Novum Alpha - Weekend Edition 6-7 February 2021 (10-Minute Read)
I hope you're having a wonderful weekend as the markets wind up a wild week!
In brief (TL:DR)
In today's issue...
The perfect balance of highs and lows - that's what investors had to look forward to heading into the weekend as poor jobs data was melded together with excellent earnings reports suggesting that the U.S. economy is strong where it needs to be and weak where it can be used to justify fresh stimulus.
Markets cheered the ideal conditions to rally stocks to new records.
Over in Asia, stocks entered the weekend higher with Tokyo's Nikkei 225 (+1.54%), Sydney’s ASX 200 (+1.09%), Seoul’s KOSPI (+1.07%) and Hong Kong's Hang Seng Index (+0.60%) all up.
1. There's No Shorting or Shortage of Optimism in the Markets
Whilst unprecedented fiscal and monetary stimulus have been presented as the culprit for what appears to be a seemingly unstoppable stock market, optimism may have risen the ranks to become the number one driver of the narrative.
Because a closer examination of the U.S. economy provides plenty of reasons for concern, especially after last Friday’s abysmal U.S. jobs report.
Yet somehow, it’s almost as if bonds, stocks and commodities are living on an entirely different planet, lavishing in the luxury of effective vaccines and seemingly unending stimulus packages.
Long-dated U.S. Treasuries, a typical safe haven in times of uncertainty, were sold off.
And oil was pushed to its highest level in a year.
But what exactly are the markets anticipating that the economic data doesn’t seem to reflect?
Several factors are at play in what would otherwise seem to be an overly optimistic trade – weaker economic data, especially on employment, provides the Biden administration with the factual matrix to push for more stimulus.
And a more competent administration raises hopes that the coronavirus vaccination program will pick up steam, never mind that it’s not altogether clear if those vaccines will work on the new variations of the disease, the placebo effect is more than enough to reflate markets.
Investors are also somewhat calmed by what appears to be the receding impact of Reddit-fueled retail investors and are hoping that markets will at least trend back towards familiar themes.
Finally, while the overall job market may have suffered, corporate earnings appear to be robust with 81% of firms listed on the S&P 500 having beat analyst estimates, according to data from Bloomberg Intelligence.
Many expect those earnings to eventually translate to better economic conditions down the line.
In other words, the data is good in the areas where it needs to be, and poor in the areas where it’s convenient to be – the Goldilocks dataset – not too bad and not too good – sufficient to argue the case for more stimulus but also suggestive that the U.S. economy is on the mend.
And that’s why optimism has taken grip of the market.
2. Oil is Rising & Why You Should Care
While the past week was a big one for stocks, in another corner of the asset universe, oil was making a comeback, with the price of the benchmark West Texas Intermediate crude soaring to its highest level in over a year and recovering all pandemic-induced losses.
And no, it wasn’t a legion of Redditors that led the recovery in oil’s price, and that’s why investors should be concerned.
The rally in oil comes on the back of a broader recovery in raw materials, with some commodity indices reaching their highest levels since 2019, before the coronavirus pandemic started.
While a recovery in raw material prices seems to suggest that the global economy is on the mend, the reality is that rising oil prices have less to do with demand than shrinking supplies.
U.S. crude stockpiles fell by over 4 million barrels last week, to its lowest level since March last year, at the height of pandemic concerns, according to the American Petroleum Institute.
Against this backdrop, OPEC+ has been able to stay true to their supply-cut agreement, exacerbating supply side issues for oil.
Yet there still isn’t a lot of demand for oil.
Although demand for mobility has improved since the worst of the pandemic, it is still muted.
And data from Kastle Systems suggests that less than a quarter of workers in America’s ten largest business districts are back in the office.
While a determined few are keen to travel, most Americans are still wary, and despite the start of vaccinations, the anticipated summer travel rebound has failed to materialize.
Which means that those who are willing to get out of the house are having to pay more for gasoline for their cars.
And higher prices for fuel should worry investors because they can give the impression that faster inflation is coming.
By one measure, investors have already priced in higher inflation, with the breakeven rate on a 5-year U.S. Treasury Bill surging to 2.29%, well above the U.S. Federal Reserve target inflation rate of 2%.
If inflation expectations translate into real inflation, that could become a serious problem for the bull market in stocks as well as other more speculative assets.
Much of the recent rally in equities has been reliant on the Fed’s promise to keep interest rates low until 2023.
But if the Fed gets a sense that inflation may start to be getting ahead of the economy, it may prompt it to pull back on its easy money policies, choking markets of the liquidity which have helped to prop up the lofty valuations in stocks.
And therein lies the illusion of higher oil prices – they are an ominous signal – if prices are rising because of intrinsic demand, or a sign that inflation is creeping up.
3. Bitcoin Rebounds to US$40,000 - Welcome to the World of Volatility
Heading into the weekend, Bitcoin rebounded past the psychologically-important US$40,000 level of resistance after a volatile week for cryptocurrencies marked by Elon Musk’s support for the bellwether digital asset.
A record runup in Ether, the world’s second largest cryptocurrency by market cap also added to the ever-increasing total market cap for digital assets which now stands around US$1.2 trillion.
Whether it’s the punters from Reddit who are spilling over into cryptocurrencies or a wider embrace by mainstream investors is harder to say.
High profile proponents of Bitcoin like Musk say that Bitcoin and its ilk are winning broader acceptance by the finance community despite regulators, including the European Central Bank warning investors that volatility inherent in cryptocurrencies, could see their investments wiped out.
Investors will want to keep a close eye on what happens Monday when CME Group (-1.11%) finally launches its cash-settled Ether futures.
Just over three years ago, the launch of cash-settled Bitcoin futures gave investors an opportunity to bet against the price of Bitcoin and almost as quickly as Bitcoin futures were launched, the price of Bitcoin virtually collapsed, falling by as much as 80% in a matter of weeks.
Traders will be watching to see if the launch of Ether futures on Monday will have a similar effect.
To be sure, the macroeconomic circumstances surrounding the launch of Ether futures on Monday are dramatically different from when Bitcoin futures were launched in late 2017.
Unprecedented fiscal and monetary stimulus to combat the economic fallout of a devastating global pandemic have fed into the narrative that Bitcoin could serve as a hedge against inflation.
And options to bet against the relentless rise in the price of Bitcoin were limited in 2017, unlike today when a wide range of cryptocurrency derivatives have existed not just for Bitcoin but for Ether and other cryptocurrencies as well.
The cryptocurrency industry as a whole has also grown somewhat more mature and growing numbers of institutional investors have come out publicly to declare their holdings in Bitcoin as well.
So the launch of Ether futures in and of itself should not necessarily see Ether’s price crash on Monday – that plot is too obvious.
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Feb 07, 2021