Novum Alpha - Daily Analysis 17 December 2021 (10-Minute Read)
A fantastic Friday to you as stocks flounder on the realization that monetary policy tightening may not be as good for risk assets as imagined.
In brief (TL:DR)
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In today's issue...
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Market OverviewCentral banks globally are prioritizing the fight against elevated price pressures by tightening monetary settings, while also keeping a wary eye on the impact of omicron.
That backdrop has investors questioning whether global stocks are due for a rougher patch after almost doubling from pandemic lows.
The gauge skidded on reduced appetite for more richly valued investments amid the Federal Reserve’s pivot toward reducing stimulus.
In Asia, markets were lower Friday with Tokyo's Nikkei 225 (-0.92%), Seoul's Kospi Index (-0.19%) and Hong Kong's Hang Seng (-0.94%) down, while Sydney’s ASX 200 (+0.39%) was up in the morning trading session.
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1. Sell the Rumor, Buy the News
Right up till the U.S. Federal Reserve’s last policy meeting of the year, nerves were shot as markets quivered on the prospect of the central bank tapering its asset purchases and ushering in higher interest rates next year.
Everything from stocks to cryptocurrencies were rattled by the prospect of a Fed tapering and an accelerated pace of interest rate hikes next year and the sell down was sharp and brutal.
Yet when the Fed delivered exactly what it promised, far from sending markets plummeting, stocks reversed course in a plot twist so unforeseen it could have been taken off the page of a daytime soap opera script.
What would have otherwise been a reckoning for stock traders, translated instead to the biggest rally since 2020.
Traders laid in hedges, braced for financial Armageddon and then threw caution to the wind when U.S. Federal Reserve Jerome Powell tempered the Fed’s tapering with a heady dose of economic optimism.
And once it became clear that stocks had a support level, investors who had loaded up on bearish options started to unwind them, lending even more ferocity to the rebound, giving the benchmark S&P 500 its best Fed day in 13 months.
But there was method to the madness beyond the unwinding of bearish options, Powell’s robust endorsement of the economy, characterizing both demand and income as strong, also came on the backdrop of fewer rate hikes in 2024.
It could also be that investors are gaining confidence from the Fed’s willingness and ability to combat inflation, decrease the odds of stagflation and reducing the odds of policy error.
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2. Is Wall Street Creating a Chinese Bear Trap?
Of all the institutional voices that have been critical of China, none has been more vocal than billionaire hedge fund manager George Soros, who has claimed that Chinese President Xi Jinping doesn’t understand the market economy.
But while other countries used pandemic stimulus to trigger speculative frenzies in everything from meme stocks to cryptocurrencies and real estate, China went the other way to try and deflate bubbles or prevent them from ever lifting off.
The result has been a Chinese stock market that has lagged global peers by as much as 37%, according to the MSCI China Index, the biggest gap since 1998, a year after Hong Kong was handed back to China.
Meanwhile, high yield Chinese debt is trailing global high yield returns by about 25%, the biggest spread in over a decade.
And while real estate prices have been surging everywhere from Singapore to Sydney, they’ve fallen in China for the past four months.
But that divergence is now tempting Wall Street to take a closer look at China’s cheap valuations, especially as Beijing has signaled it’s likely to take a more dovish policy stance, with the economy now showing signs of weakness.
Over the past few months, Goldman Sachs (+1.91%), Blackrock (+0.73%), UBS Group (+1.94%) and HSBC Holdings have all suddenly become bulls in the China shop, turning overweight on the Middle Kingdom’s equities even as risks from China’s massive property sector persist, with the latest developer Shimao showing signs of weakness.
On the one hand, there is significant scope for China to loosen policy, especially following a period of tightening, but the bull case is built on the expectation that Beijing will support the economy in 2022 to prevent a hard landing.
There is some context to suggest that may be the case.
With Chinese President Xi Jinping set to ascend the Dragon Throne for an unprecedented third term that potentially paves the way for him to be China’s leader for life, economic issues are likely to be the biggest bugbear for China’s citizenry and at least until the coronation, there is more than enough reason to believe that Beijing will do all it takes to prevent a hard landing.
The People’s Bank of China reinforced that view this month when it freed up liquidity for lenders, reducing the reserve requirement ratio and there’s growing speculation banks will lower their benchmark loan rate for the first time since April 2020.
But while Wall Street may be bullish on China, it may also be setting a bear trap for retail investors.
Wall Street has significant exposures both to Chinese shares listed on U.S. bourses, as well as through participation in a wide array of offshore debt issued by Chinese firms, many of which are now trading at cents on the dollar and why not get someone else to carry the can?
Because many of the factors that crushed China’s financial markets this year continue to be overhangs well into next year, there is more than enough reason for caution.
The Chinese Communist Party’s policymaking is opaque and unpredictable and hopes that Beijing would ease up on the tech sector were crushed when ride-hailing app Didi Global was made to delist from Nasdaq.
Cooling relations between China and the U.S. are also a threat on Chinese profits, as are soaring commodity costs and growing labor unrest.
The so-called “sideways movement” is growing in China, where workers who are fed up with the long hours, working conditions and low salaries are spending factory floor time playing video games or sleeping.
And Beijing is also wary of blowing bubbles in its own financial markets, which may limit the extent to easing.
But perhaps more disconcerting is that Chinese consumers collectively feel less rich because of declines in property prices.
With so much Chinese wealth closely tied to the embattled real estate sector, declining property prices are having a significant impact on Chinese consumption, with consumer sentiment flagging and the prospect that Wall Street may be creating a debt trap for ill-informed retail investors.
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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. Proposed Market Rules for Cryptocurrency Derivatives Reveal Institutionalization
Just when you thought you couldn’t put the Wild West of cryptocurrencies into a suit and tie, the International Swaps and Derivatives Association or ISDA, said on Tuesday that it was developing common legal standard and templates for derivatives linked to the growing digital asset market.
In a move intended to broader the appeal of cryptocurrencies for institutional investors, ISDA is looking to ensure that its common legal standards are sufficient to cover “potential disruption events.”
One key issue flagged for consideration by ISDA was forks, where a blockchain effectively splits into two branches, either because of disagreements over its development, or as typically is the case, system and software upgrades.
ISDA’s master agreements are widely used as a standardized legal template for most of the world’s derivative trades in bonds, equities, currencies and other traditional financial assets.
Using these templates helps to simplify, streamline and speed up transactions and market participations generally follow ISDA’s guidance on how to adjust contract terms if an unexpected event disrupts a derivative’s performance.
The move by ISDA comes as the first bitcoin-futures based ETF was successfully launched in the U.S. this year and institutional interest in the nascent digital asset class soars.
Last month, bitcoin and ether futures on the Chicago Mercantile Exchange, the only cryptocurrency derivative products that are accessible by institutional investors, saw average open interest soar to US$4.3 billion for bitcoin and US$1.2 billion for ether.
Cryptocurrency derivatives are increasingly the tail that wags the dog (not Dogecoin), with derivatives now representing some 55% of the total cryptocurrency market, according to data from CryptoCompare.
Industry stakeholders, their coffers rich with cryptocurrency takings, are also spending some of their newfound wealth on armies of lobbyists on Capitol Hill, to try and shape regulations surrounding cryptocurrencies to their favor.
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Dec 17, 2021