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Novum Alpha - Daily Analysis 31 March 2021 (10-Minute Read)

Investors had braced themselves for a pullback in equities as bond yields started spiking as the tepid response to the U.S. 7-year Treasury note auction percolated its way through the market.

A wonderful Wednesday to you as spiking Treasury yields batter markets. 

In brief (TL:DR)

  • U.S. stocks were all lower on Tuesday with the S&P 500 (-0.32%), tech-centric Nasdaq Composite (-0.11%) and blue-chip Dow Jones Industrial Average (-0.31%) all lower as U.S. Treasury yields hit their highest level in a year.  
  • Asian stocks were steady at the start of the last trading day of the quarter as investors await more details on the next leg of U.S. stimulus spending and monitor upward pressure on bond yields.
  • The U.S. 10-year Treasury yield rose about two basis points to 1.72% and momentarily was higher than it had ever been in the past year. 
  • The dollar held most of its overnight advance. 
  • Oil edged up with May 2021 contracts for WTI Crude Oil (Nymex) (+0.40%) at US$60.76 on expectations of higher inflation and growing consumption demand. 
  • Gold fell with Jun 2021 contracts for Gold (Comex) (-0.17%) at US$1,683.20 on the back of a stronger dollar. 
  • Bitcoin (+2.61%) surged higher to US$59,177, on inflation concerns with outflows from exchanges continuing to lead inflows (outflows suggest that investors are looking to hold Bitcoin in anticipation of rising prices).

In today's issue...

  1. Love Leverage? Odds Are You're Rich
  2. Yikes! Yields Are Yelping Again!  
  3. Not Sure Where Bitcoin is Headed? Bet on Those Who Do 

Market Overview

The good news is that it wasn't as bad as the last round, the bad news is, it can only get worse. 
Investors had braced themselves for a pullback in equities as bond yields started spiking as the tepid response to the U.S. 7-year Treasury note auction percolated its way through the market. 
But in Asia, indices were generally higher, as the important Suez Canal was reopened and manufacturing and supply chains are headed back to normal. 
Tokyo's Nikkei 225 (-0.48%) was the only laggard over concerns with rising U.S. Treasury yields while export oriented indices such as Sydney’s ASX 200 (+1.79%), Seoul's Kospi Index (+0.41%) and Hong Kong's Hang Seng Index (+0.79%) were all up on renewed confidence. 
1. Love Leverage? Odds Are You're Rich
  • Fallout of Archegos Capital Management's leveraged trades being unwound is casting a spotlight on the practice of borrowing money against shares in a bull market
  • Bull market conditions have facilitated the ability of rich shareholders to borrow more money against their stocks, but any sharp correction in markets, could lead to margin calls and unruly selloffs to cover shortfalls, as was seen last Friday 
It’s the story of life isn’t it? If you don’t have a dime, no one will give you their time, but if you’re rich, everyone’s lining up to be your b*tch.
And while ordinary Americans were waiting for stimulus checks to drop, Bill Hwang of Archegos Capital Management was gorging on leverage to take risky bets on equities to the tune of some US$50 billion.
But while most Americans on the brink of survival may be taking out payday loans, data from the Bloomberg Billionaire’s Index suggests that 10% of the world’s 500 richest people have committed some US$163 billion in stock to fund everything from their jets to their mansions.
With the net worth of most of the 1% tied up in assets, especially shares of the companies they built, liquidity has often been a luxury bought at the expense of pledging those shares, which then go on to be used to fuel bets in the market.
Whether these shares are loaned out for those looking to go short, or used to finance leverage – the permutations are limited to the creativity of fund managers and bankers.
And with central banks pumping massive amounts of liquidity into the financial system, bankers have been falling over each other to extend credit to the rich, in exchange for holding on to their shares.  
While pledging shares is pretty safe in a bull market, when rising prices ensure the value of the collateral remains well above that of the loan facility, when stocks fall, borrowers may face a wave of margin calls and have to cough up funds to avoid defaulting or liquidating their other assets – the kids can’s suddenly be yanked out of private school.
And that’s precisely what’s happening to Archegos Capital Management’s Bill Hwang – who ran a highly leveraged and extremely concentrated investment in a handful of stocks. 
But Archegos Capital Management is hardly alone in this space and there are other companies whose founders may have to unload stocks to make good on those margin calls, especially tech firms whose valuations have run ahead of fundamentals. 
2. Yikes! Yields Are Yelping Again!
  • U.S. Treasury yields for longer-term borrowings are spiking again, rising to their highest level since the start of the pandemic 
  • Fed may be forced to intervene and ratchet up asset purchases if yields spike too high, which will affect the borrowing costs for a wide variety of loans and could undermine the nascent economic recovery 
Bond markets remained relatively calm last week despite the tepid response to the U.S. Treasury auction of 7-year Treasury notes, and yields, while up, showed no signs of leaving their rangebound trading.
That changed this week as a key measure of U.S. long-term borrowing costs hit its highest level since the early days of the coronavirus crisis on Tuesday, just before the end of the quarter.
Money managers are thought to be paring down holdings on bonds, just as Washington rolls out its massive US$1.9 trillion fiscal stimulus package and the U.S. economy recovers.
The fresh volatility in bond yields comes as investors weighed optimism over the vaccine rollout against another plan by the White House to boost fiscal stimulus.
At some point, investors need to question just how much the bond market can absorb.
With inflation expectations rising, demand for government debt globally has slid, combined with the massive amounts of government spending, and unprecedented monetary stimulus.
Investors are starting to price in the prospect of higher inflation combined with higher growth, and that’s causing yields to head northwards.
Jitters over inflation saw a massive selloff in U.S. Treasuries, and while short-term U.S. government debt such as the 5-year Treasury note was less affected compared to longer-dated Treasuries, it still rose to its highest level since last March.
And that has some investors wondering out loud if the U.S. Federal Reserve would raise rates sooner than anticipated if above-target inflation challenged the central bank’s promise to keep interest rates low till 2023.
In many ways, it doesn’t matter that the Fed has repeatedly articulated it will give markets plenty of time to digest any proposed rate increases – if inflation starts running away, the Fed may not have that luxury.
For now at least, the U.S. central bank is betting that any spike in inflation is likely to be a gradual shift, that inflation does not shoot up on a dime – but history is replete with examples of mismanaged economies that saw precisely that occurring.
The U.S. is far from a mismanaged economy, but there are growing concerns whether it can continue at the current pace without more inflation and even greater doubts as to whether that inflation can be controlled once it shoots beyond target.
Part of the problem is that policymakers believe they can manage inflation the way you sail a yacht in calm waters, when in reality, it’s more like trying to navigate a mega container vessel through the narrow straits of the Suez Canal.
The shift in U.S. Treasury yields has already spread across the Atlantic to Europe, where yields are already being dragged higher.
No doubt the Fed and the Biden administration will be monitoring the situation closely – higher long term borrowing costs for Washington will affect everything from mortgages to student loans and could have a detrimental effect on the fragile economic recovery.
And sharp moves in bond yields will also rattle equity markets – hitting high growth (read Tech) stocks in particular.
Depending on one’s mid-term view on bond yields, whether now is the time to buy the dip or to lock in some of those gains from the tech rally is up for debate, and part of that bet will be whether or not the Fed will ultimately intervene by ratcheting up its purchase of Treasuries to keep borrowing costs low – there’s a good chance that will happen.
3. Not Sure Where Bitcoin is Headed? Bet on Those Who Do
  • Corporate M&A activity is rising in the cryptocurrency industry on the back of rising prices of Bitcoin and other cryptocurrencies 
  • PwC report suggests that M&A activity this year is likely to outstrip last year's as more institutional investors enter the cryptocurrency space 
In growing signs that interest in the nascent digital asset sector is heading towards peak bubble territory – M&A activity in the industry has been picking up.
Interest not just in Bitcoin and other cryptocurrencies has grown, but also the companies involved in the space as well.
Deal activity in the cryptocurrency sector rose alongside growing interest in Bitcoin and cryptocurrencies in 2020, and a PwC market overview released this week suggests that M&A activity this year is likely to outpace last year’s growth.
According to PwC, the total value of mergers and acquisitions more than doubled last year to US$1.1 billion from 2019 and average deal size expanded from just US$19.2 million the year before to US$52.7 million.
Most of that M&A activity is taking place in Europe and Asia and PwC reports that fundraising increased by a third in overall value this year.
Henri Arslanian, PwC global crypto leader suggests that M&A activity and crypto fundraising is on track to “significantly surpass it (2020’s) from every single metric,” noting that institutional investors and cash-rich cryptocurrency platforms will likely drive the bulk of that activity.
With the U.S.’s largest cryptocurrency exchange Coinbase headed for a direct listing later this year, more cryptocurrency corporate moves can be expected in its wake, depending on its reception.
PwC’s latest data suggests that the cryptocurrency market as a whole is expanding.
Having risen ninefold in the year-to-date, more interest from institutional investors and big names from Wall Street are bolstering Bitcoin’s status as an asset class.
Skeptics remain of course and there are growing concerns that the boom in token prices reflects excess liquidity in the markets with investors badly in search of yield.
But regardless of the bubble concerns, PwC predicts the industry will become more institutionalized, even as retail investors start to recede. 

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Mar 31, 2021

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