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Novum Alpha - Daily Analysis 23 February 2021 (10-Minute Read)

The rout in bonds has finally taken a breather as investors are assessing the next phase of the economic recovery spurred by effective coronavirus vaccines as well as U.S. fiscal stimulus.

Terrific Tuesday to you and I hope you're having a great start to your day!  

In brief (TL:DR)

  • U.S. stocks were a mixed bag on Monday with gains made in cyclical stocks while incides were dragged down by tech with the S&P 500 (-0.77%) and tech-centric Nasdaq Composite (-2.46%) down on weakness in the tech sector while the blue-chip Dow Jones Industrial Average (+0.09%) was up marginally as the re-flation trade came into play. 
  • Asian markets inched lower Tuesday and U.S. equity futures pared gains as investors assessed expectations for faster growth and inflation that drove up commodities and bond yields. 
  • The benchmark U.S. 10-year Treasury yield was little changed at 1.370% and may be peaking on anticipation of U.S. Federal Reserve intervention to prevent government borrowing costs from getting out of hand (yields rise when bond prices fall). 
  • The dollar continued its slide in Asian trading. 
  • Oil held onto gains with March 2021 contracts for WTI Crude Oil (Nymex) (+3.80%) at US$61.49 as investors continued to pour into commodities. 
  • Gold was firmer with April 2021 contracts for Gold (Comex) (+0.10%) at US$1,810.20 last week, enjoying the rise of commodities. 
  • Bitcoin (-5.13%) fell to US$53,715 but fell to as low as US$48,000 at one stage on Monday before recovering sharply while inflows into exchanges have slowed but are still higher than outflows (inflows typically suggest that traders are looking to sell Bitcoin in anticipation of lower prices). 

In today's issue...

  1. Risk Assets Have Become Victims of Their Own Success
  2. Bond Trading Just Got Digital & Dangerous 
  3. How do you lose US$15 billion from a US$1.5 billion Bitcoin bet?

Market Overview

The rout in bonds has finally taken a breather as investors are assessing the next phase of the economic recovery spurred by effective coronavirus vaccines as well as U.S. fiscal stimulus. 
Central banks are also mulling restarting emergency programs that have supported global markets, at a time when stocks are just starting to look fragile. 
Volatility is back on the table again, and investors are bracing themselves for a choppy ride. 
In Asia, markets were a mixed bag with Tokyo's Nikkei 225 (+0.46%) and Sydney’s ASX 200 (+0.07%)  higher, while Hong Kong's Hang Seng Index (-1.06%) and Seoul's Kospi Index (-0.98%) were down sharply as concerns over commodity price rises put a damper of manufacturing revenue expectations. 
1. Risk Assets Have Become Victims of Their Own Success
  • Threat of inflation is seeing investors offload bonds, sending yields soaring 
  • Tech and growth stocks have stuttered as investors see rising bond yields as a sign to more closely scrutinize earnings multiples at tech firms that have attracted heady valuations 
That markets tend to crash when the last bear becomes a bull is an age old adage. 
And nowhere has that become more apparent than in the most recent dumping of “safe” bonds, especially U.S. Treasuries that have sent yields rising – yields rise when bond prices fall.
Even the most pessimistic and skeptical investors have been forced to go long, after the embarrassing and financially devastating rout of short-biased hedge funds forced them to cut losses, estimated at some US$6 billion, in the wake of the GameStop (+13.08%) saga.
Making matters worse, copper surged to over US$9,000 a ton, as investors priced in bets for inflation and economic growth while tech stocks led losses in equities, as investors moved away from pandemic themes and into recovery trades.
A key part of the U.S. Treasury curve – the gap between shorter 5-year dated notes and longer 30-year dated bonds, stretched to its highest level in over five years.
And sovereign bond yields from Australia, the United Kingdom and Spain have soared, as central banks struggled to keep borrowing costs low.
Part of the reason that bond yields are rising is because investors are pricing in the prospect of inflation as coronavirus vaccinations get under way, and expectations of fiscal stimulus are factoring in rising prices just as economies reopen.
The other issue of course is that inflation eats into bond yields and investors may be dumping bonds (leading to a rise in yields) in anticipation of just that occurring.
And while the U.S. Federal Reserve remains nonchalant about any inflation, investors are not taking any chances, sitting on the sidelines and pouring into cash or commodities which they believe should do well in an inflationary environment.
Crude oil has already surged to a new high this year, blasting past US$63 for the first time, while industrial metals have all rallied.
And not all stocks have suffered equally.
While the defensive play of buying tech stocks has fallen out of favor, the fortunes of previously unloved sectors such as energy and financials have staged a comeback.
Higher bond yields make it easier for banks to earn returns on loans and rising commodity prices naturally help commodity producers and their ancillary service providers, with energy producers like Exxon Mobil (+3.69%) and Marathon Oil (+7.94%) staging a dramatic turnaround in their stock prices.
To be sure, inflation does not affect all firms equally, but investors are preparing for the outcome by favoring companies with the ability to extract profits from higher revenue on the back of rising prices – including energy producers.
While input costs increase in an inflationary environment, an increase in revenue, particularly on the back of higher prices, for demand inelastic products such as gasoline, often outweigh the production costs. 
2. Bond Trading Just Got Digital & Dangerous
  • Bond trading is becoming increasingly digital which risks leaving lesser traded bonds behind while also exposing the market to sharp corrections with the rise of algorithmic trading 
  • Electronic markets are more efficient, but given that bonds can more severely affect a company's ability to do business as opposed to stock price, it is not without risks 
Friction. It’s that thing that keeps your car on the road and scrapes your knees when you fall off your bike.
But while friction is good in that it keeps us safe by slowing us down, it also hinders efficiency. 
Nowhere is this more obvious than in the bond markets which have only just recently digitalized.
Fixed income markets look more like they belong in a museum than at the cutting edge of finance, with the vast majority of bond trades still occurring over the phone or via Bloomberg messages (think of them as WhatsApp for the bond trade).
Part of the resistance to digitalization of course has been the argument that bond markets are simply too varied, too messy and too idiosyncratic to lend themselves well to digitalization.
While there are some 41,000 stocks globally, there are millions of bonds, each with their own tenure, yield and terms, with many trading only by appointment, if at all.
That changed however after the 2008 financial crisis when stricter regulations made it more costly for banks to carry their substantial bond inventories on their books, at a time when many had to shut down their proprietary trading desks, spurring both banks and trading firms to update their infrastructure.
The rise of bond ETFs also encouraged more electronic and algorithmic trading, with most mainstream government bond trading now digital, a trend that has been making inroads into traditionally bespoke areas such as corporate debt.
But that’s not necessarily a good thing.
Because liquidity begets liquidity, the most actively-traded corners of the fixed income market will become easier to trade in, and draw in more investors, leaving a long tail of poorly, rarely or never-traded debt to languish.
And then there’s the issue that unlike the stock markets, bond trading shouldn’t necessarily be made faster.
Because companies depend on liquidity from a variety of both fixed and variable coupon bonds, excess liquidity and a lack thereof, could dramatically affect a firm’s coupon rate commitments and have real implications on the ability of a company to do business.
Given that there are millions of bonds and each one has its own flavor, investors are hard placed to discern the nuances of each one - so imagine trading them in large quantities quickly. 
Just as we’ve seen how flash crashes can affect stock prices, imagine what a flash crash could do for a firm’s debt overhang and it’s subsequent ability to borrow.
Friction is there for a reason. 
3. How do you lose US$15 billion from a US$1.5 billion Bitcoin bet?
  • Elon Musk tweet suggesting Bitcoin price may be "high" has been attributed to the benchmark cryptocurrency falling to as low as US$48,000 on Monday, before recovering 
  • About US$1.5 billion worth of Bitcoin was dumped on cryptocurrency exchange OKEx on Monday and was more likely catalyst for the cataclysmic rout  
How do you lose US$15 billion from a US$1.5 billion bet? By tweeting before thinking of course.
Whether it was a masterclass in corporate strategy (to buy more Bitcoin cheaply) or simply a no-filter tweet about the price of Bitcoin, shares of Tesla (-8.55%), which have become seen as a proxy for Bitcoin, slid as Tesla CEO Elon Musk tweeted innocuously that the price of Bitcoin seems “high.”
If traders were jarred, they didn’t show it over the weekend, as Bitcoin pushed to fresh highs, touching US$59,000 at one stage before slumping sharply on Monday.
We’ve seen this before.
Weekends, when cryptocurrency trading volumes tend to be lower, see Bitcoin as most susceptible to large price swings, both up and down, and the past weekend was no different.
While many suggested that Musk’s tweet was the primary cause of Bitcoin’s rout on Monday, what blockchain analysis revealed was that large flows of Bitcoin were being pushed into cryptocurrency exchange OKEx well before the weekend.
And yesterday, someone dumped approximately US$1.5 billion worth of Bitcoin in the afternoon in Asian trading, pushing Bitcoin to as low as US$48,000 at one stage before it recovered in North America trading.
Regardless of the reason, the flush in Tesla shares saw Elon Musk fall one spot to become the world’s second richest man, just behind Jeff Bezos of Amazon (-2.13%), even as shares in the e-commerce giant slid as well.
Tesla shares shed 7.6% on Monday at one stage, shaving some US$15.2 billion off Musk’s net worth – and that’s how you lose US$15 billion with a US$1.5 billion bet.

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Feb 23, 2021

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