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Good morning. After Unhedged’s China bonds note landed yesterday, an editor emailed from London to ask whether it is now accurate to call the Evergrande meltdown China’s “Lehman moment”. I don’t think so. In a Lehman Brothers moment, to exaggerate slightly, all correlations go to one — everything gets sold and all anyone wants is cash. For now, the selling in China remains concentrated. More on China soon. Meanwhile, email us: Robert.Armstrong and Ethan.Wu
Here is a startling series of facts, from the Bank of America equity derivatives team on Tuesday:
“The S&P has (i) reached new highs each of the past eight trading days, tying the longest streak since 1964; (ii) risen 17 of the last 19 trading days, a feat surpassed only once in 90-plus years, and (iii) for only the second time since 1950, taken less than a month to rebound from twin fragility shocks.”
The streak of new highs broke on Tuesday, but markets remain torrid (a “fragility shock” is when an overextended market, characterised by crowded trades, suddenly reverses). BofA thinks we are in a “fear of missing out” market: investors are just grabbing exposure to US stocks however they can, for fear of underperforming rivals as the market roars towards year’s end.
Action in the equity options market supports their view. For one, cash is flooding into options on individual stocks — $27bn of premiums last week, a multiyear record, overwhelmingly calls:
The flow of money is not all. Premiums for far out-of-the-money calls on the Nasdaq have risen — implied volatility of the market is up, in the jargon — reflecting strong demand for the upside, should the market surge.
The mad dash for market exposure is also reflected in the cost to roll S&P futures: loosely speaking, this is the implicit “fee” charged by market makers for maintaining the futures position. Roll costs vary with supply and demand for market exposure, and are near a record this quarter, rivalled only by the rally that followed the 2016 presidential election:
All of these options-market phenomena are emblematic of a “momentum chase”, Nitin Saksena of BofA told me. “Through the lens of the derivatives market, it seems there is a leveraged race for upside afoot . . . It’s more of a Fomo trade than fundamentals suddenly justifying the almost absurd price action we are seeing.”
I think for the first time I understand what is meant by that familiar Wall Street chestnut: “A little correction would be healthy here.”
Bitcoin’s hit another all-time high on Tuesday: $68,494, giving it a market capitalisation just under $1.3tn. The cryptocurrency market is worth more than $3tn. Shiba Inu coin — the second most important dog-based cryptocurrency — is worth more than Delta Air Lines.
A bubble? George Monaghan of GlobalData, an analytics firm, thinks bitcoin should not be the eighth-biggest asset on Earth (right between silver and Tesla):
“Investors are squirrelling away bitcoin in the hope that it will gain value, rather than using it as a currency. A product’s value should rise because people use it, not because they invest in it . ..
“Bubbles have repeatedly caused financial crises. While some may argue the utility of the technology justifies the valuations, I’d ask how many bitcoin holders could tell you what the utility is . . . The publicity around these bull runs draws in the naive/desperate/vulnerable.”
Fair enough. But bitcoin’s $1.3tn “market cap” is not the same as, say, Apple’s market cap.
First, a staggering amount of bitcoin that is included in that market cap has been lost forever. Cane Island Digital Research estimates that 28 per cent of supply has been thrown away, stranded by a forgotten password or dead owner, or been sent accidentally to a defunct address. This implies an “available” market cap closer to $900bn (Cane Island thinks another 4 per cent of available tokens are lost each year).
Market cap is also a misleading concept when applied to bitcoin, because the market for it is so odd. Under 20 per cent of supply is actively traded. Of the bitcoin that does trade, 85 per cent of the dollar value is dominated by a few big-money “whales”, according to Chainalysis. Bitcoin is something like a stock with a big share count and a very small free float: its price may not tell you much about what the asset would be worth if it had a less constricted market structure.
Unhedged believes people should be free to bet (and maybe lose) the house on bitcoin. The Bitcoin bubble question that interests us is how much a devastating collapse in the bitcoin price would affect other markets. We’re not sure. (Ethan Wu)
General Electric is splitting into three companies, and that is a big deal. For much of the late 1990s and early 2000s it was the most valuable company in the world, and was considered, under Jack Welch, the best managed. It turns out that there was no magic managerial sauce at GE under Welch. Mostly there was leverage, and the problems that leverage created have taken two decades (and counting) to clean up.
This was all foreseeable. I know this because my colleague John Plender foresaw it back in August 2000, when Welch was at the height of his pomp, and was preparing to retire. In an FT column entitled “GE’s Hidden flaw”, Plender wrote:
“General Electric is the world’s most highly valued company, with a market capitalisation of $503bn. Jack Welch, the chair and chief executive who has presided over two decades of relentless growth, is probably the world’s most admired manager . . . Can it maintain its extraordinary dynamism and capacity for self-renewal after the departure of a man who reinvented the company?”
GE was famous at the time for its culture and managerial structure. But neither one, Plender argued, had much to do with the growth of GE Capital, the company’s finance unit:
“In the five years to the end of last year, the contribution of GE Capital’s 28 operating businesses to GE’s earnings rose from 36.7 per cent to 41.5 per cent, which makes it far more important than any other GE business . . .
“GE Capital dominates the group balance sheet, accounting for 85.1 per cent of the group’s assets and 89.6 per cent of its liabilities.”
This, in turn, left GE vulnerable to financial shocks:
“At the end of last year, [GE’s] balance sheet contained $330bn of tangible assets. Of this total, $168bn consisted of loans and receivables, including investments in financing leases in such industries as aircraft, rail and automobiles. A further $80bn consisted of investment in corporate, government and mortgage-backed debt, and equity holdings. It would take only a 3 per cent fall in the value of tangible assets, or a 5.9 per cent fall in the value of receivables, to wipe out its tangible capital base of $9.9bn.
“None of this means that the company is likely to go bust tomorrow. But it is a very slender margin of safety against recession and financial shocks.”
Nailed it. Plender asked (and correctly answered) the question that should be asked in every exuberant market: where’s the leverage?
So where’s the leverage now?
One good read
The Economist’s visual explainer on different methods of measuring inflation, and their proposed new measure, is good.