Novum Alpha - Daily Analysis 19 October 2021 (10-Minute Read)
Markets are taking some comfort from robust earnings but also grappling with the possibility of earlier-than-expected interest-rate hikes to quell price pressures.
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A terrific Tuesday to you as markets tread water in the face of mounting challenges.
In brief (TL:DR)
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In today's issue...
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Market OverviewMarkets are taking some comfort from robust earnings but also grappling with the possibility of earlier-than-expected interest-rate hikes to quell price pressures.
Traders are waiting to see if a slate of U.S. Federal Reserve speakers this week will try to calm the jitters stemming from the gradual scaling back of pandemic-era policy support.
In China, the focus is on debt-laden China Evergrande Group’s real-estate unit and its coupon payment due on a local yuan-denominated bond.
In Asia, markets mostly rose Tuesday as technology shares rallied and the prospect of solid corporate earnings with Tokyo's Nikkei 225 (+0.65%), Hong Kong's Hang Seng (+1.32%), Seoul's Kospi Index (+0.60%) and Sydney’s ASX 200 (+0.17%) all up in the morning trading session.
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1. Goldman Sachs Vaults the Great Financial Wall of China
Google (+1.00%) pulled out, while Facebook (+3.26%) was a nonstarter, and now even Microsoft’s LinkedIn has thrown in the towel when it’s come to the world’s second largest economy.
Because as lucrative as the sprawling Chinese economy may potentially be, getting in and doing business there, as many an American company will attest, can be challenging at best and impossible at worst.
Yet somehow, Goldman Sachs has managed to do what some of the world’s biggest tech companies have failed to – make inroads into China, having received regulatory approval to take full ownership of its securities joint venture in China, and allowing the investment bank to expand in the country as Beijing eases restrictions on foreign firms in its finance industry.
Until now, foreign financial services firms have had to enter joint ventures with local Chinese partners to access the Chinese market.
But Beijing has progressively been increasing market access for foreign firms which have been eager to expand, despite growing concerns over a political and regulatory climate that has proved more unpredictable.
Last December, Beijing introduced fresh rules which permits foreign investment banks to own 100% of their Chinese operations, paving the way for them to inject more capital, personnel and technology.
But risks abound.
While foreign investment banks may view shares and ownership as immutable and legally defensible, there is no guarantee that Chinese regulators cannot and will not restrict their operations through other ways and means.
Furthermore, the concept of “ownership” in China is far more plastic than foreign entrants will give Beijing credit for, having only moved into market reforms towards the end of the last century, China’s property laws still leave much to be desired.
Nevertheless, Goldman Sachs has now become the second investment bank to gain full ownership of its Chinese entity, after rival JPMorgan Chase (-0.036%) received approval in August.
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2. Xi Targeted the Rich, But the Poor Are Feeling the Pinch Too
A brief study of Chinese President Xi Jinping’s illustrious political career reveals a seasoned politician who has not shied away from gambling big when the stakes are high.
And for Xi, no stake is higher than cementing an unprecedented third term as leader of the world’s second largest economy, which is why in the run-up to an all-important political gathering next year, the Chinese President and his apparatchiks have been busy “reddening” the Chinese economy.
From a crackdown on Chinese Big Tech to afterschool education and runaway property prices, all of the trappings of capitalism that had come to define the Chinese economy have come under increasing pressure from Xi’s relentless pursuit of “common prosperity.”
But this time, Xi may have overplayed his hand.
In recent weeks, Chinese authorities have moved to soften radical policy shifts designed to make the economy less dependent on debt, monopolies and fossil fuels.
While Beijing’s edicts censured China’s corporate elites, they’ve now also begun showing signs of tricking down to hit ordinary citizens, and hard.
Higher power bills and lost savings invested in China’s real estate market even as the economy continues to struggle are seeing fewer jobs at a time when Xi can least afford any social instability.
Beijing’s push to wean itself off coal, has seen factories fall into darkness and homes without heat, even as winter approaches.
And that’s had an effect on ordinary factory workers, who have had to contend with fewer shifts and falling income, even as demand globally for Chinese products has soared.
Beijing, which until fairly recently, maintained a stony silence with respect to the Evergrande Group’s debt woes, finally spoke out last Friday, with the People’s Bank of China, the central bank, assuring that risks were “controllable” and lenders should keep credit to the real estate sector “stable and orderly.”
Xi is now faced with a dilemma – continue to push ahead with structural reforms that could mean untold pain for China’s 1.4 billion people, about 40% of whom earn just US$155 per month on average or delay these reforms and allow widening inequality to persist, that could undermine the Chinese Communist Party’s legitimacy.
Against this backdrop, the odds of a messy implosion of Evergrande Group appears less likely – ahead of a twice-a-decade leadership reshuffle of the Chinese Communist Party, the last thing Xi needs is a sharp economic downturn that threatens social unrest.
China’s real estate market makes up a full 29% of GDP and makes up 40% of the country’s economy.
The wealth and aspirations of millions of Chinese is also closely tied to real estate prices, which since the opening up of China, has only known growth.
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3. The Bitcoin "Risk-Free" Trade is Back
Given the volatility inherent in cryptocurrencies, few (if any) investors would associate the term “risk-free” with bitcoin.
Yet as the price of bitcoin has rallied hard with the prospects of a U.S. bitcoin ETF, the closest thing to a risk-free cryptocurrency trade has emerged yet again.
Like the aurora borealis, the risk-free bitcoin trade is a seasonal phenomenon that traders eagerly anticipate when it makes its appearance – the basis trade.
A basis trade is a simple financial trading strategy which consists of the purchase of a particular financial instrument or commodity and the sale of its related derivative.
Traders can make “risk-free” money when there is a significant price difference between the underlying commodity and its derivative, which is otherwise called a “spread.”
With a sharp rally in bitcoin’s price, bullish sentiment has driven the price of bitcoin futures skyrocketing and a simple basis trade would be to buy bitcoin today, at its spot price, while also selling the price of a bitcoin future.
Say the price of bitcoin is US$62,000 today, a trader would buy that bitcoin today and sell a future for delivery on December 31, 2021 at US$70,000, because futures typically trade at a price premium to spot, a phenomenon called “contango.”
If the price of bitcoin were to fall, the trader may lose on the spot price of the bitcoin they’re holding, but they’ll make on the futures contract because of the delivery at the higher price.
Whereas if the price of bitcoin was to soar above the futures price, the trader would make on the spot bitcoin that they’re holding, despite losing on the futures contract.
As the price of bitcoin rises, as it is now, the contango trade becomes more crowded and eventually arbitragers will trade out that spread, which is what happens in the traditional financial markets, but given that cryptocurrency trading still revolves around retail investors, takes far longer to happen.
But given the spreads available now, anywhere from 6% to as high as 10% in dollar terms, there is plenty of upside in the “risk-free” trade.
The risk is when retail investors get sucked into the trade by more professional traders who buy bitcoin on the low, then bid up the price of the long-dated futures contract and sell that off into the strength of the market.
And the “risk-free” isn’t always available either.
Earlier this year, a broad selloff in cryptocurrencies saw spreads squeezed out of the market.
But like the aurora borealis, traders are cashing in on the seasonal occurrence and minting money in the process.
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Oct 19, 2021