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Novum Alpha - Weekend Edition 17-18 July 2021 (10-Minute Read)

Now may not be the time to panic and markets appear not to be reacting to inflation, but uncertainty.

A wonderful weekend to you as markets waver on myriad concerns from the coronavirus to inflation. 

In brief (TL:DR)

  • U.S. stocks slipped on Friday as the Dow Jones Industrial Average (-0.86%), the S&P 500 (-0.75%) and tech-centric Nasdaq Composite (-0.80%) all lower, weighed down by inflation concerns and a sharp spike in coronavirus infections. 
  • Asian stocks closed a mixed bag on Friday, with concerns over inflation weighed down by fresh flareups in infections across Asia. 
  • Benchmark U.S. 10-year Treasuries plunged to 1.294% with investors looking for safety in Treasuries (yields fall when bond prices rise).
  • The dollar continued to tick higher against a basket of major currencies. 
  • Oil rose with August 2021 contracts for WTI Crude Oil (Nymex) (+0.22%) at US$71.81, even as markets face the prospect of extra supplies from the OPEC+ coalition. 
  • Gold was little changed with August 2021 contracts for Gold (Comex) (-0.77%) at US$1,815.00 as the dollar rose. 
  • Bitcoin (-1.05%) was more or less flat into the weekend at US$31,391 (Saturday, 1330 GMT) as the benchmark cryptocurrency continues to trade rangebound and inflows continued to lead outflows (inflows suggest that investors are looking to sell Bitcoin in anticipation of lower prices). 


In today's issue...

  1. In 2021, Even Bond and Inflation Correlations are Broken
  2. Endless Night of the Unvaccinated 
  3. Inflation Hasn't Done Much to Prop Up Bitcoin's Fortunes



Market Overview

Now may not be the time to panic and markets appear not to be reacting to inflation, but uncertainty.
With the dollar rising and U.S. Treasuries seeing strong demand can only mean one thing - that investors are uncertain about the future. 
Investors who are optimistic and bullish don't buy Treasuries or go into the dollar, they buy stock. 
Which suggests that uncertainty, especially as coronavirus case numbers spiked by 70% last week in the U.S. is starting to spook markets on how resilient the economic recovery is and whether a fresh wave of infections could unleash new pandemic restrictions. 
In Asia, stocks closed Friday a mixed bag with Sydney’s ASX 200 (+0.17%) and Hong Kong's Hang Seng (+0.03%) up marginally, while Seoul's Kospi Index (-0.28%) and Tokyo's Nikkei 225 (-0.98%) were down.

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




1. In 2021, Even Bond and Inflation Correlations are Broken

  • Spike in U.S. Treasury demand more reflective of concern over the economy than concerns over inflation 
  • Higher prices may be more symptomatic of transient factors and investors appear to be more keen on hedging risk than hedging inflation 
There are several things most everyone takes for granted, that the sun rises in the east, sets in the west and the earth revolves around the sun.
But in an era when a non-zero number of people believe that the earth is flat, the U.S. faked the moon landings and that coronavirus vaccines are a government conspiracy to track us, is it any wonder then that even the tried and tested correlation between bonds and inflation could be upturned as well?
Owning a bond entitles a bond holder to a stream of future income, typically made in the form of periodic interest payments, but inflation typically erodes the purchasing power of a bond’s future cashflows.
The higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher bond yields will rise across the yield curve, as investors typically demand a higher yield to make up for inflation risk.
Yet despite signs of sharply rising inflation, which would typically send U.S. Treasury yields soaring, they’ve actually plunged against a backdrop of appetite for U.S. government debt.
Inflation is usually bad news for bond prices, eroding the value of the fixed payments the debt offers and increasing the odds that central banks will respond by raising interest rates.
But the typically reliable correlation between inflation and bonds, like so many other reliable correlations, have been overturned in the past eighteen months.
One possibility of course is that investors are simply responding to the possibility of tightening monetary policy sooner than expected, another could be that concerns remain over coronavirus variants threatening to derail the economic recovery.
Even the U.S. Federal Reserve isn’t entirely sure if the current bout of inflation is transitory or persistent.
Taken together with the recent admission by policymakers that they are starting to have conversations about scaling back their US$120 billion monthly asset purchases, there is some expectation that the Fed will be less tolerant of runway inflation than previously thought.
And that could be driving the demand for Treasuries at a time when there is increasing uncertainty whether coronavirus variants could threaten to derail the economic recovery.
Either way, the demand for Treasuries is overturning typical correlations with inflation and longer-dated debt increasingly an unreliable barometer of inflation expectations.  

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




2. Endless Night of the Unvaccinated

  • Unvaccinated populations threaten to overturn gains made in curbing coronavirus infections  
  • Fresh infections don't just threaten the reinstitution of pandemic restrictions, but they also increase the possibility of new mutations of the coronavirus, making defensive pandemic trades of tech and Treasuries a possible hedge against this uncertainty 
For many in the United States, this summer has been a far cry from the quasi-imprisonment of last year's.
With pandemic restrictions lifted across much of the United States and Americans holidaying and making merry maskless, it would be tempting to assume that the worse is behind us.
But whilst many states are making no distinction between the vaccinated and the unvaccinated and Americans go about their lives as per normal, the U.S. Centers for Disease Control and Prevention or the CDC has warned of a “pandemic of the unvaccinated.”
Last week, coronavirus case numbers soared a remarkable 70%, with the spikes occurring in many parts of the country that have low vaccination coverage.
While states with high vaccination rates are not seeing a noticeable spike in infections, states which have either not promoted vaccinations or have politicians actively dissuading their constituents not to get the shot, have still gone on to lift pandemic restrictions.
The U.S. has a relatively high vaccination rate with almost half of the population fully vaccinated, but the rate of inoculation has been slowing, thanks to the spread of misinformation.
And although the number of new infections still remains far below pandemic peaks, the latest increase has raised concerns that fresh restrictions may once again need to be instituted to prevent the American healthcare system from being overwhelmed, especially as the pace of vaccination slows.
For now, coronavirus infections are confined to a handful of states, with Florida, Texas, California, and Missouri accounting for over 40% of the new cases over the past week.
But until the U.S. reaches herd immunity, estimated at between 60% to 70% of the population through either vaccination or a previous infection, the risk of further mutations of the coronavirus remains clear and present.
Each day that the coronavirus continues to spread, the odds of a mutation increases exponentially, and this has serious ramifications on markets and investment decisions.
Already the so-called reflation trade of more economically-exposed stocks has started to falter, with industrials, financials and energy taking a hit despite a resurgence earlier this year.
And there are also signs that concern over coronavirus flare-ups has fueled demand for safe assets like U.S. Treasuries, with yields still depressed (yields fall when bond prices rise) despite a sharp increase in inflation and inflation expectations.
Tech shares on the other hand have also pulled back and may be an interesting defensive play, despite the effect that inflation has on their future cash flows, especially on the outside chance that a new more virulent variant that is resistant to existing vaccines should develop. 

3. Inflation Hasn't Done Much to Prop Up Bitcoin's Fortunes

  • U.S. Treasuries and Bitcoin have not responded as expected to prospect of higher inflation
  • Investors may be more keen to hedge against uncertainty than inflation, as demonstrated by a reversal into the greenback and U.S. Treasuries and with Bitcoin still weaker
If Bitcoin was meant to act as a hedge against inflation, it sure has had an interesting way of demonstrating it.
Despite signs that inflation is spiking, Bitcoin has stayed relatively flat this month and technical indicators are suggesting that the benchmark cryptocurrency is closing in on a key inflection point.
Bitcoin is nearing the lower band of its Trading Envelope indicator – a tool that smooths moving averages to map out higher and lower limits and upon which Bitcoin could either rebound sharply or slip towards more weakness.
Technicians suggest that if the lower band of the Trading Envelope indicator should be breached, Bitcoin could test US$30,000, a key level of support to sustain the current trading range and which if breached could see Bitcoin fall to US$25,000 and then US$20,000.
But if Bitcoin were to duck below the Trading Envelope and rebound sharply, it could retest the upper trading band which currently sits around US$36,000.
Bitcoin’s role as an alleged hedge against inflation is being called into question this week with higher prices having done little to boost the price of the cryptocurrency.
But U.S. Treasuries have also responded inversely to inflation as well, suggesting that even if Bitcoin is a hedge against inflation, investors may be less worried about current inflation numbers than would be expected.
U.S. Treasury yields have actually fallen and demand for government debt increased, even on the prospect of inflation.
To be sure, almost a third of the increase in recently released Consumer Price Index data was from the price of used vehicles, a seasonal and one-off factor.
And prices are also coming off their pandemic base, which would always reflect sharp spikes in the short term, but which have the prospect of normalizing over a longer period.
Gold, has also slipped, suggesting that it may not be so much that Bitcoin is not a good hedge against inflation, but that at this juncture, investors are just not as concerned about inflation being anything other than momentary. 

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Jul 17, 2021

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