Novum Alpha - Daily Analysis 17 June 2021 (10-Minute Read)
A terrific Thursday to you as U.S. markets started to slip after fresh data showed Americans slowed their spending last month and rising inflation.
In brief (TL:DR)
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In today's issue...
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Market OverviewIt was always a matter of time, but no investor wants to know when the party is over.
Because central banks can't support markets indefinitely, signs that the U.S. economy is on the mend has led policymakers at the U.S. Federal Reserve to consider bringing tapering ahead of schedule as well as hiking interest rates earlier than expected.
Inflation concerns took a backseat as investors that had gone long on risk, dumped everything from stocks to bonds on the prospect of having to assiduously assess valuations.
Asian markets declined with Tokyo's Nikkei 225 (-1.30%), Hong Kong's Hang Seng (-0.08%), Sydney’s ASX 200 (-0.31%) and Seoul's Kospi Index (-0.48%), all lower in the morning trading session after Federal Reserve officials sped up their expected pace of policy tightening.
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1. Wall Street Warns its Trading Boom May be Bust
When the pandemic first hit the markets last year, Wall Street banks were the first to make provisions for what they imagined would have been a cavalcade of loan defaults.
From Goldman Sachs (-0.08%) to JPMorgan Chase (+0.70%), banks, already hamstrung by post-financial crisis capital requirements, were going one step further to sandbag their levies to brace themselves for the inevitable tidal wave of bad loans that they were almost certain would wash over them.
But the debt default tsunami never arrived.
And instead, overcapitalized and conservative bankers now suddenly found themselves with excess liquidity as global central banks turned on the printing presses and Wall Street banks posted blockbuster results from trading stocks and bonds, and advising on lucrative deals and IPOs.
As the Fed flooded markets with money, and companies raced to sell new debt, retail traders and institutions moved those securities quickly, and being the middle men, banks reaped tremendous rewards.
But now some of Wall Street’s biggest names are warning that investors should brace themselves for slower returns from their trading desks, with JPMorgan Chase CEO James Dimon revealing at a financial conference this week that the firm’s trading revenue for the second quarter was likely to be down some 38% from a year ago.
Citigroup (-3.20%) has warned that its trading revenue is likely to fall by just under a third as well, with a drop-off especially in fixed income trading.
And while U.S. bank shares have been on a record pace to start the year, analysts had widely forecast that trading revenues were likely to slow this quarter on a multitude of factors, including signs that the Fed might begin to taper asset purchases, inflation concerns, and stocks hitting all-time-highs.
Nonetheless, trading revenues at Wall Street’s banks are still well in excess of any time before the pandemic, and the prospect of increasing interest rates actually plays into the favor of banks because that can translate into higher lending margins.
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2. Getting Markets to Go Back to Normal is Hard to Do
Remember the first time you rode a bike without training wheels and how unnatural it felt?
That’s what markets are experiencing for the first time in over a year.
For the past 15 months, investors confident that the liquidity taps would never run dry pushed asset prices above and beyond all conventional measures of valuation.
Analysts talked up how tech stocks were the “free lunch” trade and everything from SPACs to electric vehicle makers attracted eye-watering valuations.
But now that Californians are leading two-hour long lines at Disneyland and "The Late Show with Stephen Colbert" is playing in front of a live audience at the historic Ed Sullivan Theater, policymakers at the U.S. Federal Reserve are prepping investors for the day the training wheels on the market finally come off.
U.S. Treasury yields surged yesterday, led in particular by maturities around the 5-year zone, while measures of inflation expectations tumbled after Fed policymakers surprised markets by signaling two 0.25% interest rate hikes by the end of 2023.
Whilst the Fed had pledged to keep rates at zero all through 2023, confidence that the U.S. economy is on the mend has led policymakers to consider raising rates ahead of schedule and scaling back bond purchases.
But before investors head for the hills, bond bulls can still take some comfort from the fact that U.S. Federal Reserve Chairman Jerome Powell has insisted policy normalization is still far off.
And with the lingering threat of virus variants and millions of Americans still out of work, the Fed may only be looking to adjust the training wheels rather than ripping them right off.
While the benchmark U.S. 10-year Treasury yield did spike yesterday, after hitting a low of 1.441% in May, it’s lowest since March, it’s still trading within a relatively tight range, as opposed to yields in the 5 to 7 year maturity, which are most sensitive to expectations over Fed policy.
Traders are now betting that in the coming months, the Fed will start laying out plans on how it intends to taper its US$120 billion monthly asset purchases.
But given that interest rates continue to be low, investors which are yield-starved may still provide a captive audience for these assets the Fed no longer wants to buy.
For now though, there will be relative calm until the August central bank conclave in Jackson Hole, Wyoming, long a venue for central bankers to signal major shifts in policy.
Speaking to reporters after the Fed’s policy meeting on Wednesday, Powell said that with respect to tapering of asset purchases,
“It will be orderly, methodical and transparent.”
But make no mistake about it, the training wheels are coming off and investors may at some point actually have to assess if the valuations that they’re bidding up are justifiable or not.
Growing up is hard to do.
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3. A Glimmer of Hope for a U.S. Bitcoin ETF
The day is always darkest before the dawn.
In the depths of despair, hope.
Such platitudes are cold comfort to the legions of Bitcoin maximalists chomping at the bit and waiting for a U.S. Bitcoin ETF.
With the U.S. Securities and Exchange Commission originally due to make a decision on asset manager VanEck’s Bitcoin ETF application today, regulators have now decided to buy some time by “polling the audience” to divine the wisdom of the crowds to make a decision on the matter.
According to a filing on Wednesday, the SEC has made clear that it has not yet reached a decision either ways on VanEck’s Bitcoin ETF application, but is now “seek(ing) and encourage(ing) interested persons to provide comments.”
The SEC has approached the public to consider whether they believe a Bitcoin ETF would be susceptible to manipulation and designed to prevent fraudulent and manipulative acts and practices.
The SEC has also asked whether Bitcoin is suitable to serve as an underlying asset for an exchange-traded product.
Existing SEC rules require that national securities exchanges protect investors and the public interest, but because Bitcoin trading occurs on both regulated and non-regulated exchanges, concerns remain that the liquidity and transparency of the Bitcoin market make it difficult to guarantee the availability of such protections, regardless of the instrument used for investment.
In terms of timeline, the SEC has already extended the deliberation window once, from May 3 this year to June 17, and has the ability to extend the deadline for deliberation in various increments up to a maximum of 240 days before delivering a final decision.
While no Bitcoin ETF has yet been approved by arguably the most important capital market in the world, Canada has green lit several cryptocurrency ETFs, and similar products are listed on European stock exchanges which function like ETFs.
Many Bitcoin maximalists see a U.S. Bitcoin ETF as being the next major leap forward for institutional adoption and a bullish factor that should fuel stronger inflows, but the market has been waiting for over 13 years for that to materialize.
Nonetheless, the Biden administration has thus far proved to be the most progressive in terms of its approach towards cryptocurrencies, with the heads of all the major financial regulatory bodies forming “sprint teams” to carve up their respective jurisdictions in regulating the nascent asset class.
In and of itself, cryptocurrency maximalists should see that the proactive approach towards regulation, instead of the hands-off style of previous U.S. administrations, is a major move forward for the industry.
For greater institutional participation in cryptocurrencies, clearer regulation needs to be laid out and given the fragmented governance structure that the U.S. maintains over its financial industry, carving out areas of responsibility is an important first step.
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Jun 17, 2021