Novum Alpha - Daily Analysis 20 December 2021 (10-Minute Read)
A magnificent Monday to you as markets remain moribund on the prospect of monetary policy tightening in shortened week leading up to Christmas.
In brief (TL:DR)
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In today's issue...
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Market OverviewGlobal stocks retreated last week in part on an outlook of diminishing central bank stimulus as officials pivot toward fighting inflation.
Federal Reserve Governor Christopher Waller said a faster wind-down of the central bank’s bond-buying program puts it in a position to start lifting interest rates as early as March.
Markets are grappling with a range of uncertainties while heading toward a holiday period when thinner trading volumes can exacerbate swings.
In Asia, markets fell Monday with Tokyo's Nikkei 225 (-0.78%), Hong Kong's Hang Seng (-0.49%), Sydney’s ASX 200 (-0.30%) and Seoul's Kospi Index (-1.00%) were all red in the morning trading session.
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1. Asian IPOs Flounder After Listing
The problem with an IPO these days is that they were designed based on assumptions that retail investors and those excluded from IPO allocations would pick up the tab once shares of these companies hit the public markets.
But as the past year has demonstrated, retail investors are more savvy than ever, now constitute as much as 1 in 5 of every trade in U.S. markets, and have demonstrated how they can bring the pain down on short sellers or the so-called “smart money.”
Think of the blockbuster IPOs of food delivery app Deliveroo (+0.19%) and India’s Paytm (-4.82%) and there’s no shortage of stories where a public listing has only brought pain for a company’s promoters.
Nonetheless, IPO action has reached fever pitch in Asia, where thanks to a blistering first half, amid a global boom, public floating of companies have hit a record US$190 billion so far this year, up almost a third from all of 2020.
Momentum on the IPO front has weakened however in recent months as Beijing has escalated its regulatory assault on private enterprise, putting major listings on hold and injecting uncertainties whether or not they will go ahead and if so, which markets.
Just like nature however, markets abhor a vacuum, and while Chinese listings may decline, many expect South Korea and India to fill the void, with industries from clean energy to fintech substituting for once-dominant Chinese tech firms.
Some of Southeast Asia’s biggest tech unicorns are also expected to float shares next year, whether through SPACs or IPOs and these are likely to be in the U.S. as well, to pick up some of the slack left behind by Chinese firms headed back to Hong Kong to relist there as the risk of Chinese firms being forced to delist from U.S. exchanges increases.
Listings next year will face several headwinds, including tighter central bank monetary policy and higher inflation which will draw sharper scrutiny of valuations and this should mean that investors looking to participate in the growth story of India or Southeast Asia should pay careful attention to the listing prices of many of these companies.
Grab (+4.41%), a Southeast Asian ride hailing app that also offers everything from payments to food delivery, akin to the region’s WeChat, saw its listing on U.S. markets via a SPAC go sour soon after shares were made available, falling by 21% on its debut.
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2. The Interest Rate Outlook for 2022 is "Umm..."
While investors may have voted with their feet last week when the U.S. Federal Reserve announced that it would be accelerating its tapering of asset purchases and the Bank of England shocked investors with a surprise rate increase, there is still some ways to go before risk assets tank completely.
To begin with, with U.S. inflation roaring ahead last month at 6.8%, the Fed would be seen to be remiss in its duty by doing nothing and it can’t raise rates so long as asset purchases remain in place.
Because the future is uncertain – most would argue that inflation is no longer “transitory” – policymakers will need all the tools available at their disposal, and this includes the ability to raise rates, which is where the Fed is somewhat hamstrung for now.
The Fed won’t raise rates while it’s still buying U.S. Treasuries and mortgage-backed securities – akin to hitting the gas and the brakes at the same time and because it’s not at all clear whether supply chains will rehabilitate in time, flexibility is key.
With the Netherlands the first European Union nation to re-enter lockdown in the face of an omicron surge and case numbers soaring in the United Kingdom, the Bank of England may regret having played its hand too early.
The biggest worry for investors next year is likely to be the risk of central banks making policy mistakes.
If policymakers respond to price pressures and attempt to douse the flames of inflation with too much enthusiasm, there is a real danger that many risky assets (from overvalued tech stocks to cryptocurrencies) will be vulnerable, just not immediately.
One of the overarching narratives has been that stocks are overvalued, but when viewed in the context of bond yields, then there are not.
Buying Treasuries at the moment in such an inflationary environment means that equities, expensive as they are, remain a bargain, and that’s why equity markets haven’t tanked even though weaker hands have wavered.
Take away those rock-bottom yields on benchmark bonds however and things could change rapidly.
In a recent Bank of America survey of credit investors, the vast majority are more focused on policy missteps as opposed to pandemic problems – with 70% of the view that the omicron variant would have limited economic impact thanks to a low appetite for lockdowns and the safety net of existing vaccines.
But the fresh pandemic restrictions in both the U.K. and Netherlands may challenge that assumption.
Case numbers are soaring in U.S. urban centers and given the winter conditions, the spread of the omicron variant is being exacerbated.
To that end, the Fed has merely increased its options, scaling back asset purchases is probably advisable especially given that there are signs that the U.S. economy is recovering strongly.
U.S. Federal Reserve Chairman Jerome Powell has also oft reiterated that the central bank could reverse course if needed – the key being flexibility.
While investors remain focused on policymakers, the bigger issue really should be the pandemic – it’s not over.
Inflation is a problem, but no one knows if it’s truly “transitory” or even what that means – is six months of price increases a persistent problem if it’s met with stable prices from the seventh month on?
Most policymakers are still trying to feel their way in the dark and like it or not, central bankers serve at the behest of their political masters, which is why the fight against inflation needs to be seen to be done at the highest levels of decision making.
Central banks have been patient thus far with price increases, but many are betting next year is the year they will buckle to both political and price pressures.
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3. Have Cryptocurrency's Stablecoins Become too Big to Fail?
It used to be that cryptocurrency investors were left to their own devices – buyer beware and don’t come crying to regulators when you lost your shirt in what was clearly (to authorities at least) a highly speculative market.
But with cryptocurrencies pushing well over US$2.2 trillion in market cap (on a good day), systemic risks could potentially spillover into the financial markets.
Last week, the U.S. Treasury’s top official for financial oversight urged lawmakers on Capitol Hill to act fast to protect not just investors but the entire financial system to risks posed by stablecoins.
To be sure, stablecoins are not particularly large (for now), with Tether, the world’s most popular dollar-based (using the term “backed” would be misleading) stablecoin, having a market cap of just around US$76 billion.
The bigger issue that the U.S. Treasury undersecretary for domestic finance has identified, is what exactly those stablecoins are invested in to.
Speaking with Bloomberg Television, Nellie Liang who formerly led the U.S. Federal Reserve’s financial stability division said of regulators,
“They can do a little here and a little there, but if these are foundational to crypto assets and they aren’t stable, that could potentially be a big risk.”
“We need congressional action to address the prudential risks of stablecoins.”
Last month, a smaller group of federal agencies, including the Fed, appealed to Congress to act because of what they termed “key gaps” in regulatory authority over stablecoins, urging lawmakers to require stablecoin issuers become insured depository institutions, subject to oversight from banking regulators.
Liang has agreed with this view, noting that such oversight would allow agencies to examine them for operational risks, apply broad safety and soundness standards and assess their ability to pose collective, systemic risks.
Although stablecoins for now are largely used as a conduit into the realm of cryptocurrencies, used to trade everything from bitcoin to digital asset derivatives, their issuance could expand dramatically if they were to be adopted as a widespread tool for everyday payments.
And that may not be as farfetched as it sounds.
Myanmar’s government in opposition, in response to the continued crackdown by the country’s junta following a coup earlier this year, has declared Tether the official currency of the opposition.
Because Tether can run atop several blockchains, transfers are relatively seamless and can be done via smartphones or over the internet.
El Salvador declared bitcoin to be legal tender earlier this year as well, becoming the first country in the world to do so.
Many countries in the world continue to use the dollar as their local currency, whether or not that usage is sanctioned or supported by Washington.
From Liberia to Laos, dollars can be seen to be accepted at shops and businesses – a stablecoin version that can be transferred electronically becomes a natural extension of that.
What may be keeping Congress and Treasury up at night however is the elephant in the room – that companies like Tether, which issues USDT, the dollar-based stablecoin are potentially huge holders of both government securities and commercial paper.
Many investors assume that the markets for U.S. Treasury securities are some of the deepest and most liquid, but bouts of low liquidity have occurred during times of stress.
On numerous occasions in past years, investors had fled the Treasury markets.
Treasury auctions have been undersubscribed and last March, when the pandemic struck, liquidity in Treasuries nearly evaporated, threatening to freeze global credit markets and forcing the Fed to intervene with emergency buying.
These concerns over Treasury market liquidity have only grown, especially as the Fed prepares to eventually halt its pandemic-buying of Treasuries by next March.
That means that even a smallish sale of U.S. Treasuries, say by the likes of Tether (which reported that it holds some US$19 billion in Treasury bills in September this year, could crash the entire market.
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Dec 20, 2021