Novum Alpha

Novum Alpha - Daily Analysis 15 July 2021 (10-Minute Read)

A terrific Thursday to you as markets struggle for direction on conflicting signals for everything from inflation to recovery.

In brief (TL:DR)

U.S. stocks were a mixed bag on Wednesday as the Dow Jones Industrial Average (+0.13%) and S&P 500 (+0.12%) eked out minor gains while the tech-centric Nasdaq Composite (-0.22%) inched lower as investors grew concerned that the Fed would let inflation run hot, while there were signs that China's growth could be steadying.
Asian stocks were mixed Thursday as traders await China growth data and digest U.S. Federal Reserve Chairman Jerome Powell’s signal that more economic progress was needed before stimulus can be pared back.
Benchmark U.S. 10-year Treasuries were down about two basis points at 1.330% as traders factored in the prospect of continued stimulus (yields fall when bond prices rise).
The dollar held a retreat.
Oil fell with August 2021 contracts for WTI Crude Oil (Nymex) (-1.37%) at US$72.13 on building U.S. fuel inventories and a potential OPEC+ agreement to increase supply.
Gold was around a four-week high with August 2021 contracts for Gold (Comex) (+0.21%) at US$1,828.90, aided by inflation concerns and Powell's comments on stimulus.
Bitcoin (+1.39%) rebounded slightly to US$32,806 as traders mulled the prospect of loose Fed policy allowing for continued flows into more speculative assets, while inflows slowed against outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices).

In today's issue...

If you can’t beat China, why not buy it?
The Fed’s Not For Tapering
Cryptocurrencies Conquer Wall Street?

Market Overview

We now know what we've known all along, that we don't know very much at all.

With conflicting metrics coming in from all corners, markets are understandably trending sideways today as investors pour through the avalanche of data covering everything from inflation to China's economic growth and everything in between.

Throw in the unpredictability of how the delta variant of the coronavirus will play out and it's anyone's guess where markets will be headed to next which is why it's completely understandable that stocks are drifting sideways but up slightly on the prospect of continued central bank dovishness.

In Asia, stocks were mostly higher on Thursday morning with Sydney’s ASX 200 (+0.02%), Seoul's Kospi Index (+0.26%) and Hong Kong's Hang Seng (+0.60%) higher, while Tokyo's Nikkei 225 (-0.80%) was lower as earnings growth showed signs of slowing.

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1. If you can't beat China, why not buy it?

Global investors have poured into Chinese debt and equities at their fastest pace in almost a year
Risks remain for China, with the at-times arbitrary response of Beijing an unknowable unknown that threatens to overturn Chinese investments at the drop of a hat

You can’t beat it, so why not buy it?

Or at least that’s what global investors appear to be saying as holdings of Chinese equities and debt have surged some 40% to US$800 billion in the past year even as Beijing has grown increasingly assertive towards other nations.

But what do these Sino-savvy investors know that other investors don’t?

In the past few years, China has moved far more aggressively in the South China Sea, from building up military bases to displays of force in Taiwan.

Tensions between China and the U.S. are at their highest levels in decades, and Beijing has shown no hesitance to crackdown on its companies listed on America’s capital markets.

Washington has labeled Beijing’s alleged repression of Uighurs in Xinjiang as “genocide.”

Yet dig beneath the saber rattling and rancor and things become far more nuanced.

While some in the White House have been quick to chastise Beijing’s human rights records, the Biden administration has also come out unequivocally to declare that it does not support Taiwan’s independence, a feather in the Chinese Communist Party’s fedora.

And although rhetoric makes for interesting headlines, it’s not hard to see that the language emanating from European leaders on relations with China is far more circumspect.

It’s no surprise really, especially since China remains a massive market for German vehicles, with as much as 40% of exports from some of Germany’s largest carmakers headed to the Middle Kingdom.

According to data from Bloomberg, an estimated US$35.3 billion worth of Chinese stocks have been purchased by offshore investors this year alone, or about 49% more than the same period last year.

And figures from Crédit Agricole (+0.60%) revealed that foreign investors soaked up some US$75 billion of Chinese sovereign debt, a rise of 50% from a year earlier.

There are several reasons of course for these holdings.

Until fairly recently, it looked like China was emerging from the pandemic ahead of the west.

While the U.S. and Europe were mired in indeterminable lockdowns, China was having raves at waterparks.

As recently as six months ago, investors were betting on the Chinese case to come out on top.

But since then, the U.S. and Europe’s mass vaccination exercises have helped it leap ahead in the economic recovery.

And the relatively slower pace of vaccination, especially with China’s homegrown vaccine of dubious efficacy, and fresh coronavirus outbreaks in parts of the country now threatening to derail China’s recovery, things aren't so clear anymore.

There are also signs that China’s economic growth is slowing, from the People’s Bank of China, the central bank, reducing the amount of reserves that commercial banks need to hold and encouraging loan expansion, to tepid consumer demand.

As U.S. tech shares, the darlings of the pandemic are looking more and more pricey, global investors have shifted to Chinese equities, which offer exposure to sectors other than tech, such as industrials.

And Chinese sovereign bonds also offer better returns compared to U.S. Treasuries, a factor that was helped by loosening liquidity after months of tighter monetary policy in China.

Yet investors looking to China for returns have to also consider some of the complexities of a bet on China.

While there are several onramps for global investors to purchase Chinese debt and equities, China’s capital markets are not open and freely accessible the way they are in Europe or the United States.

Issues of corporate governance, reporting and transparency also remain a concern, with China Huarong Asset Management, a majority state-owned financial asset management firm delaying its annual results for 2020 several times and now saying that it cannot estimate when these results will be published.

And while China’s capital markets are certainly growing, they are not “established” or “mature” the way global investors might assume, with (sometimes) arbitrary moves by Beijing to shake up its own local markets resulting in disastrous consequences.

As recently as 2015, measures by Beijing to provide cash to brokers to buy shares, and the encouraging of Chinese citizens to buy more stocks, created a speculative bubble that burst soon after.

There are no guarantees that a similar scenario will not repeat itself, especially when Beijing has proved willing to exercise its visible hand in the market.

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2. The Fed's Not For Tapering

U.S. Federal Reserve Chairman Jerome Powell makes clear that the central bank is not looking to taper asset purchases anytime soon
While inflation may be rising, it's been largely confined to specific categories, and the rise of new Covid-19 variants threatening fresh lockdowns has enabled the Fed to justify its continued policy stance

You taper if you want to, the Fed’s not for tapering.

If there was any doubt that the U.S. Federal Reserve would continue to keep borrowing costs low, then those doubts can be buried for as long as Chairman Jerome Powell is at the helm.

Testifying before the powerful House Financial Services Committee yesterday, Powell noted that it was still too soon to scale back the Fed’s aggressive support for the U.S. economy, even as inflation has risen faster than expected.

Critics argue that the Fed is stoking inflation by holding interest rates near zero, while soaking up some US$120 billion worth of U.S. Treasuries and mortgage-backed securities every month.

Powell however was quick to stress that while policymakers expected high inflation to be temporary, they would react if it turned out to be materially above their 2% target.

With enhanced labor benefits set to be expiring in the coming months, it remains to be seen whether more Americans will head back into the workforce and labor conditions improve to the point that pressure will mount on the Fed to taper its asset-purchasing program or bring forward its schedule for rate hikes.

Nonetheless, the status quo was sufficient to lift both equities and Treasuries yesterday.

As Powell reiterated to members of Congress that the labor market recovery was still far from complete, investors had little to worry about outside of bidding up assets.

While the U.S. economy added some 850,000 jobs in June, its biggest monthly increase since August, the gains weren’t across the board and qualitatively, fell short of the Fed’s goal of maximum employment, a metric which also encompasses inclusivity.

Minorities have actually fared worse, despite signs of a labor recovery, with 9.2% of Black workers unemployed compared with 6% last February before the pandemic.

And that may be the justification for the Fed to keep things as they are and for investors to remain of good cheer.

For as long as there are pockets of inequality, especially when gains in employment are not evenly distributed, the Fed can cherry pick figures to justify its continued involvement in the markets.

3. Cryptocurrencies Conquer Wall Street?

Spate of cryptocurrency companies raising funds at increasingly high valuations are just the start of a sector that looks poised to rally hard and possibly become another asset bubble
Disruptive technology that seeks to reinvent the world of finance coupled with impossibly loose monetary conditions are providing the perfect circumstances for public listings of cryptocurrency firms

Could the cryptocurrency world one day conquer Wall Street? Possibly, if the likes of Sam Bankman-Fried have anything to say about it.

Speaking to the Financial Times, the billionaire CEO of cryptocurrency exchange FTX said that the company he founded in 2019 would consider buying an established financial institution such as Goldman Sachs (-0.42%) or exchange operators CME Group (-0.13%) once it had overtaken its rivals Coinbase Global (-5.50%) and Binance.

Bold words from the founder of a cryptocurrency exchange that is incorporated in Antigua and Barbuda and with its headquarters on the other side of the globe in Hong Kong.

But at least FTX has a headquarters, with Binance founder Changpeng Zhao dismissing the concept as antiquated.

For now though, Bankman-Fried’s ambitions remain somewhat a stretch, with FTX alleged to have told the Nikkei Asia that it was seeking a US$20 billion valuation in its latest funding round.

In comparison, Coinbase Global, a regulated cryptocurrency exchange in the U.S. and which unlike FTX, can serve U.S. customers, has a market cap of three times FTX, at US$60 billion.

Yet even as regulatory scrutiny of the cryptocurrency space grows, investors have shown no loss of appetite to bet ever-increasing amounts on what some have suggested could disrupt legacy financial systems.

This week, cryptocurrency-payments company Circle, issuer of the USDC stablecoin, announced that it planned to make its foray into the public markets by way of a US$4.5 billion special purpose acquisition company.

And Bullish, a decentralized exchanged backed by a group of billionaire investors also announced plans to list in New York through a US$9 billion SPAC.

FTX may be some ways off from entering the public markets preferring instead to raise capital in private rounds for now, as Coinbase Global's experience has demonstrated that it's not all smooth sailing for cryptocurrency companies.

Complicating matters is that centralized cryptocurrency exchanges like FTX are not regulated in the U.S. and do not serve U.S. customers, at a time when regulators globally are working towards a more comprehensive global framework to deal with cryptocurrency legal arbitrage – where companies domicile in one location, which typically has lighter regulations, to serve customers in more heavily-regulated jurisdictions.

Bankman-Fried is sanguine about the prospects of regulation, speaking with the Financial Times he said,

“The biggest change we’ve seen in the last year is that crypto has got big enough for regulators to care.”

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Jul 15, 2021