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Novum Alpha - Daily Analysis 4 June 2021 (12-Minute Read)

While the U.S. nonfarm payrolls report hasn't been released yet (as of time of writing), markets appear to be pricing in a car in every driveway and a chicken in every pot with tech stocks tanking amidst increasing speculation that robust economic data will force the Fed's hand to taper sooner, rather than later.

A fabulous Friday to you and I hope you're having a great one! 
Today's newsletter may be a bit of a read but it'll be worth your while if you're looking to find out how some traders were making a killing from arbitraging the difference between cryptocurrency spot and futures prices, or curious as to the psychology behind the meme stock frenzy. 

In brief (TL:DR)

  • U.S. stocks slipped on Thursday, with the blue-chip Dow Jones Industrial Average (-0.07%), S&P 500 (-0.36%) and tech-centric Nasdaq Composite (-1.03%) all lower as investors are waiting for nonfarm payrolls data out later today. 
  • Asian stocks fell early Friday after U.S. equities sagged amid robust economic data that stoked concerns about a pullback in central bank stimulus.
  • The U.S. 10-year Treasury yield held an advance at 1.63% (yields generally rise when bond prices fall) as investors bet on tapering against increasing signs that the U.S. economy is doing well. 
  • The dollar extended a gain.
  • Oil fell with July 2021 contracts for WTI Crude Oil (Nymex) (-0.48%) at US$68.48 on the back of a strengthening dollar. 
  • Gold fell with August 2021 contracts for Gold (Comex) (-0.09%) at US$1,871.60 after falling almost 2% in its most volatile session in recent times amid a rising dollar and expectations that the U.S. Federal Reserve will bring forward the removal stimulus. 
  • Bitcoin (+3.57%) rose to US$38,693 on signs of a recovery and despite cryptic tweets from Elon Musk that seem to suggest he's breaking up with the cryptocurrency and as outflows from exchanges outpaced inflows (outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. Biden is Cooling on Corporate Tax
  2. Come to the Temple of Investing
  3. Cryptocurrency Trading Takes a Serious Turn

Market Overview

While the U.S. nonfarm payrolls report hasn't been released yet (as of time of writing), markets appear to be pricing in a car in every driveway and a chicken in every pot with tech stocks tanking amidst increasing speculation that robust economic data will force the Fed's hand to taper sooner, rather than later. 
In an irony only the current economic circumstances can justify, investors are selling stocks because the U.S. economy appears to be recovering nicely, and is symptomatic of how reliant markets have become on central bank stimulus. 
And that presents challenges on many levels. 
If the Fed removes stimulus too quickly and too suddenly (it won't), markets are almost certain to tank, but even if it slowly creeps out the backdoor, how do you sneak a 400-pound gorilla that everyone is watching quietly out the back alley? 
This was a day or reckoning that the Fed would eventually have to deal with (exiting the markets) and investors are increasingly pricing the Fed's departure earlier than later, which might end up being a good thing. 
So long as the Fed doesn't leave the markets all at once, asset prices can normalize over a longer period and with time for market participants to adapt. 
Stung from the 2013 taper tantrum, when then-U.S. Federal Reserve Chairman Ben Bernanke announced that the Fed would withdraw its bond purchases at some unspecified date in the future sent markets into a turmoil, the Fed has since been far more measured and consistent in its messaging. 
Elsewhere in Asia, traders woke Friday to sharp declines with Tokyo's Nikkei 225 (-0.82%), Seoul's Kospi Index (-0.59%) and Hong Kong's Hang Seng Index (-0.58%) all down in the morning trading session, taking their cue from Wall Street while Sydney’s ASX 200 (+0.19%) was the only outlier as a rising greenback helped boost the prospects of its commodity producers which sell in U.S. dollars but incur costs in the Australian dollar. 

Did you miss us at the World Family Office Forum? Watch it here...


1. Biden is Cooling on Corporate Tax

  • Biden open to keeping U.S. corporate tax at 21% if Republicans are willing to come onboard his additional US$1 trillion infrastructure spending plan 
  • Investors pricing in tax status quo should keep a keen eye on stiffer enforcement by U.S. tax enforcement agencies and the possibility that Republicans may not come to the table, meaning Biden will need to negotiate solely with his Democratic counterparts, who will want higher corporate taxes on the negotiating table 
Build it and they will come, tax it and we can’t even talk anymore – or at least that’s what U.S. President Joe Biden appears willing to accept as he indicates he is prepared to drop his demands for an increase in corporate taxes if enough Republicans support his proposed infrastructure spending bill.
On paper, Republicans would appear obvious candidates to embrace infrastructure spending, with such programs typically supporting their more blue-collar voter base, as well as the big construction and material companies which tend to be GOP donors, but Biden’s infrastructure plan was intended as a tax-and-spend plan, something that Republicans are allergic to.
By dropping the corporate tax bait-and-switch, Biden is maneuvering to gain bipartisan support for his additional US$1 trillion in spending over the next decade to upgrade roads, bridges and broadband networks across the country.
Originally, Biden had intended to fund the increase in spending almost exclusively from a corporate tax increase from 21% to 28%, a move that Republicans adamantly opposed on the grounds that it would hurt the economy and partly unwind the previous administration’s tax cuts.
Instead, Biden is looking to fund the additional infrastructure spending through more aggressive tax enforcement by the Internal Revenue Service on wealthy households, and impose a 15% minimum tax on businesses so that they can’t take advantage of loopholes that mean they pay very little or nothing at all.
But investors betting that corporate tax increases are no longer a risk will also need to guard against the politics of Biden’s current proposal.
Should the U.S. President end up negotiating an additional spending package with Democrats alone, a corporate tax increase is almost guaranteed to be back on the table. 

Did you miss us at the World Family Office Forum? Watch it here...


2. Come to the Temple of Investing

  • Meme stocks have taken on a life of their own as "cult stocks" with their own sentiment echo chambers 
  • Surging on at times purely ideological buying activity, cult stocks may form an extension of broader social movements or be subject to hijack through internet-forum led pump-and-dump or boiler room type operations 
You’ll come for the stock, you’ll stay for the Kool-Aid.
While investing in any stock comes with the usual caveats, unknowingly joining a cult is unlikely to have been one of them.
Shares of companies thin on fundamentals but Thic (sic) on hype have long been known as “cult stocks” yet investors at AMC Entertainment (-17.92%) are taking things one step further and resembling a cult.
The same way devotees of Berkshire Hathaway (+0.71%) look forward each year to the firm’s annual general meeting like devotees on a pilgrimage, investors in cult stocks like AMC Entertainment and GameStop (-8.52%) can feel like they’re part of the community making a difference and that emotion can be very addictive.
Investing in companies like AMC Entertainment for instance is contrarian and in the investing world at least, puts you out of sync with time-honored fundamentals, so defending the move becomes a full-time job.
Just as how cult leaders are quick to isolate their hapless followers from the outside world and create their own echo chambers, cult stocks have their own Reddit forums and Twitter feeds that insulate them from the scrutiny of traditional stock analysis.
For investors of these cult stocks, critics are "them" and only followers of the cult "understand" the movement.
Forget about P/E ratios and fundamentals, for cult stocks, pushing the price up is a badge of loyalty and losses, the battle scars of fighting for the cause.   
Some cult stock investors are even seeing their investments as part of a broader move to “stick it to Wall Street” with some alleging to not even care if they lose money or not.
Whether such investors are a continuation of the “Occupy Wall Street” movement or not, their actions have already resulted in real world consequences, with prime brokerage Jeffries, telling clients on Wednesday that it will no longer allow the execution of short sells in shares of GameStop and AMC Entertainment.
Regardless, companies like AMC Entertainment are selling stock while the sun shines and announced its intention in a regulatory filing on Thursday that it intends to issue another 11 million shares to a market dominated by frenzied retail investors.
Appended to the regulatory filling was perhaps one of the most frank and forthright acknowledgments of the circumstances surrounding AMC Entertainment’s impending share sale,
“We believe that the recent volatility and our current market prices reflect market and trading dynamics unrelated to our underlying business, or macro or industry fundamentals, and we do not know how long these dynamics will last.”
“Under the circumstances, we caution you against investing in our Class A common stock, unless you are prepared to incur the risk of losing all or a substantial portion of your investment.”
Let’s not forget that before the Reverend Jim Jones got his followers at the People’s Temple to drink cyanide-laced Kool-Aid in one of the worst episodes of mass suicide, they were cautioned too that the end was coming.  

3. Cryptocurrency Trading Takes a Serious Turn

  • Cryptocurrency markets appear to be deleveraging, which should assist a reduction in volatility
  • Increased hedging activity seems to suggest that investors are getting more sophisticated (as opposed to openly bullish) and measured in their approach to the market 
While meme stock traders may still be in their hoodies and flip-flops, there are increasing signs that the cryptocurrency markets are trading up for suits.
In signs that digital asset markets are maturing, hedging activity is on the rise and bullish calls (the option to buy at a specified price) are finding muted demand, even with Bitcoin almost 40% below its peak, in a sign that market excesses fueled by leverage are being snuffed out.
During the height of cryptocurrency fever in April, the premium between the futures and spot price for Bitcoin soared to 50% on an annualized basis, meaning investors could make a massive profit with a simple convergence trade.
Because futures contracts move towards spot prices as the expiry date on those futures contract approaches (convergence) a trader could have arbitraged the premium by buying Bitcoin at the spot price, short futures contract and then making delivery of the Bitcoin.
The trader profits because the amount of money received by shorting the contracts exceeds the amount spent buying the Bitcoin to cover the position.
But the presence of that arbitrage opportunity was quickly traded out by arbitrageurs and according to data provider Skew, has collapsed to just 9% per annum based on rolling three-month Bitcoin contracts on cryptocurrency exchange Binance.
Derivatives volumes typically exceed spot trading activity on most days and strong (mostly retail) demand to speculate with easy-to-trade instruments (Binance academy anyone?) that offer leverage, as much as 100 times, means that bulls almost always outnumber bears.
But now that retail investors have headed to the beach for the summer, demand for long positions is drying up and the futures-spot spread is narrowing on retail hotspots like BitMEX, where spreads are narrowing to levels on the Chicago Mercantile Exchange (+0.76%), an institutional platform that facilitates the trade in Bitcoin cash-settled futures.
And while traders in the stock market primarily use options for hedging, cryptocurrency traders have long preferred to use options as a way to boost their bets for further gains, which is why outstanding bullish call options (the right to buy at a specified price) have long exceeded bearish put options (the right to sell at a specified price), according to data from Skew.
Open interest data (the number of unmatched contracts) show that’s still true, but the costs of one-month puts (bearish) on Bitcoin has also risen above the price of comparable calls (bullish) – a sign of rising demand to hedge positions on the downside.
All of which suggest an increasing sophistication in the cryptocurrency markets, with cryptocurrency options markets more closely resembling their equity counterparts, where defensive put options have long commanded a premium over bullish call options. 

What can Digital Assets do for you?

While markets are expected to continue to be volatile, Novum Alpha's quantitative digital asset trading strategies have done well and proved resilient.
Using our proprietary deep learning and machine learning tools that actively filter out signal noise, our market agnostic approach provides one of the most sensible ways to participate in the nascent digital asset sector. 
If this is something of interest to you, or if you'd like to know how digital assets can fundamentally improve your portfolio, please feel free to reach out to me by clicking here.  
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Jun 04, 2021

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