Novum Digital Asset Alpha – Daily Analysis 16 June 2020 (10-Minute Read)

I hope you had a massive Monday and that your week is off to a great start! 

Like the doting grandfather who’s come to give us a Werther’s Original after we’ve scraped our knees, U.S. Federal Reserve Chairman Jerome Powell has swooped in with words of calm and some candy to make markets feel a whole lot better. 

Markets received the boost that we had spoken about yesterday and the S&P 500 (+0.83%) recovered lost ground from last week’s doldrums as the Fed said it will start buying (get this) a broad portfolio of corporate bonds, overshadowing concerns over a second wave of the coronavirus pandemic and lifting U.S. stocks. 

Wait, what? 

Yes, while the Fed has been known to buy a U.S. government bond or two, corporate bonds? 

You heard right. This is 2020 and moral hazard be damned. 

¯\_(ツ)_/¯

But trading on Wall Street, as expected was schizophrenic, with the S&P 500 plunging by over 2.5% at one stage before bouncing back to over 1.3% at its highest point.  

Stocks in Asia opened higher on the back of optimism from the U.S., with Tokyo’s Nikkei 225 (+3.32%), Seoul’s KOSPI (+4.78%), Hong Kong’s Hang Seng Index (+2.77%) and Sydney’s ASX 200 (+3.77%) all up in the pre-lunch trading session. 

U.S. Treasuries slipped as the 10-year U.S. Treasury yield rose to 0.701% from 0.698% – yields typically rise as demand and prices for government bonds fall.

The dollar fell against a basket of major currencies as investors threw caution to the wind and sent a bevy of risk assets upwards. 

Oil bounced back after trading below US$35 at one stage, with the benchmark WTI Crude Oil (Nymex) (+0.59%) soaring past several levels of resistance to trade at US$37.34, suggesting that traders see a return to demand for the black stuff and the unlikelihood of renewed lockdowns. 

Gold edged up slightly with Comex Gold (+0.27%) at US$1,7431.80, as traders kept an eye on inflation risks with increasingly dovish moves by the U.S. central bank.  

Bitcoin (+0.73%) recovered in what can only be described of as a heart-stopping 24 hours, which saw the world’s firstborn cryptocurrency plunge to as low as US$8,900 at one stage before rapidly recovering and now sits around US$9,430 at 0000 GMT. 

Because what should investors do when the biggest kid in the pool makes a splash? Get wet. 

And now that the Fed is in the water, it’s summertime! 

No Stone Left Unturned, No Bond Left Unsold

Traders might just need a bottle of heart medication next to their Bloomberg terminals because yesterday was a real doozy. 

The blue chip Dow Jones Industrial Average saw thousand-point swings from peak to trough before closing up 157.62 points to 25,763.16 as the Fed said it would expand its bond-buying program to include debt from individual companies. 

Gains in U.S. stocks accelerated in afternoon trading when the Fed said that it would widen a previously announced program to purchase bonds of American companies to include a portfolio of corporate bonds based on a broad, diversified index. 

So…champagne? 

Not quite. 

Led by the Fed, central banks have been a stabilizing force for stocks not just in the past few months, but in the over a decade since the 2008 financial crisis. 

Short term liquidity bottleneck? Fed’s got you covered. Sovereign debt contagion? Fed’s got you covered. Stock market rout? Fed’s got you covered. 

Almost every bet taken against the stock market has been like a frown turned upside down. 

Is it any wonder then that the world’s foremost central banker can declare

“But I would just say this. In the long run, and even in the medium run, you wouldn’t want to bet against the American economy.”

Given that the Fed is playing with a loaded deck and has every ace conceivable, that’s good advice. 

But that also means that eventually, these chickens will come home to roost – just as trees don’t grow to the sky, markets can’t spiral upwards indefinitely. 

Thankfully, we’re nowhere near that.

The Fed and central banks across the world are merely doing everything they can to prevent an economic calamity in the markets. 

So if the Fed’s buying, the only logical thing to do right now is buy as well – but not everything is worth buying. 

Monday’s optimism contributed to a rally in stocks that are closely tied to the reopening of the economy. 

Airlines were deep in the red in the early trading session – on fears that travel restrictions thanks to a new outbreak of the coronavirus in China, will persist. 

But by market’s close, airlines such as American Airlines (-0.24%) and Delta Airlines (+0.10%) were little changed. 

And cruise operators, whose ships turned into floating coronavirus incubators at the start of the pandemic, bounced off their day lows, with major operators Carnival (-2.70%) and Royal Caribbean Cruises (-0.57%) registering insignificant losses. 

To be sure, given the risk-taking behavior and complete lack of social distancing observed in summer states like Florida, it wouldn’t be altogether surprising if Americans start boarding cruise liners again, but whether or not that would be in sufficient numbers to warrant an uptick in cruise operator revenues and profits is another thing altogether. 

The major problem with buying stocks in airlines and cruise operators is that their business model relies on constant motion. 

Every second that a plane is not in flight, or a cruise liner remains at port, it isn’t just “not making money,” it’s hemorrhaging funds. 

From parking fees to rotational maintenance – a plane on the ground is depreciating and literally, rotting. Cruise ships are no different, with fouling and berthing charges. 

And while airlines may be seen as strategic assets and therefore warrant a bailout from the government, the same can’t necessarily be said about cruise lines. 

There is some talk of Washington issuing another round of stimulus that is directly intended for Americans to go on vacation (a US$4,000 tax credit to be exact), so stay tuned on that front, which would see these stocks reflect a short term bump upwards.

Airlines have already received bailout packages from Washington, to ensure that their employees don’t get laid off until the expiry of those restrictions. 

But when those restrictions ultimately lift, airlines may be in for a double bump, because letting go of airline workers will lift their bottom lines and a threat to do so may see another round of stimulus from the government, which will lift stock prices as well. 

Picking Stocks From Rocks & Why You Shouldn’t Bank on Banks

The future of the bank is digital – which makes for a good advertising tagline, but is completely unreflective of the sea change that is facing the financial services industry – some banks have adapted faster than others.  

Just four years ago and one Trump presidency later, stocks of financial companies have declined from making up 15% of the S&P 500 to just over 10% today. 

Increased regulation and a dramatic fall in interest rates has meant compression in profits. 

And with an expectation that loan losses will rise, once the bills from the coronavirus pandemic are tallied up, investors can expect bank shares to continue to come under pressure. 

Investors still sold on banks should pay close attention to this year’s stress test results. 

As part of the sweeping Dodd-Frank Act – a legislation for banks following the 2008 financial crisis, the Federal Reserve puts bank holding companies through various economic scenarios each year to determine whether banks can maintain adequate capital if a severe recession were to occur. 

The goal of course is to make sure that banks can continue to provide credit to individual borrowers and businesses during a downturn, and the tests also influence a bank’s capital distribution plans, including share repurchases and dividends. 

Because the Fed wants to ensure that a bank’s capital distributions do not push bank capital levels below certain regulatory thresholds in an adverse scenario, it places a cap on how much banks can use to buy back their own shares (rewarding shareholders) and how much they can dole out as a dividend (which also rewards shareholders). 

The results for the next Fed stress test for banks is due on June 25, 2020 and there are reasons for investors who favor bank stocks to watch the results of this stress test more than any other. 

While the stress test used by the Fed has seen its fair share of changes over the years, this year’s will be unlike any other. 

This year, the Fed plans to examine two scenarios – baseline and severely adverse and the problem is that the severely adverse scenario is supposed to be a highly unlikely situation. 

In the severely adverse scenario planned by the Fed, unemployment would rise to a peak of 10% by the third quarter of 2021 and GDP would fall by about 8.5% from its pre-recession peak, over a 9-quarter period. 

But sh*t got real, fast. 

And what was once hypothetical is now reality, and probably worse, which could heavily influence the Fed’s capital requirements, putting pressure on bank stock dividends. 

If the Fed requires banks to cater for much higher loan losses or much smaller profits compared to last year’s stress tests, which is definitely possible, bank capital levels and capital ratios could be found to fall below regulatory minimums. 

One way to add capital back to the bank’s balance sheet is of course to trim dividends, the other way is to curb stock buybacks, which haven’t been happening anyway. 

And both ways are detrimental to bank stock prices. 

The other issue facing banks is that while commercial banks were once the biggest lenders to companies – the Fed has entered that market – making loans at far more favorable rates directly to the companies that need them. 

Yesterday, the Fed announced that it was broadening its purchase of corporate bonds, to shore up debt markets – meaning that companies can borrow more cheaply directly from the Fed, instead of having to pay the middlemen – banks. 

That means that another reliable source of revenue from banks has been hit. 

So what will future banks look like? 

Fintechs For the Future

While the shares of most fintech companies haven’t been listed yet on any stock exchange, there are plenty of other companies which are already winning from the coronavirus pandemic. 

And in this respect, we like Visa (-0.26%). Why? Because Visa likes Bitcoin.

Visa posted strong revenue growth of 11% for 2019 and 18% growth in earnings in 2019 and followed that up with a stellar first quarter for 2020. 

Amidst the pandemic, online shopping helped to fuel Visa to a 10% rise in revenue and a 12% growth in earnings for the first quarter of 2020. 

And Visa also recently announced the purchase of financial aggregator Plaid for US$5.3 billion, giving the global payments giant access to one of the fastest growing areas in fintech.

San Francisco-based Fold, an app that offers users Bitcoin rewards has also joined Visa’s Fintech Fast Track Program and plans to launch a co-branded Visa debit card that pays out as much as 10% of cash purchases with Bitcoin instead of traditional reward points like airline miles or cash (because who needs either anymore am I right?).

Fold reported that around 90% of its existing 90,000 users would switch spending away from their existing card, for a card with Bitcoin rewards for dollars spent, but that number should be unsurprising considering that Fold caters to Bitcoin maximalists anyway.

The fintech currently offers its somewhat modest user base the ability to spend Bitcoin or traditional currency at the likes of online shopping sites including Amazon (+1.09%) and ride hailing giant Uber (+1.33%) as well as Starbucks (+0.79%), synchronizing their accounts either with an existing card or a Bitcoin wallet. 

Visa however is not cheap.

At 26.5 times one-year forward earnings, it’s a lot more expensive than the average for banks of 9.49. 

But Visa is not a bank, yet it enjoys having less regulatory burdens than a bank, doesn’t need to maintain adequate capital reserve ratios and can strongly benefit from a shift towards contactless payments that has been accelerated by the coronavirus pandemic. 

Embracing cryptocurrencies is just the icing on the cake.  

Bitcoin Bounces Back Up

No stronger constitution was needed than to whom trades in the assets of digital origin. 

And constitutions were tested yesterday, especially for Bitcoin. 

Thankfully, most cryptocurrency trading is carried out by nameless, faceless and more importantly, emotionless bots – because most human traders would have suffered multiple cardiac episodes by now. 

Bitcoin plummeted to as low as US$8,900 yesterday before the Fed’s lease of life on markets saw a huge upswing in Bitcoin as well, which saw the firstborn cryptocurrency recover in a matter of hours to within a hair’s breadth of US$9,500 before settling to now trade around US$9,400. 

Whilst we are loathe to ascribe any macro factors to Bitcoin (the data is insufficient to do so), it does look (caveat emptor) as if the Fed’s promise of greater liquidity has investors betting on inflation (buying up Bitcoin as a hedge) as well as greater risk appetite (betting on Bitcoin as a speculative endeavor). 

Bitcoin appears to have real trouble crossing US$9,500 for now, but markets somewhat buoyant, another run at that level of resistance is entirely possible. 

Yesterday, the long trade we suggested for Bitcoin, entering at closer to US$9,250 and selling at US$9,400 with a stop loss at US$9,100, was profitable. 

The short trade we suggested was to short Bitcoin at US$9,300 again and short all the way down to US$9,000, with a short cover at US$9,400 – which was also profitable. 

Bitcoin had a wild ride yesterday, that would have put a Six Flags roller coaster to shame. 

In the immediate term, it looks like US$9,400 is a level of support. 

Those looking to go long on Bitcoin can consider entering around US$9,430 and taking profit at US$9,500, with a stop loss at US$9,400. Keeping the stops tight is safer for now. Bitcoin is likely to return to rangebound trading in the immediate 24 hours. 

Shorting Bitcoin would require some patience to time an entry at US$9,490 and taking profit at US$9,300, with a short cover at US$9,550. 

Bitcoin – down but not out. Not by a longshot. (Source: Novum Alpha internal charting tools.)

Endless Ethereum

If Bitcoin boarded the rollercoaster, then Ethereum rode shotgun, crashing to as low as US$218 at one stage before rapidly roaring up again to now settle around US$230. 

Yesterday the short trade for Ethereum was pipped at US$230 and short to US$220 with a short cover at US$232 – this trade was in the money. 

And for those looking to go long for Ethereum, we suggested an entry at US$227 and profits at US$230, with a stop loss at US$225 – also in the money. 

Ethereum, is showing substantial resilience at US$229, those looking to go long can consider entry at US$230 and exit at US$233, with a stop loss at US$229. 

Shorts for Etherum can wait till it retraces to US$233 and short to US$228, with a short cover at US$235. 

Novum Digital Asset Alpha is a digital asset quantitative trading firm.

Exclusive access to Novum Digital Asset Alpha’s Daily Analysis is made in conjunction with Bitcoin Malaysia.

The information and thoughts laid out in this analysis are strictly for information purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws.

It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.

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