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Markets approaching a boiled frog moment



Markets have a whiff of simmering frog about them. Investors are growing adept at ignoring the warning signs like the proverbial amphibian in a pot of slowly heated water, not recognising the dangers until too late.

But on a near daily basis, something extraordinary crops up to remind us that the whizz-bang rush into risky bets may be getting out of hand. 

The more cautious investors out there have been wringing their hands for nearly 10 months now, and they have been thoroughly beaten up in the process. Global stocks have climbed 74 per cent since last March.

Betting that asset valuations will fall back to meet the dire global economic picture has proven to be a fool’s errand in the face of overwhelming support from central banks. Fund managers have largely mentally moved on from the coronavirus crisis that is still jamming up hospitals and locking down economic activity around the world. Faith in vaccines has taken over.

Optimists quite reasonably point out that once we all have jabs in our arms, those of us lucky enough to have amassed savings over the past year are itching to go out for a meal, catch up with friends in a bar, splash out on a holiday, or fill the wardrobe with clothes that fit our slightly more padded lockdown physiques. Companies are going to have to work fast to meet demand, and central banks are in no hurry to spoil any recovery, as US Federal Reserve Chairman Jay Powell reminded us this week. 

Still, what Mr Powell’s predecessor Alan Greenspan might have referred to as pockets of “froth” merit close attention.

One is the surge in stock market speculation among retail investors, particularly in the US. The explosion in this space drew most attention last summer, when the “stocks only go up” crowd demonstrated more bravery (or foresight) in buying the coronavirus dip than many more sober professional fund managers.

But they have not gone away. Far from it. Data tracked by Vanda Research shows that retail buying of US stocks has kicked off the new year in rude health. The first two weeks of 2021 can rival even the most exuberant weeks of last year, its figures show, and that is before the next stimulus cheques land in Americans’ bank accounts.

Buying is focused on a tiny clutch of stocks, particularly in the electric vehicles sector. Tesla remains a favoured pick. Its scorching 900 per cent rally since the start of last year may not be entirely down to retail punters putting their stimulus cheques to work on a bet, but it is hard to imagine the army of fans has not helped. Similarly, penny stocks popular with have-a-go investors are in hot demand. Analysis by Themis Trading shows that trading in stocks valued at less than $1 accounted for almost a fifth of all equity trading in the US on January 11.

The screaming rally in bitcoin — 300 per cent last year and a further 35 per cent in the opening days of 2021 — is another symptom of a powerful wave of retail enthusiasm, despite increasingly noisy protests from policymakers. Christine Lagarde, who heads the European Central Bank, has railed against “funny business” in cryptocurrencies and UK regulators have reiterated their advice that anyone betting on them must be prepared to lose everything. But one 22-year-old TikTok influencer has built up a million-strong following partly by divining the next steps in bitcoin’s wild ride based on astrology. 

Does that add up to a reason for professional fund managers to bet on a pullback now? No. But if and when a reckoning comes, we will look back on it as a bizarre fever. As Jeremy Grantham, the famed founder of GMO, warned in his widely read new year note, “really crazy investor behaviour” especially on the part of individuals” is one of the more reliable signs of unsustainable bubbles.

Lively risk-seeking behaviour is not confined to individual investors, of course. Drawing together two of the frothiest aspects of 2021, a blank-cheque company, or Spac, this week announced plans to launch Bakkt Holdings on to public equity markets. Bakkt, a cryptocurrency platform, had zero customers last year, its regulatory filings show. It is hoping to get that tally up to 30m in five years. It will boast an enterprise value of more than $2bn when it lists, according to current owner Intercontinental Exchange.

Fund managers are desperate for places to park their cash. Low-cost European airline Wizz Air, fresh from recording an 80 per cent slide in passenger numbers in the year to December, this week issued three-year debt for a coupon a little over 1 per cent. Bankers say borrowers have never had it so good.

Again, this is no reason to bet the farm on a crash. But complacency is a clear danger.

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Gensler raises concern about market influence of Citadel Securities




Gary Gensler, new chair of the Securities and Exchange Commission, has expressed concern about the prominent role Citadel Securities and other big trading firms are playing in US equity markets, warning that “healthy competition” could be at risk.

In testimony released ahead of his appearance before the House financial services committee on Thursday, Gensler said he had directed his staff to look into whether policies were needed to deal with the small number of market makers that are taking a growing share of retail trading volume.

“One firm, Citadel Securities, has publicly stated that it executes about 47 per cent of all retail volume. In January, two firms executed more volume than all but one exchange, Nasdaq,” Gensler said.

“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” he said. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”

Gensler is scheduled to appear at the third hearing into the explosive trading in GameStop and other so-called meme stocks in January.

Trading volumes in the US surged that month as retail investors flocked into markets, prompting brokers such as Robinhood to introduce trading restrictions that angered investors and drew the attention of lawmakers.

The market activity galvanised policymakers in Washington and investors. Lawmakers have focused much of their attention on “payment for order flow”, in which brokers such as Robinhood are paid to route orders to market makers like Citadel Securities and Virtu.

That practice has been a boon for brokers. It generated nearly $1bn for Robinhood, Charles Schwab and ETrade in the first quarter, according to Piper Sandler.

Gensler noted that other countries, including the UK and Canada, do not allow payment for order flow.

“Higher volumes of trades generate more payments for order flow,” he said. “This brings to mind a number of questions: do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict?”

Gensler also said he had directed his staff to consider recommendations for greater disclosure on total return swaps, the derivatives used by the family office Archegos. The vehicle, run by the trader Bill Hwang, collapsed in March after several concentrated bets moved against the group, and banks have sustained more than $10bn of losses as a result.

Market watchdogs have expressed concerns that regulators had little or no view of the huge trades being made by Archegos.

“Whenever there are major market events, it’s a good idea to consider what risks they might have placed on the entire financial system, even when the system holds,” Gensler said.

“Issues of concentration, whether among market makers or brokers at the clearinghouse, may increase potential system-wide risks, should any single incumbent with significant size or market share fail.”

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European markets recover after tech stock fall




European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.

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Yellen says rates may have to rise to prevent ‘overheating’




US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.

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