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Novum Alpha - Weekend Edition 28-29 August 2021 (10-Minute Read)

The same way that a lover can't hear the words "I love you" often enough, investors can't be reassured of central bank policies often enough. And like a considerate lover whispering sweet nothings into the ear of their partner, U.S. Federal Reserve Chairman Jerome Powell's speech at the virtual Jackson Hole conclave provided all the comfort that investors needed to feel that things would be better. 

A wonderful weekend to you as investors have plenty to cheer with a dovish U.S. Federal Reserve! 
 

In brief (TL:DR)

 
  • U.S. stocks flashed higher on Friday with the Dow Jones Industrial Average (+0.69%), the S&P 500 (+0.88%) and tech-centric Nasdaq Composite (+1.23%) all roaring to fresh records on signs of a persistently dovish U.S. Federal Reserve. 
  • Asian stocks dipped Friday as U.S. Federal Reserve Chairman Jerome Powell noted that the withdrawal of stimulus would be gradual and organized and investors poured into U.S. equities and bonds. 
  • Benchmark U.S. 10-year Treasury yields slipped to 1.314% as investor appetite for bonds grew with the Fed's even hand at tapering (yields fall when bond prices rise). 
  • The dollar stumbled against major trading peers. 
  • Oil advanced with October 2021 contracts for WTI Crude Oil (Nymex) (+1.96%) at US$68.74 on bullish demand expectations. 
  • Gold continued to rise with December 2021 contracts for Gold (Comex) (+1.35%) at US$1,819.50, as investors hedged inflation risk on rising demand expectations.
  • Bitcoin (+1.07%) was higher in the middle of the weekend at to US$48,824 as investors digested the sentiment from Jackson Hole and priced in the status quo of continued stimulus feeding into the Bitcoin-hedge narrative with outflows leading inflows (outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). \

 

In today's issue...

 
  1. Market Risks are Stacking Up
  2. China's Billionaires Get a taste for Philanthropy 
  3. Does the Cryptocurrency Space Really Need Regulators to Intervene?

 

 

Market Overview

 
The same way that a lover can't hear the words "I love you" often enough, investors can't be reassured of central bank policies often enough. 
 
And like a considerate lover whispering sweet nothings into the ear of their partner, U.S. Federal Reserve Chairman Jerome Powell's speech at the virtual Jackson Hole conclave provided all the comfort that investors needed to feel that things would be better. 
 
While the Fed chairman has been promising right from the very beginning that the central bank would be transparent in its rate hikes and stimulus policies, few if any investors took the Fed at its word, hedging constantly.
 
But given how central banks have been prone to respond reactively in the past, the Bank of England for instance when it was no longer able to maintain its peg to the then-Deutsche mark, and then-U.S. Fed Chairman Ben Bernanke's taper tantrum of 2013, it's no wonder investors have been jittery. 
 
But those concerns were allayed as Powell repeated what he's said all along, keep calm and carry on. 
 
Unfortunately the comments meant investor turned towards the U.S. and Asian stocks missed a beat at the close on Friday, with Tokyo's Nikkei 225 (-0.36%), Hong Kong's Hang Seng (-0.03%) and Sydney’s ASX 200 (-0.04%) lower, while Seoul's Kospi Index (+0.17%) managed a marginal increase headed into the weekend. 
 

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1. Market Risks are Stacking Up

 
  • Risks are stacking up as global stocks push fresh highs 
  • Impossible to say which would be the risk that overflows to become a systemic crisis without the benefit of hindsight, but it's likely to be the one that was hiding in plain sight 
 
As anyone who’s ever played the brick-stacking game Jenga will tell you, selecting which log to pull out only gets harder as the tower stacks higher.
 
And with stock markets pushing fresh records, investors have to contend with the fact that the next risk that gets pulled out of the stack, and piled back atop the heap, may be the one that brings the market down.
 
With a multitude of risks everywhere from the rise of the delta variant to what increasingly appears to be a Chinese crackdown on capitalism, there are more than enough reasons why investors should start to get nervous about equity markets.
 
U.S. Federal Reserve Chairman Jerome Powell’s dovish speech at the virtual Jackson Hole conclave of the movers and shakers of the financial markets sent the S&P 500 to another record on Friday.
 
But a reduction in both leverage and volumes seems to suggest that investors appear more cautious compared to a few weeks ago when companies were in the middle of a record-setting earnings season.
 
The issue that investors must confront with next is, what will be the risk that gets piled atop the rest that takes down the entire tower of logs?
 
While the delta variant rages, the general consensus appears to be that vaccinations will help the bulk of the rich world navigate out of the pandemic.
 
Slowing growth in China may pose a drag on the global economy, but also provides the pretext for the U.S. Federal Reserve to remain dovish and keep asset prices inflated.
 
Rising prices and supply chain disruptions appear likely to eventually smooth themselves out, especially if consumer demand growth starts to stall.
 
Concerns over inflation appear to have subsided as the global economy enters the Goldilocks zone, with sufficient growth to signal recovery, but not so significant to warrant a central bank withdrawal from markets.
 
So which is the last log to destabilize the current stack?
 
As with so many prior crises, it will likely be one that has been hiding in plain sight all along.
 
A plethora of companies have taken the opportunity to borrow money cheaply and pile debt on high.
 
Investors searching for higher returns in a low yield environment have taken on more risks, both in opaque off-market swaps and derivatives, as well as in junk bonds and “higher” yielding debt of some of the shakiest companies.
 
But as long as the U.S. Federal Reserve continues to spike the punch, the party can go on and investors can continue to stay drunk on excess liquidity.
 
The risk comes when that liquidity is withdrawn, or worse, investors decide they no longer want to continue to fund fiscal and monetary profligacy, something that is likely to happen in a manner and way in which no one expects or sees without the benefit of hindsight. 
 
 

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2. China's Billionaires Get a taste for Philanthropy

 
  • Rich Chinese companies and individuals are giving away money at the fastest rate ever, before Beijing comes bearing down on them to redistribute wealth 
  • It's unclear if the move to give away money and profits will be sufficient to assuage Beijing's concerns over inequality or slow the crackdown on some of China's biggest companies  
 
When you’re rich they let you get away with it, giving it away that is.
 
As Beijing’s crackdown on some of China’s largest and most profitable companies continues, jittery Chinese billionaires are giving away money like it’s going out of fashion before the Chinese Communist Party comes for it.
 
So far this year, seven Chinese billionaires have directed a record US$5 billion to charity, according to data compiled by Bloomberg, exceeding last year’s giving by over a fifth.
 
These pledges, whether through corporate interest, foundations or personal wealth, have been heating up as Chinese President Xi Jinping pushes for “common prosperity” – a national drive to close the country’s wealth gap.
 
While it’s not clear what “common prosperity” entails, Beijing has identified a “third distribution of wealth” through individual giving and corporate philanthropy, alongside government and market intervention.
 
President Xi’s call for “common prosperity” marks a major policy shift from Chinese reformist leader Deng Xiaoping’s push for some Chinese to “get rich first” and Chinese billionaires are not wasting a minute to give away as much as they can while they still have it to give.
 
On August 17, a high-level meeting chaired by President Xi said that the government should, “reasonably adjust excessive incomes and encourage high-income people and companies to give back more to society.”
 
Embattled Chinese tech giants have pledged both current and future corporate profits to invest in philanthropic projects, including no less than US$15 billion set aside by Tencent Holdings (-1.14%), owner of the ubiquitous WeChat and a major shareholder in Epic Games, publisher of the massively successful and popular video game Fortnite.
 
But whether such moves should appease the Gods atop the Chinese Communist Party leadership is less clear and how it will play out for investors is even more cloudy.
 
With Beijing all but regulating out of existence the afterschool education market and putting restrictions on how much time young people can spend on their devices gaming, the maze of challenges faced by the richest Chinese companies can be daunting.
 
For global investors who were sold on the growth story of China, this forcible redistribution of wealth will come as an affront to the pursuit of pure profit.
 
Viewed against that backdrop, perhaps no amount of giving would be sufficient to pacify Beijing’s rage against the concentration of both power and wealth in the handful of a clutch of companies and businessmen. 
 
 

3. Does the Cryptocurrency Space Really Need Regulators to Intervene?

 
  • Grassroots-led vigilantism in the cryptocurrency space appears more effective than regulatory intervention 
  • Nature of blockchain technology is such that regulators and the industry at large are better off working with industry stakeholders than trying to bully them into submission 
 
In May 2019, one of the world’s biggest cryptocurrency exchanges Binance experienced a “large-scale security breach,” where hackers stole 7,000 Bitcoin, worth over US$40 million at the time, but over US$337 million today.
 
Without flinching, Binance CEO Changpeng Zhao or “CZ” as he is better known, pledged to cover Binance users for the full extent of those losses, no questions asked.
 
When decentralized finance project PolyNetwork was hacked earlier this month, it pleaded with the Ethereum miners not to validate the malicious transactions and called on CZ and Tether to invalidate the proceeds of the hack.
 
The PolyNetwork hacker relented and ultimately returned the hacked cryptocurrency, changing their story to allege that they had always intended not to keep the proceeds of the hack.
 
Throughout the entire PolyNetwork hack, a string of blockchain analytics firms were monitoring the movements of the hacked cryptocurrencies across the blockchain, making it almost impossible for the stolen funds to escape the watchful eye of service providers.
 
As the cryptocurrency space has grown, evolved and matured, just like America’s Wild West, Sheriffs and vigilantes have emerged to enforce their own brand of justice.
 
And while hacks and fraud still occur with an unfortunate regularity, the grassroots-led efforts to police the space have proved far more effective than any financial regulator.
 
Which is why the concession by the U.K.’s Financial Conduct Authority last week that Binance was “not capable of being supervised” marked a welcome recognition of the challenges that regulators face in overseeing the cryptocurrency space.
 
The FCA instead decided to warn investors of the “significant risk” of continuing to trade with Binance, as it was outside the regulatory umbrella.
 
Yet these are not risks that most cryptocurrency investors don’t already contend with on a daily basis.
 
When Binance was hacked in 2019, it was under no obligation to make traders and investors on its platform whole and could have easily cited force majeure.
 
But credibility means everything in the cryptocurrency space, and Binance, rightly so, determined that 7,000 Bitcoins was a small price to pay for their reputation as the world’s most heavily used cryptocurrency exchange.
 
Yet cryptocurrency investors and traders relying on the largesse and magnanimity of exchanges and their leaders isn’t a long-term solution either.
 
And as cryptocurrencies continue to rise in adoption and price, more investors are likely to come into the fold.
 
Which is why authorities like the FCA are at a unique crossroads.
 
Instead of objecting and alienating cryptocurrency exchanges like Binance, authorities should work together with stakeholders to find a means to govern and provide more certainty to investors.
 
Exchanges like Binance would stand to benefit if more retail investors were assured of their ability to withdraw their cryptocurrencies safely and freely.
 
And regulators eager to prevent cryptocurrencies from being used to facilitate criminal activities or launder money would find it far easier to deal with a few key exchanges where the bulk of liquidity lies than an entire sector.
 
In this regard, the FCA’s concession that Binance is beyond the long arm of its laws should be an opportunity for all stakeholders to gather at the table and break bread.
 
Binance has already gone on record to demonstrate that it is committed to being compliant and working with authorities, and regulators who recognized the difficulty behind policing the space should accept that olive branch, failing which the entire industry loses.  
 

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Aug 28, 2021

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