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Novum Alpha - Weekend Edition 12-13 June 2021 (10-Minute Read)

he Treasury market was the one to watch heading into the weekend and it did not fail to disappoint. Whether it was a short squeeze on Treasuries or a market that genuinely accepts inflation is no longer a matter for concern, the slide in benchmark U.S. Treasury yields and strong demand for government debt saw equities charge ahead, led primarily by Big Tech. 

A wonderful weekend for you filled with vaccine-enabled wanderlust! 
In brief (TL:DR)
  • U.S. stocks managed to finish higher in a choppy trading session with the blue-chip Dow Jones Industrial Average (+0.04%), the S&P 500 (+0.19%) and tech-centric Nasdaq Composite (+0.35%) all marginally up as investors remained divided on the outlook for growth and inflation. 
  • Asian stocks were mostly higher at the close on Friday as a decline in the dollar and strong demand for U.S. Treasuries renewed confidence in markets.
  • Benchmark U.S. 10-year Treasuries finished at 1.453% after falling to as low as 1.43% at one stage, and investors shrugging off any prospect for higher inflation (yields generally fall when bond prices rise).
  • The dollar rose against its global peers. 
  • Oil surged with July 2021 contracts for WTI Crude Oil (Nymex) (+0.88%) at US$70.91 on demand recovery.
  • Gold slipped with August 2021 contracts for Gold (Comex) (-0.89%) at US$1,879.60 as lowered concern over inflation saw a decline in demand for inflation hedges. 
  • Bitcoin (-3.97%) fell further into the weekend to US$35,304 (0630 GMT, Saturday, 6 June 2021) as inflows into exchanges led outflows as trading volumes overall slipped (outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. Beware the Zombie Stock Apocalypse 
  2. Yields Inversely Correlated with Inflation? 
  3. Futures Look Bright for Bitcoin

Market Overview

The Treasury market was the one to watch heading into the weekend and it did not fail to disappoint. 
Whether it was a short squeeze on Treasuries or a market that genuinely accepts inflation is no longer a matter for concern, the slide in benchmark U.S. Treasury yields and strong demand for government debt saw equities charge ahead, led primarily by Big Tech. 
Even as an ominous antitrust legislation directed at Big Tech brews in Washington, which will still need Senate approval, investors piled into technology firms on the back of U.S. Treasury yields sliding, as a sign that concerns over inflation could be thrown into the wind.  
Asian entered the weekend mostly higher with Tokyo's Nikkei 225 (-0.03%), the only laggard as concerns over a fresh outbreak of the coronavirus in Japan outweighed optimism, while Seoul's Kospi Index (+0.77%), Hong Kong's Hang Seng Index (+0.36%) and Sydney’s ASX 200 (+0.13%) all finished up.
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1. Beware the Zombie Stock Apocalypse

  • Continued resilience of so-called "zombie" stocks rewrites conventional wisdom on investment
  • Zombie stock investments are not completely without rationale as retail traders profit from short squeezes and pile into some companies which do have a shot at revival thanks to a reopening U.S. economy 
Just when you thought it was safe to be a value investor again, the Zombie Stock Apocalypse rolls in.
As the U.S. and Europe reopen in earnest, thanks to relatively successful vaccination programs, like the Brood X cicadas re-emerging from their slumber, there was a sense in some investment circles that level heads would finally prevail.
Cyclical stocks in more economically-exposed sectors were seeing a bump, and meme stocks, that many investors saw as a symptom of the madness of the pandemic, were getting their comeuppance – except they weren’t.
More resilient than a 17-year old invertebrate slumbering in the soil, companies like AMC Entertainment (+15.39%) and GameStop (+5.88%) have been well-documented for getting a second lease of life thanks to Redditors and retail investors chasing up their stocks.
But the duo is hardly alone, with 726 companies in the Russell 3000 Index, a broad benchmark of U.S. stocks, whose earnings don’t cover their interest payments, looking to Reddit magic to resurrect their fortunes.
Up an average of 30% in 2021, these zombie companies trounced the return for the entire Russell 3000 Index, with no less than 41 of them doubling in 2021.
Company going bankrupt? No problem.
Take GTT Communications (-3.05%), an embattled IT service management company that warned shareholders a bankruptcy plan under consideration could wipe out the value of their stock, yet investors shook off the risk and rallied shares of the company by 69%.
Theater operator AMC Entertainment which was staring down bankruptcy last year, now has a path to a sustainable capital structure, in part at least because it’s been able to sell new shares amid huge demand from retail investors.
And as for the stock that started it all GameStop? It’s now debt free and on a turnaround program.
Even companies in bankruptcy have not been left behind – Medley Management (-15.91%), an alternative asset management firm that is already in bankruptcy proceedings, has seen its share soar this month.
But there is some method to the apparent madness.
Redditors have specifically targeted stocks with huge short bets against them and which also tend to be in industries which could see a revival of fortunes as the worst of the pandemic is in the rearview mirror.
Short squeezing, or bidding up the prices of stocks and forcing short sellers to cover their positions by buying back shares at a higher price, is an almost guaranteed way to see stock prices rise in a relatively short period of time.
How the Zombie Stock Apocalypse will end though is less clear, but right now at least, the spread between textbook investing and the forums of Reddit remain wide. 

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2. Yields Inversely Correlated with Inflation?

  • Surge in demand for U.S. Treasuries have seen benchmark yields fall, even as inflation hits its highest rate of increase since 2008 
  • Short sellers may be being squeezed out and covering their short positions on Treasuries, or the market may no longer be concerned over inflation, creating higher risks for investors as asset prices continue to rise 
Economics teaches that as inflation increases, the price of bonds fall, and yields must rise to compensate bond investors for the lower yield on the debt that they hold.
So when U.S. consumer prices rose at the fastest pace since 2008, there may have been at least some expectation that U.S. Treasury yields would spike.
Instead, the benchmark yield on U.S. 10-year Treasuries fell by 0.103% to 1.453%, its largest weekly decline since last June when concerns over the pandemic led a flight to haven assets.
Some analysts suggest that the recent rally in Treasuries has been fueled by a short squeeze, as investors who placed bets against Treasuries earlier in the year were forced to throw in the towel when the market moved against them
But despite the buying this week, many investors still hold short positions on Treasuries, suggesting the squeeze could continue and yields could drop even further.
Another school of thought suggests that this week’s Treasury rally will prove transitory, whilst inflation will not, which will force the U.S. Federal Reserve to have to eventually begin the process of softening up market for the slowing of bond purchases.
The challenge lies in deciding whether the sharp decline in yields is a result of a short squeeze or because investors are less worried about inflation moving forward.
Many fund managers had bet that the Fed would have to respond to inflation by scaling back its monetary stimulus, tapering purchases of Treasuries and government-backed mortgages that run to US$120 billion a month and forcing yields northwards.
But evidence in equities, with the S&P 500 surging to a fresh all-time-high is reflective of a market that no longer seems to be worried about tapering, and yields also seem to suggest that concerns over inflation have waned as well.
The market response to inflation data creates a unique set of risks and opportunities.
On first inspection, it looks as though the Fed’s narrative on inflation has taken root in the markets – that this bout of inflation is temporary and is due to pandemic distortions.
If so, the bigger question then is, how much higher can markets rally?
The clue comes from the Fed’s guidance itself – when the U.S. reaches target levels of employment.
If inflation data itself has not curbed investor appetite for both bonds and equities, then a Fed taper might.
Whilst investors were eyeballing inflation data for signs of where equities or bonds could head next, it could well have been that it was employment data all along that mattered, as the Fed has been reiterating for several months.
What the recent rise in yields does throw up is that the correlation between inflation and yields is not a given.
The pandemic has overturned plenty of conventional wisdom, from cryptocurrencies to meme stocks, and typical correlations can no longer be relied on for making investment decisions. 

3. Futures Look Bright for Bitcoin

  • Fall in short futures for Bitcoin on CME could be sign that Bitcoin may be set to rally soon  
  • Hedge funds have taken short bets on Bitcoin and rolled them into other assets, paving the way for a bullish uptick for Bitcoin in the medium term
Part of the reason why Bitcoin went on a relentless ascent in its early history was that there just simply weren’t a lot of ways to take a contrarian bet on the nascent asset class.
Whilst derivatives to bet against the rise of Bitcoin existed on unregulated cryptocurrency derivative exchanges like BitMEX, there wasn’t a meaningful way for hedge funds and other institutional investors to short Bitcoin on a regulated forum, until the Chicago Mercantile Exchange (+0.75%) and the Chicago Board of Exchange (+0.44%) introduced cash-settled Bitcoin futures.
And while the CBoE Bitcoin futures product gave up the ghost, the CME cash-settled markets chugged along in both bull and bear markets.
But following a recent drop in the price of Bitcoin as well as other cryptocurrencies, hedge funds who had been plying the CME are rolling their short bets into other markets that they deem to be more lucrative in the short term.
The decline in bearish short futures on CME has led to a corresponding drop in open interest in Bitcoin futures and highlights the critical role that the CME plays in bootstrapping liquidity for institutional derivative markets.
But the decline in short bets against Bitcoin could also be a sign that institutional investors are gearing up for Bitcoin to rally sharply again.
After coming close to testing US$30,000 last week, a key level of support for Bitcoin, a new law in El Salvador accepting Bitcoin as legal tender, as well as more institutions piling into the cryptocurrency space had provided bullish inputs for the benchmark cryptocurrency.
Whilst still well off its all-time-high of close to US$65,000, Bitcoin has proved remarkably resilient at a time when regulators have signaled a growing intent to regulate the cryptocurrency space, while China has cracked down on cryptocurrency activity within its borders.
But the decline in bearish Bitcoin futures on the CME could also be part of a broader shift to avoid very obvious shorts by hedge funds altogether.
Short sellers have had a hard time this year, with hedge funds like Melvin Capital nursing billions of dollars’ worth of losses from their shorts on companies like GameStop, and retail investors have demonstrated that they are willing and able to continue to squeeze short sellers.
Whilst short selling on CME has never been a primary driver of Bitcoin prices anyway, hedge funds may have got wind that growing institutional interest in cryptocurrencies and the dominant presence of retail investors in crypto markets in general, makes them prime targets for a concerted effort to squeeze Bitcoin short sellers. 

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Jun 12, 2021

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