening credit conditions just before last Friday’s announcement.
Data last Thursday suggests that China is expected to grow just 8% in the second quarter, from a record gain of 18.3% in the first quarter, according to a Bloomberg poll of economists.
Retail sales, industrial production and fixed asset investment growth are all expected to moderate as well.
To be sure, the Chinese economy, which was perhaps one of the first few to start emerging from the pandemic, was always expected to moderate its recovery after its initial rebound, but now economists are concerned that it has happened earlier than expected and could affect the rest of the world.
But the mystery remains as to why retail sales in China have also slowed.
Some have suggested that Chinese consumers remain wary about sporadic resurgences of the coronavirus, dampening the expected “revenge spending” when lockdown measures were lifted, but that in an of itself can’t explain the tapering of consumer demand.
Another possibility is that the pandemic itself, especially its pervasiveness and its serving as a reminder of mortality may have led to a perceptible shift in Chinese consumer priorities and choices.
Whereas before the pandemic, where the threat of sudden death was remote, Chinese may have focused primarily on the acquisition of material goods and comfort.
The Chinese, who have suffered numerous hardships throughout their history, have had a tendency to save far more than other nationalities and given that the pandemic, its economic consequences and job losses are fresh on their minds, may have reverted to tried-and-tested prudence.
Now that human mortality has been brought back into sharp focus, Chinese may be spending more on experiences and time with family, instead of cars and other durable goods, shifts that could prove to be persistent.
In that vein, the strict restrictions on travel between regions and cities in China may have prevented the manifestation of that wanderlust, and demand for services, hospitality and recreation may increase once China fully opens up.
But durable goods sales and Chinese consumer consumption may take awhile before recovering in the long term – introspection, fortunately tends not to be a persistent human trait.
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2. U.S Stocks May Not Be "Expensive" Much Longer
"Price is what you pay. Value is what you get."
– Warren Buffett
Investors lamenting the eye-watering valuations that U.S. equities are commanding at the moment could derive comfort from the fact that companies may soon deliver on the promises that their prices seem to indicate.
With shares on the S&P 500 trading at some 22 times forward earnings, bubble-callers say that stocks have not been this expensive since before the dotcom bubble burst in 2001.
But bearing in mind that shares are coming off a very low pandemic-induced base and outside a handful of dominant tech firms, most companies haven’t generated any profits over the past year, the opportunity for stocks to live up to their expectations was always present.
Reality is now meeting expectations as big U.S. companies are largely anticipated to reveal mammoth rebounds in profits as the second-quarter earnings season gets underway.
According to data from FactSet, S&P 500 firms are expected to post a 63% year-on-year earnings-per-share growth for the second quarter of 2021, a staggering 52.5% increase over the previous quarter and the largest increase since the 2008 Financial Crisis.
While the reflation trade took a hit last week, banks like JPMorgan Chase (+3.20%), Bank of America (+3.25%) and Citigroup (+2.58%), which have rallied some 16% since the start of the year, will be reporting this week, could see them rebound slightly.
Industrials, financials and energy, the more economically-exposed sectors on the S&P 500, are all expected to have done well in the second quarter as the U.S. reopened in earnest.
But investors expecting a sharp uptick for prices in the wake of earnings may need to manage such expectations especially because they may have already been priced in.
While the S&P 500 has rallied to a historic peak, key measures of valuation have mostly remained stable.
Data from FactSet revealed that companies on the S&P 500 are currently trading at 21.6 times expected forward year earnings, versus 22.16 last December.
And if past earnings seasons are anything to go by, equities could even see a sharp correction.
In the first quarter of 2021, tech tumbled despite reporting massive profits, on expectations that the bulk of growth for tech was behind it, with the U.S. economy reopening.
The reverse could happen this time.
With signs that the Chinese economy is cooling, economically-exposed sectors could see a hit despite reporting superb earnings, while tech, which has remained resilient throughout every quarter, could see a boost on concerns that the worst of the pandemic, especially with new, more virulent variants, lingers as an ongoing threat to the recovery.
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3. Achtung! German Institutional Investors Get a Taste for Cryptocurrencies
Even as regulators around the world crack down on cryptocurrency exchange Binance, German institutional investors may soon be able to get a taste of the burgeoning digital asset space.
BaFin, the German financial watchdog has rolled out new rules which will enable German funds targeted at institutional investors to allocate as much as a fifth of their assets to cryptocurrencies, but managers are expected to take a cautious approach at the offset.
The new rules, enacted at the start of July, come as German regulators try to balance concerns over what have been described as “highly risky and speculative” cryptocurrencies with the desire to encourage innovation in new technologies that could have a significant effect on financial services.
But given the size of assets held by Spezialfonds, German funds open only to institutional investors and not retail, even a small allocation could have a sizeable impact on the cryptocurrency markets.
According to data from BVI, a trade association representing German asset managers, Spezialfonds held some US$2.38 trillion in assets at the end of the first quarter of 2021.
For reference, the total market cap of all cryptocurrencies was estimated at just US$1.4 trillion, based on data from CoinMarketCap.com, a cryptocurrency data website.
But even though Spezialfonds are not accessible by Europe’s retail investors, they’re not completely locked out of participating in cryptocurrencies because there is a large selection of exchange-traded products or ETPs listed on Switzerland’s stock exchange SIX that have cryptocurrencies as their underlying assets.
The most prolific issuer of digital asset ETPs on SIX has been 21Shares, which has partnered ARK Investment Management to apply for a Bitcoin ETF with the U.S. Securities and Exchange Commission.
While German pension funds and other retirement schemes are naturally conservative, years of negative yields on German government bonds and diminishing returns from equities, at a time when obligations to members are increasing, could force their hand into more speculative segments of the market.
And to that end, German regulators have been paving the way for its institutional investors and hedge funds to take on greater risks.
German officials have introduced a new legal framework for Germany’s asset managers that will remove them from the same regulations as banks, with over 700 investment companies now free of the shackles that once constrained their operations and risk-taking ability.
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Jul 12, 2021