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Novum Alpha - Daily Analysis 20 August 2021 (10-Minute Read)

While equities are arguably over valued, prices were often predicated on high expectations of a strongly reopening economy with surging pent-up demand.

A fabulous Friday to you as U.S. equities ended a mixed bag, with some of the bleeding from equity markets starting to slow. 

In brief (TL:DR)

  • U.S. stocks tread water on Thursday, with the Dow Jones Industrial Average (-0.19%) down slightly on reopening concerns while the S&P 500 (+0.13%) and tech-centric Nasdaq Composite (+0.11%) inched higher as investors started buying the dip.
  • Asian stocks fell Friday as the fast-spreading delta virus strain stoked concerns about economic growth and China’s regulatory curbs sapped sentiment.
  • Benchmark U.S. 10-year Treasury yields were at 1.24% with little to affect demand (yields fall when bond prices rise).
  • The dollar was around a nine-month high.
  • Oil was up with September 2021 contracts for WTI Crude Oil (Nymex) (+0.14%)  at US$63.78 and will end this week lower as concerns over demand loom over any prolonged price recovery. 
  • Gold was little changed with December 2021 contracts for Gold (Comex) (+0.11%) at US$1,785.10.  
  • Bitcoin (+4.94%) rose to US$47,231 as inflows slowed against outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices). 

In today's issue...

  1. Don't Hold Your Breath, Stocks Could Sink
  2. Chinese Tech Stocks Not Safe Yet
  3. Cryptocurrencies Exchange Coinbase Saves for a Rainy Day

Market Overview

They were the worst of times, they were the best of times. 
And right now, investors can't decide which sort of time the market is in right now. 
While equities are arguably over valued, prices were often predicated on high expectations of a strongly reopening economy with surging pent-up demand. 
But that narrative has now come under challenge as a virulent delta variant of the coronavirus threatens to derail the economic reopening and recovery. 
Data has shown flagging consumer demand and sentiment and business spending has also diminished. 
Early employment gains are starting to show signs of flattening out and economists are all revising downwards their GDP estimates for the U.S., where a full 70% of the economy relies on consumption. 
But the flip side to this equation is that that provides the perfect pretext for the U.S. Federal Reserve to maintain its loose monetary policy and asset purchases. 
Whereas investors were jittery about the Fed tapering purchases and hiking rates ahead of schedule, weak economic conditions could ensure that the central bank stays engaged. 
At stake is the larger question - what is fueling asset prices right now? Is it excess liquidity or expectations of a recovering economy? 
Asia can't decide either, with Asian stocks mostly lower and Tokyo's Nikkei 225 (-0.74%), Hong Kong's Hang Seng (-1.10%), Seoul's Kospi Index (-0.53%) all down, while Sydney’s ASX 200 (+0.25%) was up slightly on Friday morning. 

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1. Don't Hold Your Breath, Stocks Could Sink

  • Weakening economic data is suggesting that stocks could slip lower, especially as retail investors are suddenly turning more cautious 
  • Investors will want to watch what the U.S. Federal Reserve's next move will be, it's sudden withdrawal from asset purchases or decision to hike rates could occur at the worst possible time
With U.S. equities topping some US$51 trillion, a growing proportion of investors are coming round to the view that the delta coronavirus variant could unsettle the global economic recovery and worse still, threaten a record-breaking rally in stocks.
Global stocks were battered over the past week, as major indices in the U.S., Europe and Asia all closed lower, amidst a flurry of news which seems to suggest that the economic recovery may be faltering, at a time when the U.S. Federal Reserve is considering tapering.
From Beijing to Boston, there are signs that all is not well in the global economic recovery narrative.
Slowing consumer confidence, flagging retail sales and weaker business activity in several regions of the U.S. is coming at a time when China’s growth is slowing.
Options trading activity already seems to suggest that investors have turned cautious, as many traders turned to derivatives to hedge otherwise bullish positions.
Goldman Sachs (-1.31%) has already shaved U.S. GDP growth for the quarter between July to September, to 5.5% a fall of almost half from an earlier estimate of 9% and dragging the full-year forecast lower by 0.4% to 6% for all of this year.
Nonetheless, it’s important for investors to note that the recently released Fed meeting minutes were at a time when policymakers saw the economic situation as peachy.
Resilient consumer demand, rising prices and a vaccination program that at first blush appeared to have held the delta variant at bay were seen as providing sufficient pretext to roll back stimulus.
And while Fed Chairman Jerome Powell did make the case last month that the economic impact from the delta variant may not have been as significant as previous waves, minutes from that meeting suggest a heightened awareness that surging infections could delay any pivot away from stimulus.
For investors, the greater worry isn’t so much that the Fed pulls its stimulus, it’s what happens if that stimulus fails to revive economic conditions.
At some point there’s just so much money you can throw at the problem. 

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2. Chinese Tech Stocks Not Safe Yet

  • Chinese tech stocks could come under further pressure as their business models have to be adapted to cater for more inclusive growth and profits 
  • Chinese Communist Party will want to show that it is a party of the people and so tech firms that share more equally and openly to their users or service providers will do better 
Just when you thought it was safe to plunge into Chinese tech stocks again, a fresh round of proposed regulations has sent shares of some of China’s biggest tech companies plunging yet again.
Investors holding on to Chinese tech equities or catching falling daggers are growing increasingly despondent as Beijing’s crackdown on the sector shows no signs of losing steam.
Beijing is said to be studying proposals to ensure the rights of drivers who work for online companies and step-up oversight of its booming live-streaming industry to prevent exploitation.
To be fair, U.S. drivers for companies like ride-hailing app Uber (-2.50%), have been calling for benefits and other employee protections for years, while technology platforms have long maintained that their service providers are “contractors.”
And while years of litigation in the U.S. can bog down any effort to increase the rights and benefits of the independent service providers on platforms like ride-hailing and food delivery, China doesn’t suffer from such hang ups, with a diktat from Beijing sufficient to reign in entire industries.
To that end, investors in some of China’s hottest tech stocks may suffer as the entire business models for Chinese tech companies that had mimicked their western counterparts gets upended.
Companies like Airbnb (-2.79%) and Uber have long profited from their ability to run the biggest hotelier without ever owning a single room, and the biggest private transport service provider, without owning a single vehicle.
These platforms leverage technology to extract the maximum value out of the business model, whilst limiting their risk exposure and obligations to service providers.
Because service providers are “independent contractors,” these companies don’t need to provide healthcare, paid sick leave, annual leave, insurance or a host of other benefits that full-time employees typically receive.
Yet many of these “independent contractors” provide these services on a full-time basis.
Beijing understands such inequality can over the long run foment discontent and lead to political instability, which is why it hasn’t hesitated to crackdown on its tech sector, wiping out about US$1 trillion in market value from Chinese shares listed globally last month alone.
From issues of antitrust to use of data, e-commerce concerns to private tutoring, gaming and online content, there appears to be no sacred cows in Beijing’s purge of its tech sector.
Beijing’s actions have flustered even the most diamond of hands, with Cathie Woods walking away from Chinese stocks over the past few months and a growing number of investors questioning allocations to Chinese assets altogether.
Investors plucky enough to seek bargains amidst the carnage must factor that the breakneck growth of Chinese tech companies over the past several decades may well be over and profit margins are likely to be squeezed moving forward.
Therefore, investors looking to pick up value from Chinese tech stocks will need to do their math and look out for far lower multiples, as acquisitive growth (antitrust) and profit margins (redistribution of wealth) become harder to maintain.

3. Cryptocurrencies Exchange Coinbase Saves for a Rainy Day

  • Cryptocurrency exchange Coinbase Global prudently stashes away large amount of cash to cater for potential cryptocurrency winter and regulatory expenses 
  • Prudent move by Coinbase Global may lead to a "lazy" balance sheet, but is in line with cryptocurrency industry experience of periods of feast and famine  
Veterans of the cryptocurrency industry recognize the value of saving.
While proponents may outwardly sing the praises and transformative value of decentralization and some may even rue fiat currencies as relics of the past those same cryptocurrency firms that have survived thus far, recognize the value of contingency plans, including shoring up fiat.
Which is why Coinbase Global (+1.58%), America’s only listed cryptocurrency exchange, built up a US$4 billion war chest in its first few months as a publicly traded company in preparation for lean times and regulatory battles.
Given how volatile the cryptocurrency industry tends to be, with feast and famine common, Coinbase Global’s decision to pad up its balance sheet with cash instead of Lambos is to be welcome.
Operating in the cryptocurrency space, there are known unknowns and even more unknowable unknowns, which is why maintaining outsized cash reserves, even if this could be seen as an inefficient use of capital, is a more prudent insurance policy.
A recent surge in cryptocurrency trading has buoyed Coinbase’s profits, with the exchange earning US$1.61 billion in the second quarter of this year, compared to US$32 million just a year earlier.
And that massive increase in profits for Coinbase, serves as a reminder of just how quickly the fortunes for companies that ply the cryptocurrency space can change.
Coinbase is also becoming increasingly savvy, taking advantage of both an increase in interest in cryptocurrencies against a backdrop of declining interest rates to raise a further US$1.4 billion by selling debt.
With U.S. Securities and Exchange Commission Chairman Gary Gensler stating this month that he intends to regulate cryptocurrency trading and lending platforms to the maximum extent possible, Coinbase is in a unique position to ride that wave of regulation as it has from day one.
Unlike other cryptocurrency exchanges like Binance, which opted to embody the decentralized ethos and go regulation-lite, that helped it in its breakneck growth, Coinbase elected to work with regulators, proactively choosing compliance over growth.
And that approach by Coinbase may have ultimately proved prescient as Binance rushes to become regulatorily compliant in as many jurisdictions as possible.

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Aug 20, 2021

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