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Novum Alpha - Daily Analysis 31 August 2021 (10-Minute Read)

Beijing is taking its purge on its private companies to fresh new levels of ludicrousness in what looks more like an assault on capitalism as it becomes increasingly apparent that socialism with Chinese characteristics is really just socialism, with hints of capitalism.

A terrific Tuesday to you as U.S. stocks continued their advance and Asian stocks drifted on this last day of August. 

In brief (TL:DR)

  • U.S. stocks continued their bullish trend with the Dow Jones Industrial Average (-0.16%), pulling back slightly on a selldown of more economically sensitive stocks on concern over the resurgent pandemic, while the S&P 500 (+0.43%) and tech-centric Nasdaq Composite (+0.90%) continued their upward trajectory buoyed by tech. 
  • Asian stocks dipped Tuesday as traders assessed weaker economic activity in China and the latest escalation in Beijing’s crackdown on private industries.
  • Benchmark U.S. 10-year Treasury yields dipped about one basis point to 1.27% as concerns over the economic recovery saw a demand for safety (yields fall when bond prices rise). 
  • The dollar was little changed.
  • Oil fell with October 2021 contracts for WTI Crude Oil (Nymex) (-0.52%) at US$68.85 as demand concerns outweighed any potential supply disruptions from Hurricane Ida. 
  • Gold was up with December 2021 contracts for Gold (Comex) (+0.22%) at US$1,816.10.
  • Bitcoin (-3.26%) fell to US$46,946 as investors saw opportunity to buy into Ethereum following the latter's overcoming a software bug as inflows into exchanges led outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of falling prices). 

In today's issue...

  1. Bailout of Chinese Asset Manager Roils Already Jittery Investors
  2. Hedging Bets with Hedge Funds
  3. Ethereum Endures a Tricky Bug Demonstrating its Resilience

Market Overview

Beijing is taking its purge on its private companies to fresh new levels of ludicrousness in what looks more like an assault on capitalism as it becomes increasingly apparent that socialism with Chinese characteristics is really just socialism, with hints of capitalism. 
Investors were understandably riled on revelations that not only is Chinese President Xi Jinping now making decisions on everything from pollution to monopolies, but tightening his grip on the lives of 1.4 billion Chinese people in many aspects of life. 
Asian stocks were understandably weaker on concerns over Beijing's ever-widening crackdown with Tokyo's Nikkei 225 (-0.07%), Seoul's Kospi Index (-0.41%) and Hong Kong's Hang Seng (-0.79%) down, while Sydney’s ASX 200 (+0.28%) was slightly higher on Tuesday's morning session. 

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1. Bailout of Chinese Asset Manager Roils Already Jittery Investors

  • Bailout of embattled Chinese asset manager China Huarong Asset Management is roiling investors in offshore Chinese debt 
  • Inconsistent application of bailouts in the world's second largest economy is leading to soaring yields demanded on offshore Chinese bonds 
The problem with a specific bailout is that it doesn’t cover everyone, and leads investors to wonder which troubled company will be the next to collapse.
Last week, China Huarong Asset Management, China’s biggest investment company received a bailout, “extraordinary support” (translated to mandarin), from Beijing, given that most of the companies involved are under direct control of China’s Ministry of Finance anyway.
On Sunday, after a 5-month delay in releasing its financial report for 2020, China Huarong Asset Management revealed that its leverage rose to 1,333 times at the end of last year, as losses wiped out most of its equity value.
And now investors are wondering which will be the next highly-geared Chinese company to implode, with stresses showing at heavily-indebted property developer China Evergrande shaking sentiment for Chinese bonds on the international bond markets.
Interest rates on Chinese high-yield bonds issued offshore soared to 13.3% last week according to an index from ICE (+0.80%) and Bank of America (-1.95%), up from less than 10% in June and close to levels when the onset of the coronavirus pandemic dragged down bond prices at the start of 2020 (bond prices fall when yields rise).
The timing for shaky Chinese debt could not be worse.
In the wake of an at times pernicious crackdown on some of the biggest Chinese companies, investors are naturally concerned that Beijing may also be inconsistent in its approach when it comes to bailing out heavily indebted state-owned firms.
That Beijing has allowed some smaller local and regional banks to fold is symptomatic of the growing pains of a country making the gradual shift towards more market-style economics.
Yet the same allegations that “favored” companies helmed by insiders could be rescued by Beijing would also apply to Washington’s numerous bailouts as well, moral hazard doesn't respect borders apparently. 
The bigger difficulty for investors is trying to figure out which Chinese company’s heavily indebted bonds are worth a punt, as their prices are likely to soar on news that they will be rescued by Beijing, and which are not.

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2. Hedging Bets with Hedge Funds

  • Investors are turning to hedge funds as the path out of the pandemic becomes less certain
  • Flows have increased into hedge funds for the fist time in years, despite underperformance against major benchmarks and stimulus which has distorted markets  
With the S&P 500 having delivered 19.7% so far this year alone, and stocks attracting eye-watering valuations, investors awash with liquidity are asking where to put their money next.
As if the pandemic-fueled stimulus wasn’t warping markets enough, China has thrown a spanner in the works with a regulatory crackdown that has shaken global confidence in the certainty of returns from the world’s second largest economy.
Which is why some investors are ramping up allocations to hedge funds, reversing many years of retreat for the sector, hoping that active managers will be more adept at plotting a path out of the landscape of lockdowns and rebounds.
Although hedge funds have generally underperformed passive funds over the past 18 months, these are extraordinary times, where a rising tide floats all boats, and therefore obscures many of the attributes inherent to hedge funds - flexibility. 
And as investors recognize the complexity of charting a course out of the pandemic, they are increasingly appreciative that the lower returns (for now) could help to set up a much better outcome in the years when the central banks and governments start to pare back stimulus.
Picking stocks right now is a particularly underappreciated talent, especially when everything is going up.
But in the years to come, when things get more challenging, that’s when hedge funds will have a chance to shine again, and even the short sellers may make a comeback.
In a year which the short sellers would probably rather soon forget, high-profile short sellers like Melvin Capital are nursing billions of dollars in losses from taking one on the chin from retail investors, armed with access and ability.
The role of retail investors in the coming years is hard to overstate, as the gamification of trading and investing has likely made some retail investment behavior durable to say the least.
While this was a phenomenon that the so-called “smart money” may not have anticipated, they have certainly adapted, with recent trading activity in retail favorites like AMC Entertainment (+6.10%) and GameStop (+2.07%) appearing to come primarily from professional investors, according to data from Vanda Research.
Which is why some of the world’s biggest investors are betting on hedge funds again.

3. Ethereum Endures a Tricky Bug Demonstrating its Resilience

  • Ethereum survives a tricky bug that could have introduced the possibility of double spending
  • Resilience of the Ethereum blockchain is testimony to its adaptability to both the strict adherence to blockchain immutability and the recognition that real life is messy 
As blockchains go, the Ethereum blockchain has endured its fair share of teething issues and come out the stronger for it.
Back in 2014 when Ethereum was released, few at the time would have bet on the fledgling blockchain to eventually become the world’s second largest by market cap.
And in 2016, the hack of the decentralized autonomous organization, or DAO hack as it’s better known, threatened to derail the adoption of smart contracts, given their potential weaknesses.
Since then though, the hard fork of Ethereum – one that recognized the ill-gotten proceeds of the DAO hack to become Ethereum Classic has faded into the shadows, as Ethereum has soared to primacy.
Powering Ethereum’s rise has been a fundamental recognition that while software code is helpful, like humans it isn’t infallible and shouldn't be approached with rigidity. 
And that recognition that the underlying blockchain, which is meant as an immutable source of truth, needs to also be flexible and nuanced enough to cater for the messiness of life, has helped Ethereum.
That Ethereum is still the main blockchain used for smart contracts and powering everything from decentralized finance or DeFi to non-fungible tokens or NFTs is testimony to the resilience of Ethereum.
Ethereum’s resilience was once again tested as it weathered a software bug in its core code that split the world’s most heavily used blockchain and opened up the possibility of spending counterfeit Ether tokens.
One of the biggest challenges for any digital currency is the risk of double spending – spending the same token twice.
Last week, outdated software caused a fork in the Ethereum blockchain, with users rushing to minimize the damage by rapidly updating a key program, and the deviant fork likely to wither as more users adopt the fix.
According to a report from The Block last Friday, at one point, more than half of Ethereum nodes (the computers that secure the Ethereum blockchain) may have been running the bug in their software.
And several Ethereum mining pools, including the world’s largest cryptocurrency exchange by volume, Binance, appear to have been mining on the wrong version as well.
What was heartening however was that the decentralized community that supports the Ethereum blockchain were quick to spot the vulnerability and quick to act on it, although there were several Ethereum addresses that exploited the bug.
Because the blockchain is built and maintained on consensus, the version of the truth that most closely adheres to the ideals of stakeholders is the only one that ultimately matters.
Earlier this month, the PolyNetwork hack and subsequent reversal and return of the hacked proceeds once again demonstrated the admirable capability of Ethereum stakeholders to self-regulate and police their own blockchain.
PolyNetwork immediately appealed to other stakeholders following the hack to not recognize the proceeds of the hack, including reaching out to Binance, Tether and Ethereum nodes.
The outpouring of support against the hack was phenomenal and may have helped explain why the hacker almost immediately returned the proceeds of the hack.

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Aug 31, 2021

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