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Novum Alpha - Daily Analysis 13 July 2021 (10-Minute Read)

Time to make some money and that appears to be exactly what U.S. companies have been doing in the last quarter.

A terrific Tuesday to you as markets continue to make their turn for the better. 

In brief (TL:DR)

  • U.S. stocks entered the week higher with the blue-chip Dow Jones Industrial Average (+0.36%), S&P 500 (+0.35%) and the tech-centric Nasdaq Composite (+0.21%) all up as investors anticipate higher corporate earnings.  
  • Asian stocks advanced Tuesday after their U.S. counterparts notched yet more all-time highs as investors awaited second-quarter earnings season.
  • Benchmark U.S. 10-year Treasuries were steady at 1.360% after a solid U.S. debt sale (yields rise when bond prices fall).
  • The dollar dipped against most major peers.  
  • Oil was steady with August 2021 contracts for WTI Crude Oil (Nymex) (+0.19%) at US$74.24 after dipping for the first time in three days as traders grappled with the demand implications of a Covid-19 resurgence in several regions and slowing economic growth in China.
  • Gold was higher with August 2021 contracts for Gold (Comex) (+0.17%) at US$1,809.00. 
  • Bitcoin (-2.92%) fell to US$33,147 as volumes continue to decline and in the absence of factors to take the benchmark cryptocurrency in either direction and with flows into exchanges balanced (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices, while outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. Never Bet on a Defense Contractor Before? Now Might be a Good Time
  2. Cheapening Commodities Could Cause Concern
  3. Cryptocurrency Derivatives Return to be the Tail that Wags the Dog

Market Overview

Time to make some money and that appears to be exactly what U.S. companies have been doing in the last quarter. 
With earnings season under way, investors are pricing in record recoveries in America's most valuable companies and equities are reflecting those expectations. 
Investors are shrugging off concerns that the delta variant of the coronavirus could derail the economic recovery even as China's growth appears to be slowing. 
In Asia, stocks were led higher in Tuesday's morning trading session with Sydney’s ASX 200 (+0.45%), Seoul's Kospi Index (+0.72%), Tokyo's Nikkei 225 (+0.77%) and Hong Kong's Hang Seng (+0.80%) taking their cue from Wall Street.  

Did you miss us at the Super Crypto Conference 2021? Watch it here...


1. Never Bet on a Defense Contractor Before? Now Might be a Good Time

  • Lockheed Martin (-1.05%) could be a good defensive play for investors as geopolitical tensions ratchet up and as key tests for its F-35 fighter program get kicked down the road 
  • Decent dividend yield in a low yield environment and fair price-to-earnings ratio for Lockheed Martin compared with its historical P/E make it an interesting consideration 
To date, the United States taxpayer has spent US$398 billion on the F-35 stealth fighter program and the weapon is expected to cost US$1.7 trillion throughout its lifecycle according to the Pentagon’s Cost Assessment and Evaluation Office’s 2020 estimate.
For some perspective, the amount spent so far on the F-35 could have paid for 10 brand new carrier programs or 36 bran-new aircraft carriers (assuming costs similar to the Gerald R. Ford program) and remains America’s most expensive weapon system period.
But costs aside, does it even work?
Meant as a cost-effective fifth generation fighter replacement for the ageing but combat-tested F-16, the F-35 has delivered in some areas, its price to the U.S. Air Force has dropped to below US$80 million, less than some advanced contemporary non-stealth competitors and its stealth characteristics are definitely better than the F-16 it replaces for penetrating airspace guarded by modern air defense missiles.
How much better though remains to be seen as the Pentagon is only just closing in on deciding a new schedule for completing crucial combat testing of the F-35 that was originally planned for 2017.
And that delay may be music to the ears of the F-35’s maker, Lockheed Martin, because lawmakers may have to find themselves authorizing the Pentagon to keep buying the jet even through 2022 and 2023 without having a complete picture of the aircraft’s full capabilities.
The barrage of tests is meant to determine how the F-35 will fare against the most advanced Russian and Chinese aircraft and missile defenses, a key benchmark in a program that’s been a work in progress for two decades.
Despite being in development for such a long time, the F-35 is not yet in full-rate production, the most lucrative phase for Lockheed Martin that will allow the U.S. to enter into long-term multiyear contract that guarantee quantities, prices and maintenance.
With a price-to-earnings ratio of 12.6, Lockheed Martin is below its five-year average of 22.9 and its dividend yield is toward the higher end of the company’s historical range, at roughly 2.7%, which is extremely generous compared to the broader market and more than double the S&P 500.
And with geopolitical tensions set to ratchet up in the coming years, Lockheed Martin could enjoy what’s called the “sunk cost fallacy.”
It no longer matters if the F-35 can perform whatever it was intended to do, the Pentagon will buy it anyway.
At this late stage of the game, politicians on both sides of the aisle and career bureaucrats won’t have the appetite to shutter a program that has spanned numerous administrations and a Congress that at its inception would be unrecognizable today.
For investors though, the prospect of a steady stream of income, a guaranteed customer in the United States government and its allies, means that with Treasury yields plummeting and a generous dividend policy, investors could do far worse than Lockheed Martin.
In fact the longer it takes the F-35 program to enter full-rate production, the better it is for Lockheed Martin, because it’s not as if the U.S. isn’t buying F-35s in the meantime, adding to the tally and providing the “excuse” for upgrading this current fleet later, meaning more revenue.

Did you miss us at the Super Crypto Conference 2021? Watch it here...


2. Cheapening Commodities Could Cause Concern

  • Commodity prices are softening as concerns are growing that China growth is slowing 
  • Prices of raw materials may help to ease inflation concerns, but could portend something far worse - low growth and central bank stimulus that no longer has any effect 
Inflation is likely on the backburner and commodity prices seem to be slipping and surely that’s good because it won’t tempt the U.S. Federal Reserve to bring forward the schedule for raising interest rates and dampening the party in equities?
But concerns over a new coronavirus variant and slowing growth in China are causing everything from copper to corn, crude to coal, to slip.
The rapid spread of the delta variant of the coronavirus and signs that the Chinese recovery is slowing are clouding the outlook for commodity markets which have thus far enjoyed a blockbuster run thanks to concerns over inflation and expectations of strong demand.
Last weekend, G20 finance ministers warned that the rapid spread of the delta variant was casting a shadow over the improving economic outlook in Europe and infections are soaring again in the United States just as a broad reopening was underway.
Making matters worse, a failure to come to an agreement within OPEC+ could see members jack up oil production in a self-destructive race to the bottom.
Better weather is also leading to bumper harvests in the U.S. and slowing domestic consumption in China is reducing demand for soybeans, an important feedstock for livestock.
All of these factors are combining to put pressure on the so-called reflation trade, stocks of companies more closely tied to the economy, such as industrials, financials, energy, hospitality, travel and leisure, which had seen a resurgence earlier this year on expectations of a broad reopening and return to normalcy.
Despite a high rate of vaccinations, confirmed Covid-19 cases in the U.S. soared 47% to the end of last week according to data compiled by Johns Hopkins University, the largest rise since April 2020, when the pandemic first took hold.
Rising infections across the world are coming as the highly infectious delta variant spreads across the U.S. as initial gains in vaccinations are starting to taper off and as a large bloc of the American population resists vaccination.
Around half of all Americans remain unvaccinated and globally infections were up 12% to about 3 million last week.
Investors who had already positioned themselves for a sharp uptick and recovery may need to brace themselves for a rocky ride ahead and consider picking up some defensive positions in tech and Treasuries as more volatility lies ahead.

3. Cryptocurrency Derivatives Return to be the Tail that Wags the Dog

  • Healthy cryptocurrency derivatives trading suggests institutional activity is taking on a bigger influence again 
  • Sideways markets for cryptocurrencies such as the present favor the use of derivatives to generate returns in rangebound scenarios 
While nobody knows for sure how big the size of the global derivatives market is, with estimates on the high end putting it at US$1 quadrillion (yes, that’s a real number), they can at least agree on one thing, it’s many times the size of the underlying assets that they derive (hence the term “derivative”) their prices from.
Derivatives are quite simply, a product, such as a future, option or warrant, whose value derives from and is dependent on the value of an underlying asset, such as a commodity, currency or security.
Investors, traders and stakeholders use derivatives for a variety of reasons, including hedging risk, guaranteeing price, arbitrage and of course, profit.
Contrary to popular belief, derivatives do not only serve a speculative role but are important as a hedge, especially for raw material producers.
The earliest known derivative was created in Osaka, where the Dōjima Rice Exchange provided for  the first rice futures contract that guaranteed rice farmers a price for their rice so that they could hedge their cost of production.
Since then, derivatives have been created on any number of underlying assets, from stock indices to cryptocurrencies and have often been seen both as a measure of the level of speculation, as well as the maturity of the market.
Which is why there are signs that the cryptocurrency markets may be growing up.
Last month, more cryptocurrency derivatives were traded than their underlying assets, according to data from CryptoCompare, an information service provider, in a sign of both increasing institutional participation in the space and sophistication.
Derivative activity in the digital asset markets has also been picking up, rising from 49.4% of market volume in May, to 53.8% of all trading volume in June, with derivatives volume hitting US$3.2 trillion, or just over double of the market cap for all cryptocurrencies at the time.
To be sure, cryptocurrency derivative trading has for the most part exceeded spot market volumes, but lowered volatility and prices have seen traders move into the derivative markets to deploy derivative strategies that tend to do better in sideways markets.
According to a CryptoCompare report released yesterday,
“As a result of both lower prices and volatility, spot volumes decreased by an immense 42.7%, while total derivative volumes decreased 40.7%.”
Lower volumes are generally to be expected when cryptocurrency prices fall as a whole and when the market starts to enter a relatively flat phase as it is in currently.
Traders are well advised to pay attention to the derivatives market for cryptocurrencies as they could also provide signs of where the market is headed to next, with a move in either direction, suggestive of future prices.
For now, the odds are slightly in favor of a medium-term bull case.
Given that the risk-reward ratio for bullish options and futures for cryptocurrencies with a relatively capped downside appear to be a favorable trade that isn’t particularly crowded at this point, some major macro event could be all that is needed to shift prices northwards.
Concern over a resurgent coronavirus, the catalyst for cryptocurrencies in 2020, as well as central banks hitting the limit on effective stimulus, or a U.S. Bitcoin ETF all provide “justification” for a bull case that could see the cheaper bullish options at this point in time turn profitable.

What can Digital Assets do for you?

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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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Jul 13, 2021

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