Novum Alpha - Daily Analysis 16 December 2021 (10-Minute Read)
A terrific Thursday to you as stocks take a turn for the better on tapering, given the certainty of the U.S. Federal Reserve's actions.
In brief (TL:DR)
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In today's issue...
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Market OverviewThe U.S. central bank said it will double the pace at which it tapers bond purchases to $30 billion a month and projected three quarter-point interest-rate increases in 2022, another three in 2023 and two more in 2024. It also flagged economic risks from the omicron virus strain.
The market response to the Fed so far suggests some relief from more policy clarity and a belief that the pivot away from ultra-loose monetary settings won’t undo the rally in a range of assets from pandemic lows.
On the virus front, omicron continues its global spread. A European official said the variant will likely be the dominant strain there by mid-January.
In Asia, markets were mixed Thursday with Tokyo's Nikkei 225 (+1.78%) and Seoul's Kospi Index (+0.20%) up, while Sydney’s ASX 200 (-0.50%) and Hong Kong's Hang Seng (-0.79%) were down in the morning trading session.
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1. Shimao Bond Crash Demonstrates Extend of Opacity in China's Real Estate Sector
It’s been said that people who live in glass houses shouldn’t throw rocks, but what if the home was made from mirrored glass?
With a balance sheet less than a third the size of China Evergrande Group’s, Shimao Group Holdings, a Chinese property company that doesn’t even crack China’s top ten by sales has suddenly become the single weak spot in the damn of debt that has beleaguered the China’s real estate market.
The problem with Shimao has been one of reputation and in this case, a good one.
Long considered one China’s healthier real estate players, until recently, Shimao had appeared largely insulated by the credit market turmoil that has plagued bigger rivals like China Evergrande Group and Kaisa Group Holdings.
But unconfirmed speculation of payment difficulties at Shimao has sent its dollar-denominated bonds plummeting from almost 90 cents on the dollar to 59 cents as of yesterday.
What makes Shimao’s bond slide particularly disconcerting for investors is that higher-rated Chinese developers have mostly weathered the recent selloff in Chinese debt, with the yield on a gauge of Chinese junk debt recently soaring past 20%.
Shimao is still rated investment grade by Fitch Ratings, even as S&P Global Ratings lowered its rating of the firm to junk last month.
But more significantly, Shimao’s alleged troubles are leading investors to question which will be the next shoe to fall?
Shimao’s higher rating has also been its own undoing as its debt is more likely to be held by investors who have much lower tolerance for defaults than the swashbuckling bond heroes who trade in more high risk, high yield bonds like those of Evergrande.
That Evergrande was leveraged to the hilt was no secret, which is why in many ways, Shimao is systemically more important to the ever-slowing Chinese economy than Evergrande.
While Evergrande was never likely to be China’s Lehman Brothers moment, Shimao could well be, leading to speculation that Beijing will need to step in with some form of assistance because a default by Shimao could cause a much broader reassessment of risk across the entire Chinese property sector.
Funding costs for higher-rated developers could soar and homebuyers who had flocked to companies like Shimao, for their perceived safety, could get even more spooked by a Chinese real estate sector that has been reeling from declining prices and unfinished projects.
Because the real estate sector makes up some 70% of China’s economy and 29% of GDP, a systemic shock could cause social instability, at a time when Chinese President Xi Jinping is looking towards his coronation as leader for life next year.
Not helping matters, on Monday, a Shimao services unit had agreed to buy another unit of Shimao Group Holdings for US$259 million and interpreted as a sign by some analysts that the developer is shifting monies to shore up weaker parts of the business.
Fortunately, Shimao Group Holdings has debt which is far more manageable from Beijing’s perspective, with just US$10.1 billion in outstanding local and offshore bonds, compared with Evergrande’s over US$305 billion in liabilities.
But unfortunately, that is the debt that lenders know about, and beneath the surface, the true picture may be far less sanguine.
Chinese developers have long found myriad methods to obscure debt off their balance sheets, using everything from privately placed bonds to joint ventures and wealth-management products, a favorite strategy of China Evergrande Group.
Such wealth-management products were often sold to retail investors, homebuyers and even the real estate developer’s own employees and these products were loosely regulated, if regulated at all.
Because it’s difficult to know the true extent of these off balance sheet obligations, HSBC estimated that Chinese developers have at least US$2.7 billion of private placement notes due in the 18 months from October, but even these numbers can’t be certain.
The total exposure to wealth management products is even harder to estimate because the sector was barely regulated.
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2. Investors Are Voting With their Wallets into Inflation-Linked Securities
As widely anticipated, the U.S. Federal Reserve brooked no surprises yesterday when it predictably doubled the pace of its tapering of asset purchases to usher in the flexibility to raise rates earlier next year should it need to.
The world’s foremost central bank has also dropped any pretense that inflation is “transitory” despite growing evidence that it may in fact be.
Take chipmakers for instance, which are seeing their order backlogs slowly but surely being cleared.
Soaring shipping rates, while stubbornly high, are also starting to taper for longer-dated voyage bookings.
And even as Covid-19 rears its ugly head again in China, Beijing is desperately trying to get manufacturing activity up again as economic growth slows.
All of which seem to suggest that inflation will start to ebb towards the end of 2022.
Nevertheless, investors are not waiting to find out, as inflation-protected government bonds, commodity funds and real estate investment trusts see a boom in flows.
With interest rate hikes months away, the Fed has said that it won’t raise rates while buying assets, akin to hitting the brake and the accelerator at the same time, more investors are betting that a combination of soaring energy prices, supply chain snarls and heavy government spending are worth hedging against.
Even though the year isn’t over, funds holding U.S. Treasury Inflation-Protected Securities (U.S. government debt that is indexed to inflation), saw a record US$66.8 billion worth of inflows, according to data provider EPFR.
But it’s not just TIPS which are drawing flows, so-called “real assets” such as commodities and real estate are drawing a second look from investors, with a US$4.5 billion Invesco commodities ETF, with holdings in futures tracking everything from copper to crude oil and soybeans, seeing US$2.4 billion in inflows in the year to November, much of which came in October.
Gold, which has historically been touted as a haven asset during inflationary times, has so far failed to bedazzle investors this year.
Despite both Goldman Sachs (+0.28%) and Citigroup (-0.66%) suggesting that the precious metal could hit as high as US$2,300 per ounce this year, gold has remained relatively lackluster, even as U.S. headline inflation has exceeded 5% for six consecutive months.
A leading gold ETF has seen over US$10 billion in outflows according to ETF.com while cryptocurrencies meanwhile have surged, helped in large part by the narrative that bitcoin can help hedge against inflation.
Because energy costs play a large role in inflation calculations, the two are seen as closely linked and rising oil and natural gas prices have drive up costs for consumers directly.
A higher price for a tank of gas or a more expensive heating bill, as well as increased manufacturing and shipping costs, have all helped to fuel inflationary price pressures.
And to that end, bets on higher energy costs have pushed flows into energy-related stock funds to a record high this year, according to EPFR.
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Find out more about Novum Alpha as leading luxury portal Luxuo.com interviews our CEO & General Counsel, Patrick Tan...
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3. November was a Good Month for Cryptocurrency Hedge Funds
In signs of broader adoption and search for greater returns, hedge funds offering exposure to a more diverse portfolio of cryptocurrencies outperformed bitcoin last month after the benchmark digital asset fell off its all-time-high.
While bitcoin ended the month lower by 6.17%, the Eurekahedge Crypto-Currency Hedge Fund Index only fell by around 2% in comparison, adding to growing evidence that so-called “altcoins” might offer investors superior performance to bitcoin, especially given bitcoin’s torrid rally to almost US$69,000 in early November.
Although bitcoin is the oldest and by far the most well-known cryptocurrency, as more investors pour into the space, there will naturally be some degree of curiosity to explore opportunities outside of bitcoin.
Bitcoin’s gains are also tempered somewhat because there are an increasing number of instruments to bet against the inexorable rise of the cryptocurrency versus many altcoins.
The volume and liquidity of derivatives for bitcoin far exceeds those of other cryptocurrencies, making it somewhat easier for traders to bet against the benchmark cryptocurrency.
And investors looking to gain access to altcoins without handling the cumbersome private keys themselves may have more options sooner than expected.
Digital asset firm Securitize is launching two tokenized funds that will track cryptocurrency indices from S&P Dow Jones Indices.
Of greater relevance to those looking for more exposure to altcoins, the Cryptocurrency Large Cap Ex-MegaCap Index, among the first of such funds and will only be available to accredited investors, with 30 different cryptocurrencies constituting the fund and a management fee of just 0.5%.
According to a press release from Securitize Capital, the asset management arm of Securitize,
“The new tokenized funds provide investors exposure to a diverse blend of cryptocurrencies and emerging technologies.”
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Dec 16, 2021