Novum Alpha - Daily Analysis 5 May 2021 (10-Minute Read)
A wonderful Wednesday for you as tech stocks took a beating on just the slightest hint that interest rates may rise faster than expected.
In brief (TL:DR)
In today's issue...
Let's get one thing straight, no one is raising interest rates...yet.
But a Freudian slip by U.S. Treasury Secretary Janet Yellen taken out of context and plastered across Bloomberg terminals was enough to see tech stocks come crashing - a closer inspection would have revealed that market rates barely budged.
Yellen was talking about the prospect of raising rates in the event that a massive fiscal stimulus package for infrastructure gets passed and increases the risk of an overheated U.S. economy.
Ultimately, it's the U.S. Federal Reserve that dictates interest rates, not the U.S. Treasury Department and had traders understood their organs of government more than trading using their internal organs, that would have been blindingly apparent.
Asian markets were mixed on Wednesday with Tokyo still closed for a holiday and Sydney’s ASX 200 (+0.67%) and Seoul's Kospi Index (+0.64%) up slightly, while Hong Kong's Hang Seng Index (-0.61%) was lower on concerns over raw material price increases, in the morning trading session.
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1. Commodities Rally on Coronavirus Trade
Betting that governments will start hoarding basic raw materials as the global economy rebounds, commodities have rallied to their highest in almost a decade, stoking demand for metals, food and energy.
Meanwhile poor weather is harming crops, and supply chains are once again being tested.
Against this backdrop, a resurgence in coronavirus case numbers in many parts of the world is threatening to put many economies back into lockdown, and will ensure an accommodative monetary policy within the immediate term.
Given that commodities are denominated in U.S. dollars, the U.S. Federal Reserve’s dovishness, even on signs that the economy is recovering, is fueling inflation concerns and a rally in commodities not seen since 2011.
China has been gobbling up supplies of everything from corn to copper, and traders betting on higher inflation are bidding up the prices of all commodities.
That soaring cost of raw materials is raising the prices of everything from homes, through increased lumber costs, to toilet paper and food, stoking global inflation fears.
On Tuesday, U.S. Treasury Secretary Janet Yellen, warned that interest rates may have to rise to ensure the economy doesn’t “overheat” – though she walked back those comments later, conceding that she wasn’t predicting rate increases, and didn’t anticipate a bout of persistently high inflation.
Loose monetary policy and a flood of fiscal stimulus, coupled with a resurgent economy may help to fuel inflation at a time when the world can scarcely afford it.
The key culprits at the moment are the world’s two largest economies, with the U.S. and China recovering fast from the pandemic, stoking demand for everything from cars to electronics, infrastructure to appliances.
But betting on a commodities supercycle may be a tricky business.
For starters, if the global economy reopens, workers returning back to office will reduce demand for home computing, electronics and appliances.
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2. Rates Rising Tech Dying
When does a premium not become worth paying for?
When there are alternatives.
And that’s precisely what higher interest rates portend for an investment landscape that for the longest time has been starved of yield.
Yesterday U.S. Treasury Secretary Janet Yellen warned that interest rates may need to rise over time to keep the U.S. economy from overheating, exacerbating a selloff in technology stocks that was already underway before she clarified her comments.
When interest rates rise, the present value of money goes down and the higher rates go, the lower the present value of a future stream of earnings.
This model is known as the “Discounted Cash Flow” model and is at the heart of why interest rates so badly affect tech stocks.
Stocks compete with other investments like bonds, cash and even cryptocurrencies, for our dollars.
So say you have a hundred dollars (look at you!) then you need to look at the time value of that money.
That $100 can be invested in a 2% bond that will pay you $102 in a year from now, or it can be invested in a stock that may more than double five years from now - how do you decide?
Most stocks are valued based on how much cash they can generate in the future.
Discounted cash flow uses a formula to figure out what the present value of an expected stream of future cash flows will be.
But trying to figure out what future cash flows will be isn't easy and you can’t just punch some numbers into a financial calculator and get the answer – because there are too many assumptions involved – no one can know for certain how much cash a company is going to generate a year from now, let alone five.
But they do know where interest rates are today.
With interest rates so close to zero, the opportunity cost of taking a bet on a high-growth tech stock is much lower than when rates are high.
Sure, many of these tech firms may not necessarily live up to expectations, but when it costs so little to bet, why not take a punt?
Which is why Yellen’s interest rate comments added extra pressure on shares of high-growth tech companies, whose future earnings look relatively less valuable when rates are higher and which consequently fell sharply in yesterday’s trading session.
In reality though, Yellen’s comments were more musings and in the context of massive fiscal stimulus by way of an infrastructure bill that her boss, U.S. President Joe Biden, is proposing.
Market interest rates barely moved yesterday and the Fed is far from raising rates, saying that the U.S. economy would need to reach full employment and accepting of inflation exceeding 2% for an extended period, before even thinking about raising rates.
So the pullback in tech yesterday? Perhaps an opportunity for investors to buy back into tech, and many of them did.
3. Finally, A Cryptocurrency You Can Use!
If Bitcoin is the Ariel Atom in your garage, only seeing the light of day when it’s time to head to the track, then Ethereum is the minivan, the daily driver for every trip to the grocery store and to get the kids from school.
And just as Bitcoin flatlines below US$60,000, cryptocurrency’s perpetual bridesmaid Ether has seen an unparalleled rally.
With Ethereum serving as the blockchain supporting decentralized finance or DeFi, and digital art via non-fungible tokens or NFTs, Ether is now up some 1,500% over the past year and hit a fresh peak close to US$3,500 yesterday.
Ether’s rally is stirring predictions of even greater gains, even as some technical indicators are flashing that the rally may be overextended.
One possibility of course is that investors who’ve popped their cherry with Bitcoin, are now looking at other cryptocurrencies, in search of opportunities.
For most of the past year, Bitcoin’s rally has outpaced that of Ether’s and every other cryptocurrency.
Unlike Bitcoin, which does very little outside of acting as a store of value (thus far, myriad caveats apply), Ethereum has been quietly providing the base layer for a plethora of applications.
And while Bitcoin’s blockchain is often valued for its permanence – it’s nearly impossible to gain the consensus required to make changes to the Bitcoin blockchain – Ethereum has been relatively more nimble, adapting its blockchain to new needs as it has developed.
From gradually shifting to a proof-of-stake protocol, that would do away with the energy-hungry proof-of-work consensus that cryptocurrency is so often criticized for, to increases in efficiency and supporting smart contracts, there are far more actual use cases for Ethereum than Bitcoin.
And institutional investors are starting to recognize Ethereum’s value as well, with volumes for Ether futures contracts on CME inching closer to those of Bitcoin’s, even though CME Group (+0.32%) only started offering Ether futures in February.
But for technicians, Ether’s rally may appear stretched – with its 14-day relative strength index (a measure of the momentum of the underlying asset) rising to the “sell” zone – suggesting that Ether may be overbought or overvalued.
Like any good cryptocurrency, a correction for Ether is an inevitability, and with greater price momentum comes greater volatility, but that shouldn't affect its long term value proposition.
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May 05, 2021
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