Novum Alpha - Daily Analysis 5 February 2021 (10-Minute Read)
Fantastic Friday to you as we head into the weekend and thankfully (most) markets will be closed.
In brief (TL:DR)
In today's issue...
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Market OverviewIt's bad, but just not as bad, which makes it possible to spin the story both ways. Confused yet?
The Biden administration needs to put the fear of God into lawmakers to make sure that they help him push through his US$1.9 trillion fiscal stimulus package, yet they also don't want things to appear to be too bad so that they don't look like there's no progress being made.
Running the gauntlet, it also explains why there are both signs that suggest the U.S. economy is both improving but faces severe pressure.
Regardless, stocks stomped to new records mainly on optimism that things are not as bad as they appear on the coronavirus front.
Over in Asia, stocks were mostly up in the morning trading session with Tokyo's Nikkei 225 (+0.90%), Sydney’s ASX 200 (+0.80%), Seoul’s KOSPI (+0.16%) and Hong Kong's Hang Seng Index (+0.82%) all up.
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1. Could Retail Investors Cause the Next Crash?
While much has been said about the turmoil caused by retail investors bidding up the stocks of companies like GameStop and AMC Entertainment (-20.96%), less has been mentioned about their potential to wreak havoc in the other direction.
Short sellers are an “easy enemy” to coalesce around, they bet against a company succeeding when everyone would prefer a story about a hero and a grassroots-led initiative to "punish" these pessimists ought to find no shortage of supporters.
But what if the Redditors themselves became the ones to short companies?
Retail-centric trading apps like Robinhood have made going short just as easy as going long, with share options trading a remarkably painless process.
And while Redditors have a natural preference for long positions, bearish put options were laid on just as shares of GameStop came crashing down, many of which were retail positions.
Given that the markets contain plenty of froth right now, put options (the right to sell at a specified price) have the potential to cause much greater damage to the downside.
When a trader buys a bullish call (the right to buy at a certain price – the “strike price”), the market maker who sold the contract will typically hedge by purchasing the underlying stock.
The more the stock rises toward the option’s strike price, the more shares the market maker will have to buy and that can supercharge stock prices as shares rise and market makers are forced to buy more to hedge their exposure.
But the dynamic, known as “gamma squeeze” (because why not give it a fancy name?), works in reverse as well.
Market makers who have sold bearish put options need to hedge themselves by selling the underlying shares.
And as the price of the share falls towards the option’s strike price, market makers will be forced to sell more shares which will cause the price to drop further.
That self-perpetuating feedback loop is what has some investors concerned that the next market crash may be caused by retail investors.
Because if the bearish put options are placed on say overvalued tech stocks that are components of key indices like the S&P 500 or the Nasdaq Composite, that could cause a market panic.
And it doesn’t help that tech stocks are already at frothy valuations, providing plenty of room for a narrative that they are overvalued that could plunge the market into despondency.
But any putsch of such tech stocks is likely to be short-lived, because unlike GameStop and shares of such other unloved companies, the stocks of tech giants are highly liquid and make up the portfolios of countless pension funds and other institutional investors.
That’s not to say that a crash couldn’t happen – it absolutely could, but it won’t be durable – the same way that the rally in GameStop share’s wasn’t permanent, or the invasion of the Capitol building by Trump supporters did not lead to another American Civil War.
But it’s not so much the duration of such a crash, rather the systemic damage that it can cause that makes it problematic.
As it is, market makers are short on puts (the right to sell) because persistent bullish demand has made them overweight on call options and buying up stocks to hedge.
If buying demand for put options increases, market makers would then need to unload stocks to hedge their positions.
And successive waves of selling could lead to market turmoil that has the danger to see big corrections, with the cascading effect (like dominoes, but more deadly) leading to an entire market collapse.
Apocalyptic? Perhaps, but also entirely possible given what was just witnessed with GameStop shares.
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2. No Inflation? Depends on who you ask
Despite central bankers and governments touting low inflation to gin up their borrowing prowess, food prices have reached their highest globally in almost seven years.
According to the United Nations Food and Agriculture Organization (UNFAO) food price index for January, food prices are up by 10% from a year ago, their sharpest rise since July 2014.
Fed by a combination of lower tan expected production in the U.S. and substantial corn stockpiling by China, food commodities chalked their eight consecutive monthly increase, the longest rising streak in a decade.
And while prices are not yet at the level seen during the food crisis of the late 2000s, there is concern that rising food prices could become a problem for less prosperous countries that depend on food imports.
China is looking to restore its grain reserves as well as keep a lid on rising domestic food prices as it rebuilds its hog herd that was decimated by African swine fever and that has put upward pressure on grain prices.
Disruption in the shipping industry is also not helping matters with freight prices for grains and oilseeds at their highest since before the pandemic, according to data from the International Grains Council.
The UNFAO has warned that the lowest grain inventories in five years and larger volumes of global trade, made markets far more vulnerable to production shortfall, potentially precipitating a sharp move upwards for food commodity prices.
Grains and soybeans have seen a tremendous rally after years of favorable weather led to bumper crops and depressed prices.
Corn is up 45% year-on-year to US$5.55 a bushel, wheat is up 16%, rice has surged by 27% and soybeans are up 56% to US$13.71.
Excess liquidity in the markets because of central bank monetary policy is not helping matters either, with traders speculating on food commodity futures and the future price of corn projected to be at its highest level in a decade.
Inflation could just be around the corner.
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3. Bitcoin Booming? Blame the Banks
If history was a proper teacher, Bitcoin’s price ought to have collapsed by now.
Around this time just three years ago, an unprecedented rise in Bitcoin to near US$20,000 precipitated a collapse that saw the bellwether cryptocurrency languish in what many referred to as the “Crypto Winter.”
But the spring thaw for cryptocurrencies appears, for now at least, to be durable, thanks to a flood of central bank stimulus and growing interest from both retail and institutional investors.
Bitcoin turned into the new month just a touch over US$36,000, but still well below it’s all-time-high above US$41,000 achieved last month.
So far, Bitcoin has managed to avoid a repeat of the brutal crash in 2017 and some investors are putting that down to a deluge of central bank stimulus, which has inflated the price of assets globally and triggered a frantic hunt for returns.
Professional investors are also beginning to play a more active role in the cryptocurrency markets as liquidity has increased.
Some skeptics however suggest that Bitcoin continues to be frothy and point to the recent volatility seen in the stock prices of companies like GameStop and AMC Entertainment as well as last week’s surge for silver as evidence of retail-led volatility distorting normal market movements.
The moves in those assets were driven primarily by retail investors who are now armed with increasingly sophisticated trading tools and have become a captive (if fickle) audience that wields substantial sway.
And those retail investors may just have one more way to bet on cryptocurrencies outside of buying them through apps like Robinhood.
San Francisco-based Coinbase, one of the largest and earliest U.S.-regulated cryptocurrency exchanges is preparing for a direct listing that would give investors direct exposure to the lucrative cryptocurrency services industry.
Coinbase’s direct listing comes as investors chase proxies for investing in cryptocurrencies without needing to hold them outright, including Grayscale Bitcoin Investment Trust, a favored investment channel for many traditional investors dipping their toes into the Bitcoin pool.
And business software firm MicroStrategy (+3.29%) said last year that it was raising a US$400 million bond to purchase more Bitcoin – the company made headlines earlier last year by putting some US$250 million of its balance sheet in Bitcoin, the value of which is thought to have more than doubled.
Late last month, analysts from Manulife (+1.22%), a Canadian insurance company said that the expansion in central bank balance sheets and rising public debt would push investors further into alternative asset classes, which could turn cryptocurrencies into “a solution to investor fears that ongoing extraordinary policy support could lead to resource misallocation.”
In other words, if Bitcoin is booming, blame the central banks.
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Feb 05, 2021