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Novum Alpha - Daily Analysis 10 November 2021 (10-Minute Read)

Staggering factory price increases in China have spooked global investors, as China's factory prices rose to a 26-year high on the back of heightened commodity costs and energy supply disruptions at the world's second largest economy and a key global manufacturer. 

In today's issue...

  1. A Chinese Real Estate Crisis will Not Leave the U.S. Unscathed
  2. Europe to Ban Trading Practice that Fueled U.S. Meme Stock Boom
  3. The Crypto Picks & Shovels Trade Comes Under Pressure

Market Overview

Staggering factory price increases in China have spooked global investors, as China's factory prices rose to a 26-year high on the back of heightened commodity costs and energy supply disruptions at the world's second largest economy and a key global manufacturer. 
Consumer price increases are also souring investor sentiment. 
Inflation hasn't been an issue for so long that now any signs of it are shaking investors already contending with unprecedented asset valuations.  
In Asia, markets were uniformly lower on Wednesday's morning trading session, with Tokyo's Nikkei 225 (-0.30%), Hong Kong's Hang Seng (-1.03%), Sydney’s ASX 200 (-0.09%) and Seoul's Kospi Index (-0.97%) all lower on inflation concerns. 

1. A Chinese Real Estate Crisis will Not Leave the U.S. Unscathed

  • U.S. Federal Reserve warns that Chinese real estate crisis could have contagion effects globally 
  • Fed highlights systemic risk from over-leveraged Chinese companies and local governments
For centuries Americans have comforted themselves cocooned in the isolation of their continent. To the north, a weak neighbor, to the south, a weak neighbor, to the west, fish, to the east fish.
But despite centuries of attempt isolation, the U.S. is more intertwined in the affairs of the world than at any point in its history.
Whether it’s been global conflicts or a pandemic, what happens offshore affects Americans onshore.
Which is why the assumption that a Chinese property market collapse would leave the U.S. economy unscathed is naïve at best and delusional at worst.
On Monday, the U.S. Federal Reserve warned that stresses in the Chinese real estate sector “posed some risks” to the U.S. economy, in its semi-annual Financial Stability Report.
Earlier, the Fed had been relatively sanguine about the potential fallout of China Evergrande Group’s spreading to the global financial markets.
The Fed has grown increasingly worried over the stability of the Chinese economy, given the high levels of local and government debt, elevated levels of leverage in the financial sector and real estate valuations that remain stretched.
“In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group.”
The Fed said the Chinese financial system could come under pressure if there were “spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite.”
Coming just barely two months after Fed chairman Jerome Powell had dismissed concerns over the China Evergrande Group’s troubles to issues that were “very particular” to China, the tone of the central bank has changed since then.
As with countless other global financial crises which have tended to be triggered by flaky emerging markets at the other side of the world, there are growing concerns that China could have a similar impact not just on the U.S. economy, but the global one as well.
According to the Fed,
“A sharp tightening of financial conditions, possibly triggered by a rise in bond yields in advanced economies or a deterioration in global risk sentiment, could push up debt-servicing costs for EME sovereigns and businesses, trigger capital outflows, and stress EMEs’ financial systems.”
For now, there are signs that Beijing may force a restructuring of China Evergrande Group, akin to what was organized for the highly leveraged HNA Group that had for years gone on a debt-fueled acquisition binge, and that should provide investors some comfort.
Ahead of a key leadership conclave of the Chinese Communist Party next year which will see Chinese President Xi Jinping make a play for an unprecedented third term in office and potentially leader for life, Beijing will be eager not to implode the economy ahead of what should otherwise be a coronation for Xi. 

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2. Europe to Ban Trading Practice that Fueled U.S. Meme Stock Boom

  • European financial regulators move to ban payment for order flow, which has been blamed for fueling the meme stock frenzy in the U.S. 
  • Zero commission trading in Europe is starting to pick up and regulators are looking to ensure that speculative bubbles are not encouraged in its markets 
As any trader will tell you, liquidity is everything. Liquidity is key to getting into the market and cashing out, whether it’s cryptocurrencies or meme stocks.
When a retail trader buys a stock or an option, even though the screen or app suggests that the trade has been executed, in reality, retail brokerages of the likes of Robinhood Markets don’t actually finish the last leg of that order.
Instead, retail brokerages take those trades and pass them on to wholesalers like Citadel Securities or KCG who pay them for those trades.
In a typical transaction, a trader instructs the broker to execute a stock trade and the broker then passes on this trade to a wholesaler who pays a fee to the brokerage.
The wholesaler now looks to find the “best execution” for the trade which could mean different things, including the speediest trade, the lowest price or the order that is most likely to be filled.
If the trade gets executed, the wholesaler returns the proceeds of that trade to the brokerage who then credits the trader.
In reality, the entire process takes seconds to complete and for the most part is opaque to the retail investor.
Regulators are growing increasingly concerned that by paying for order flow, brokerages are being incentivized to encourage their customers to trade in excess.
And because brokerages receive a fee from wholesalers for passing orders through to them, they can afford to offer zero-fee trading on their platforms, which lures in more traders.
Although regulators suggest that this payment for order flow helped to fuel the meme stock frenzy earlier this year in companies like GameStop and AMC Entertainment, some investors argue that it gave these companies a second lease of life.
AMC Entertainment is seeing a rebound as Americans head back to the theater as pandemic restrictions are lifted.
Although day trading is not as prevalent in Europe, zero-fee trading is starting to make inroads and drawing scrutiny from financial watchdogs.
Part of the problem for European regulators is that order flow tends to be opaque, and it’s difficult to assess how prevalent the practice of paying for order flow is across Europe’s multiple market execution venues.
European financial regulators are setting out rules to ensure greater transparency for order flows and will be banning the controversial practice of payment for order flow. 

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3. The Crypto Picks & Shovels Trade Comes Under Pressure

  • Coinbase Global revenue misses analyst estimates, despite rising cryptocurrency prices  
  • Shift to focus more on institutional investors may have put pressure on margins, leading to missed revenue targets 
Cryptocurrencies may have had a fantastic run last month, but that hasn’t translated into more profits for the picks and axes trade, cryptocurrency exchanges.
For some investors, betting on cryptocurrencies may be too speculative a venture and instead chose to bet on the businesses that supply traders with the tools to trade, like Coinbase Global.
But worse than forecast second quarter results at America’s sole listed cryptocurrency exchange saw shares of the company plummet by as much as 12% in afterhours trading.
Coinbase Global posted US$1.24 billion in revenue for the third quarter of 2021, lower than analyst expectations of US$1.57 billion.
The cryptocurrency exchange blamed lower cryptocurrency prices at the start of the third quarter and market turbulence for falling short of expectations which had been lifted thanks to the sharp increase in the number of downloads of the Coinbase Global app.
Those downloads however did not translate into increased trading volume, as easing pandemic restrictions over the summer saw more retail investors put aside their phones and opt for outdoor and in-person entertainment.
Analysts are mixed in their assessment of what happens next for Coinbase Global.
Although bitcoin continues to rise, setting a fresh all-time-high on Tuesday, recurring monthly user numbers at Coinbase Global slumped, as have trading volumes.
Coinbase Global is trying to attract more hedge funds and institutional investors to its platform, because retail trader volumes tend to slough off during periods when cryptocurrency prices trade relatively flat.
But regulatory restrictions on Coinbase Global have stymied attempts to draw in more institutional traders and hedge funds, as the cryptocurrency exchange remains hamstrung in offering new products or derivatives.
In September, the U.S. Securities and Exchange Commission threatened to sue Coinbase Global if the cryptocurrency exchange went ahead with its cryptocurrency lending product, leading to the withdrawal of the Lend product.
Shifting to focus on institutional investors also puts pressure on margins, as they can demand lower fees, compared with retail and that may also have had an effect on earnings for Coinbase Global.
Maybe investors who wanted exposure to bitcoin should just gone ahead and bought some?  

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Nov 10, 2021

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