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Novum Alpha - Daily Analysis 30 August 2021 (10-Minute Read)

Stocks continued their relentless ascent on the back of signs that the U.S. Federal Reserve was taking a measured approach towards any potential tapering of its US$120 billion-a-month asset purchases of mortgage-backed securities and U.S. Treasuries.

A magnificent Monday to you as we kick off the dog days of August to head into the autumn in the northern hemisphere. 

In brief (TL:DR)

  • U.S. stocks rallied higher on Friday with the Dow Jones Industrial Average (+0.69%), the S&P 500 (+0.88%) and tech-centric Nasdaq Composite (+1.23%) as comments from U.S. Federal Reserve Chairman Jerome Powell continued to perpetuate the dovish stance of the central bank. 
  • Asian stocks were steady Monday as traders weighed Jerome Powell’s signal that pandemic-era U.S. Federal Reserve policy support will be withdrawn cautiously and gradually.
  • Benchmark U.S. 10-year Treasury yields were at 1.30% as investor appetite for bonds grew with the Fed's even hand at tapering (yields fall when bond prices rise). 
  • The dollar held a drop. 
  • Oil was lower with October 2021 contracts for WTI Crude Oil (Nymex) (-0.07%) at US$68.69 as investors priced in the effects of Hurricane Ida on the American Gulf Coast. 
  • Gold was little changed with December 2021 contracts for Gold (Comex) (+0.04%) at US$1,820.30.
  • Bitcoin (-1.69%) fell to US$48,529 as investors rotated into altcoins in search of outsized returns, and with flows balancing each other out (outflows suggest that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. The Fed’s Taper Could Tear Up Emerging Market Economies
  2. Investors Turn to the “Just in Case” Trade
  3. Altcoins Have Their Bitcoin Moment

Market Overview

Stocks continued their relentless ascent on the back of signs that the U.S. Federal Reserve was taking a measured approach towards any potential tapering of its US$120 billion-a-month asset purchases of mortgage-backed securities and U.S. Treasuries. 
But risks are building up in equity markets that are chasing new highs and attracting eye-popping valuations and there are increasing risks in emerging market equities as the threat of a Fed taper and rising borrowing costs take a heavier toll over there. 
Asian stocks have however put those concerns on the backburner for now, with Tokyo's Nikkei 225 (+0.18%), Sydney’s ASX 200 (+0.03%) and Seoul's Kospi Index (+0.27%) higher while Hong Kong's Hang Seng (-0.11%) was just so slightly lower.

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1. The Fed's Taper Could Tear Up Emerging Market Economies

  • International Monetary Fund Chief Economist warns of damage to emerging markets should the U.S. Federal Reserve raise rates ahead of the rest of the world recovering 
  • Investment flows could very rapidly turnaround should borrowing costs increase and cripple emerging market economies at a time when vaccinated rich nations return to economic normalcy 
The U.S. Treasury may have no theoretical limit to how much it can borrow, but the same does not apply for emerging market economies.
While Congress barely flinched when passing trillions of dollars’ worth of stimulus, comforted in the knowledge that U.S. Treasuries would help to pay for that expense, battered emerging market economies had to contend with dollar denominated debt.
“It simply deals with unpredictability in complex systems. The shorthand is the ‘butterfly effect.’ A butterfly can flap its wings in Peking, and in Central Park, you get rain instead of sunshine.”
– Dr. Ian Malcolm, played by Jeff Goldblum in Jurassic Park
The threat of a Fed tapering of asset purchases isn’t so much a butterfly flapping its wings as a 400-pound gorilla jumping into the pool.
And IMF Chief Economist, Gita Gopinath, in an interview with the Financial Times is sounding the alarm on a hasty withdrawal from bond markets by the world’s foremost central bank,
“[Emerging markets] are facing much harder headwinds. They are getting hit in many different ways, which is why they just cannot afford a situation where you have some sort of a tantrum of financial markets originating from the major central banks.”
The pandemic has hit countries around the globe unequally, with rich countries getting vaccinated at a faster rate and business activity in the U.S. picking up sharply over the past five months.
And the global economy might have to contend with a situation where the pandemic continues to linger in developing nations, against a backdrop of the Fed returning to a more normal monetary policy, leading to what the IMF has warned of a “double whammy.”
According to the IMF, as much as US$4.5 trillion worth of GDP could be erased by new waves of infections in developing economies which still struggle to gain access to vaccines, at a time when borrowing costs in the U.S. are returning to normal.
Major emerging markets have seen their debt spike from 52.2% to 60.5% of GDP as their governments raced to increase fiscal and monetary support in the wake of the devastating economic effects of the pandemic.
And while many developing economies are in far better shape today than in 2013’s U.S. taper tantrum, a large shock could easily break open their modest war chests.
With yields depressed, more money has flowed into emerging market stocks and bonds in the past nine months, according to the Institute of International Finance, as global investors searched for returns.
But these fickle flows could reverse overnight once normalization returns to the U.S. and Europe, something that could be devastating for emerging market assets.
U.S. Federal Reserve Chairman Jerome Powell has at least been very clear in his communication with the market, laying out a roadmap and a precise plan of action and staying the course.
And that has helped avoid some of the volatility that marked Ben Bernanke’s ruinous 2013 tapering of asset purchases that occurred ahead of schedule, roiling emerging market assets.
Investors in general and those invested in more volatile emerging markets in particular, don’t like surprises.

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2. Investors Turn to the "Just in Case" Trade

  • U.S. economy may be recovering but markets appear to be turning cautious with a rise in demand for defensive stocks 
  • Healthcare and utility sectors are outperforming the S&P 500 as investors price in the possibility of a prolonged pandemic thanks to the delta variant of the coronavirus  
“What you do speaks so loudly that I cannot hear what you say.”
– Ralph Waldo Emerson
While U.S. Federal Reserve Chairman Jerome Powell’s speech at the Jackson Hole symposium would have brought much comfort to investors worried that the Fed would yank support for the economy, the stock markets seem to be telling a different story.
Although Powell spoke of how the U.S. economy was strong enough for the Fed to potentially start paring back asset purchases this year, there are signs that all is not well and even Powell himself hinted at that,
“The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful.”
Kudos to Powell because stocks seem to be painting a picture of increasing expectations that the economy may be in for another bout of struggle, with some of the hottest U.S. equities pointing to an economic cool down.
Over this quarter, some of the best-performing sectors in the S&P 500 have been defensive plays, including healthcare and utilities, hardly the stuff of growth, including big winners like NextEra Energy (-0.48%) which is up around 14% this quarter, and medical company Danaher Corp (+0.24%) which is up a cool 19%.
These gains are significant because investors have typically piled into these sort of stocks when expecting the economic outlook to darken because visits to the doctor and demand for electricity are less volatile than say demand for a brand new phone or a cruise vacation.
With Goldman Sachs (+1.77%) this month cutting its third quarter U.S. economic growth forecast to 5.5% from 9%, even the so-called “smart money” is recognizing the slowing consumer spending in the face of a resurgent Covid-19 outbreak.
While a rally in defensive sectors such as healthcare and utilities is hardly the stuff of recessions, they can serve as an early warning to a broader market retreat, potentially providing a fresh test for a market whose post pandemic rise has surprised even the biggest bulls.
But there is increasing concern that a resurgent and more virulent delta variant of the coronavirus could derail consumer demand, which makes up 70% of the U.S. economy, at a time when the Fed is contemplating withdrawing its support.
A worst-case scenario for investors would be a dreaded bout of deflation – slow economic growth against a backdrop of high inflation.
In those circumstances, there’s little that the central bank can do to stimulate growth because adding more liquidity into the market no longer results in higher economic activity but actually worsens the problem by contributing to inflation.
It’s entirely possible that the U.S. economy and the world at large, heads into a period akin to Japan’s “lost decade” with the bursting of that country’s massive property bubble. 
As Americans approach the second autumn of the pandemic, with no clear light at the end of the tunnel, more questions are being raised about the resilience of markets.

3. Altcoins Have Their Bitcoin Moment

  • Altcoins rise faster than incumbent Bitcoin and Ethereum as investors go in search of the next big thing 
  • Excess liquidity, speculation and different economic narratives are all seeing a demand for cryptocurrencies outside of the mainstream few
Always the bridesmaid, never the bride.
For holders of so-called altcoins, cryptocurrencies that are not Bitcoin or even Ethereum, watching the topmost digital assets soar while leaving everything behind in its dust can be somewhat disheartening.
While Bitcoin and Ethereum capture most of the mainstream media attention, there has been no shortage of challengers looking to do what the key cryptocurrencies do, but even better, and with more features.
And now might be their moment as investors start fanning out into lesser-known cryptocurrencies in search of the next big thing.
Over the past week, as Bitcoin and Ethereum have stayed flat, following a failed push by Bitcoin to clear US$50,000 unequivocally, the altcoins have rallied hard.
Cardano has doubled this month and overtaken XRP to become the world’s third most valuable cryptocurrency by market cap, while something called Avalanche has tripled in August alone.
Against this backdrop, NFTs or non-fungible tokens have taken off, tied to anything from cartoon depictions of cute animals, to CryptoPunks with bright red lipstick.
But there’s little to explain the recent frenzy, with some suggesting that investors have turned from meme stocks to cryptocurrencies as institutional investors started picking up the meme stock gauntlet.
Others suggest that in a world awash with excess liquidity, investors can’t lose by making a bet on almost anything.
According to a survey of more than 1,000 American adults by The Harris Poll for Yahoo Finance, about 15% who received the first two stimulus checks invested all or part of the money with about half pouring that specifically into cryptocurrencies.
In many ways that makes absolute sense because viewed from their perspective, seeing as to how it costs nothing to make a bet on a cryptocurrency that could potentially return multiple times on the amount invested, there’s really nothing to lose.
Rising inflation has also played into the Bitcoin narrative as a hedge against the perceived debasement of fiat currency.
Put all these various factors together and it’s no wonder that investors are all searching out the next Bitcoin or Ethereum from the myriad altcoins available.
A recent survey by online brokerage eToro found that the average investor was set to increase their portfolio allocation in cryptocurrencies in the coming months and with the bulk of that interest in cryptocurrencies other than Bitcoin and Ether.

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Aug 30, 2021

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