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Novum Alpha - Daily Analysis 11 August 2021 (10-Minute Read)

The U.S. Federal Reserve is postulating the prospect of unwinding its US$120 billion-a-month asset purchases as expectations are high that Consumer Price Index or CPI data due out later this week will reveal elevated levels of inflation.

A wonderful Wednesday to you as markets continue to trend sideways. 

In brief (TL:DR)

  • U.S. stocks continued to drift on Wednesday with the Dow Jones Industrial Average (+0.46%) and S&P 500 (+0.10%) both up modestly, while the tech-centric Nasdaq Composite (-0.49%) pulled back on expectations that the Fed would taper asset purchases sooner than anticipated. 
  • Asian stocks were mixed Wednesday as investors awaited a key report on U.S. inflation.
  • Benchmark U.S. 10-year Treasuries held at 1.35% (yields rise when bond prices fall) with traders sitting on the sidelines ahead of inflation data.  
  • The dollar was steady.
  • Oil rose with September 2021 contracts for WTI Crude Oil (Nymex) (+0.06%) at US$68.33 on bets that the global demand recovery will remain intact despite the fast-spreading delta variant.
  • Gold was little changed with December 2021 contracts for Gold (Comex) (+0.05%) at US$1,732.80 and may see a slight boost with inflation data. 
  • Bitcoin (-0.50%) was slightly lower at US$45,766 with outflows slowing against inflows  (outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. What does Xi Jinping want?
  2. Borrowing in a Pandemic Belies Belief
  3. Decentralized Help to Combat US$600 million Cryptocurrency Hack

Market Overview

The U.S. Federal Reserve is postulating the prospect of unwinding its US$120 billion-a-month asset purchases as expectations are high that Consumer Price Index or CPI data due out later this week will reveal elevated levels of inflation. 
Hawks on the Federal Open Market Committee which have a say in setting interest rates, will be looking to find justification for paring back stimulus and bringing forward rate hikes. 
However, there are signs that inflation growth may be slowing. 
While CPI data was fueled in large part by the one-off spike in demand for used vehicles, coincident with the summer driving season and lifted pandemic restrictions, the normalization of supply chains and a re-emerging virus wave fueled by the delta variant are likely to slow the rate of price gains.
And for policymakers, in particular U.S. Federal Reserve Chairman Jerome Powell, that slowing increase of prices should provide sufficient justification to keep the status quo just the way it is, for just that little bit longer. 
Over in Asia, stocks were mostly higher on Wednesday with Tokyo's Nikkei 225 (+0.69%), Sydney’s ASX 200 (+0.48%) and Hong Kong's Hang Seng (+0.77%) up, while Seoul's Kospi Index (-0.30%)  continued to be lower thanks to continued concerns over the delta variant. 

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



1. What does Xi Jinping want?

  • Investors remain concerned that Chinese President Xi Jinping intends to roll back market reforms and re-institute Marxist-style measures 
  • Real goal of recent purges may have more to do with shoring up popular support ahead of an unprecedented move to secure a third term in office for Xi, investors need to tread carefully and pick sectors and stocks inline with Xi's broader social goals 
Despite “Xi Jinping Thought” being widely available for study, it sheds little light on the motives behind some of the Chinese President’s latest moves to crackdown on China’s tech companies and afterschool education market. 
As investors nurse billions of dollars in losses from shares of what were until fairly recently, some of the most profitable Chinese companies, analysts are rushing to figure out which industry might be next, but more importantly, why now?
To be sure, Chinese President Xi Jinping isn’t the first to extol the virtues of Marxism and socialism, while overseeing a wildly capitalist economy that has birthed some of the world’s most valuable companies.
But Xi has been the only President in recent Chinese history to act on those socialist inclinations.
From anti-monopoly probes against China’s Big Tech to cybersecurity reviews for foreign listings and a ban on profits in the US$100 billion education sector, jittery global investors are dumping Chinese stocks at the first hints of trouble.
Even something as seemingly innocuous as a state media warning to chipmakers can send shares of the sector plummeting.
In Xi Jinping’s China, there are no sacred cows.
But far from rolling back market reforms first enacted by Chinese premier Deng Xiaoping, Xi’s goals are far more Machiavellian – the consolidation of power ahead of a once-every-five-year leadership shuffle due next year, where he’s widely expected to extend his rule indefinitely.
For Xi, power is nothing without control.
And for so long as some of China’s biggest companies could raise monies overseas, it meant that their leaders could become increasingly vocal, as was evidenced by Alibaba Group Holding’s (+0.25%) Jack Ma.
For Xi, the cult of personality is even more egregious than the cult of commerce – for China, there can only be one superstar on the global stage, the Communist Party.
But behind Xi’s moves also lie a push to boost the incomes of the masses, where the Chinese Communist Party derives its legitimacy, by plundering from the rich and redistributing to the poor - not bad for someone whose estimated net worth is in the billions.
In a country where almost half of 1.38 billion Chinese live on a monthly income of just over US$150, there are 1,000 billionaires and some see the Communist Party as having been captured by the wealthy.
Xi is eager to demonstrate that that is not the case ahead of consolidating his power next year and it’s unclear how far he will go to prove his socialist credentials.
Investors considering a round of bargain hunting as Chinese shares continue to be battered across a variety of sectors should examine China thematically – understand Xi Jinping Thought.
In other words, look at sectors like renewable energy, electric vehicles and even semiconductors.
Review past comments made by Xi in a variety of state media where he emphasizes the redistribution of wealth, the easing of stresses and burdens for average Chinese and populist policies that are likely to sit well with the people.
While Communist Party leaders are not democratically elected, they are not entirely immune to popularity contests and Xi is no different, the only difference is how far he'll go to remain popular. 

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



2. Borrowing in a Pandemic Belies Belief

  • Once popular high yielding debt of some of the most shaky companies is starting to show signs of weakness 
  • Lower rated debt is showing the highest spread against safe U.S. Treasuries in months 
During the depths of the pandemic, the debt of companies most heavily battered by the coronavirus crisis was selling for pennies on the dollar.
And as governments and central banks intervened heavily to shore up their embattled economies, with investors rushing into safe havens such as U.S. Treasuries which delivered negative real yield, the demand for fixed income soared.
Overnight, some of the most dicey companies which couldn’t get a drop of liquidity in a torrent of money saw demand for their debt soar, including companies most heavily exposed to the economy like movie theater chains, cruise operators and airlines.
With the reopening of the U.S. economy and the inoculation of the American population, investors rotated into the debt of some of the most battered firms, much to the delight of their executive suites.
But as the delta variant starts to take hold in the U.S., bonds issued by cruise companies, cinema operators, airlines and retailers were all hit last week.
As more companies delay plans to return workers to offices, and with others opting to impose vaccine requirements in order to return back to their cubicles, investors are now starting to dump corporate debt of companies that had staged miraculous turnarounds.
The moves across these sectors are a sign that investors are paring back expectations of the pace of recovery from last year’s downturn.
And to make matters worse, the delta variant, which thrives in colder conditions, might see a winter boost, making the recovery story all that more uncertain.
Nonetheless, the lack of options against a backdrop of excess liquidity means that fresh funding will continue to be available, albeit at a decelerating pace.
And so long as inflation isn’t a persistent problem, as the Fed has repeatedly reiterated, there are still some bargains to be had in corporate debt.
While the spread – the additional yield demanded by investors for corporate debt over and above safe U.S. Treasuries has increased slightly to 3.5% from 3.16% at the beginning of July, according to data from ICE BofA indices, it is still historically low.
But further down the corporate debt ladder, junk bonds are revealing potential bearish sentiment for the economy, with CCC-rated debt spread soaring to 6.75% from a low of 5.88%.
Fed tapering and the potential advancement of rate hikes could also put a damper on demand for the riskiest corporate debt.  


3. Decentralized Help to Combat US$600 million Cryptocurrency Hack

  • Massive US$600 million hack of DeFi protocol Poly Network shakes decentralized markets 
  • Grassroots-led intervention and willingness to disavow the stolen tokens is a reassuring sign of the cryptocurrency industry being willing to police itself 
Make no mistake about it, the cryptocurrency landscape is a bit of an investing Wild West, where brigands lurk at every corner waiting to execute the next rug pull, but just like any other frontier lands, heroes and sheriffs exist as well to bring law and order.
One of the biggest criticisms leveled against cryptocurrencies has often been the limited recourse investors have when things go wrong.
And nowhere is this more evident than in the swashbuckling decentralized finance or DeFi space.
Poly Network, which links some of the world’s most widely used blockchains, said on Tuesday that hackers absconded with about US$600 million worth of cryptocurrencies in one of the largest heists to date, by exploiting a vulnerability in its smart contracts, the stuff that powers DeFi.
Because DeFi does away with the need for a trusted intermediary, smart contract code automatically executes transactions.
But given that smart contract technology is still somewhat in its infancy when applied to finance, it’s often difficult to determine built-in vulnerabilities or foresee the consequences of multiple contract calls.
As a general rule, the more complex the code, the more vulnerable it becomes to exploitation and often it’s because software developers can’t see their own blind spots.
Poly Network allows users to transfer their cryptocurrencies across different blockchains, by transacting directly with each other and the alleged hacker exploited a vulnerability in “contract calls” a type of transaction that is not intended to be published on the blockchain, to access the cryptocurrencies held in the smart contracts and effect their transfers.
But the hack has also seen a groundswell of decentralized intervention – Poly Network made a plea to cryptocurrency miners to block the transfers of these stolen cryptocurrencies.
Tether, issuer of the dollar-based stablecoin USDT, has said it froze about US$33 million worth of its tokens, to prevent the hacked proceeds from being used.
USDC, operated by payments service company Circle was also among the hacked coins, as was Binance Coin.
Binance founder and CEO Changpeng Zhao conceded that because no one controls the Binance blockchain, the group has had to co-ordinate with its security partners to proactively help as far as possible, but with no guarantees that the lost funds could be recovered or frozen.
The grassroots-led intervention by some of the biggest names in the cryptocurrency industry should be seen as a welcome move.
In 2016, when the Ethereum blockchain was still in its infancy, the infamous DAO hack, or the exploit of the decentralized autonomous organization, saw the creators of Ethereum decide to execute a hard fork, so as not to recognize the proceeds of the hack, leading to the break-off into Ethereum and Ethereum Classic.
Today, not many investors have even heard of Ethereum Classic, whereas Ethereum has soared to become the world’s second largest cryptocurrency by market cap.
At the time, the ideological debate surrounded the belief that if the blockchain was supposed to be the final arbiter of truth, human intervention to rewrite a different version of the truth, no matter how magnanimous, would introduce moral hazard into the equation.
Over five years and countless hacks later, the cryptocurrency industry as a whole has matured and the value of being more flexible is self-evident, providing investors some comfort that there may potentially be some recourse, even if such recourse is not entirely satisfactory.
As decentralized finance continues to evolve and smart contracts become more complicated, hacks similar to the Poly Network exploit are likely to become more prevalent.
There is a genuine elegance in being able to own and manage your own funds, but there is an inherent responsibility as well.  

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Aug 11, 2021

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