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Novum Alpha - Weekend Edition 2-3 October 2021 (10-Minute Read)

Although many investors expect stocks to keep rising, a multitude of factors has prompted them to anticipate slower gains and more persistent volatility. Rising headline inflation numbers, over 5% for the past three months and soaring energy prices, at a time when economic growth is slowing and the U.S. Federal Reserve is looking to scale back asset purchases and hike rates are all contributing to general market malaise. 

A wonderful weekend to you as we head deeper into October! Can you smell the pumpkin spice?

In brief (TL:DR)

  • U.S. stocks recovered some of the week's losses with the Dow Jones Industrial Average (+1.43%), the S&P 500 (+1.15%) and the tech-centric Nasdaq Composite (+0.82%) all recovering as investors bet on a change in season to fuel a change in sentiment. 
  • Asian stocks continued to struggle headed into the weekend.
  • Benchmark U.S. 10-year Treasury yields fell to 1.463% (yields fall when bond prices rise) as traders bought into oversold sovereign debt. 
  • The dollar was flat on Friday. 
  • Oil rose with November 2021 contracts for WTI Crude Oil (Nymex) (+1.13%) at US$75.88 on sustained bets that the energy crisis will persist for longer. 
  • Gold inched higher with December 2021 contracts for Gold (Comex) (+0.08%) at US$1,758.40.
  • Bitcoin (+0.32%) soared to US$47,677 heading into the weekend, with traders ascribing a variety of reasons for the recent rally, from seasonal shifts to key technical levels supporting a push higher. 

In today's issue...

  1. The Energy Crisis Could Preface an Even Larger Financial One 
  2. Evergrande Bond Investors Bet on Red
  3. Bitcoin's Biggest Jump Since July Leaves Traders Puzzled 



Market Overview

Volatility my old friend, I've come to trade with you again. 
Because the markets are creeping, 
me out with all the risks seeping. 
And the Vix, that had stayed quiet for so long, is running strong,
this is the song, of the market...
- Sung to the tune of The Sound of Silence, by Simon & Garfunkel, (C) 1964. 
Although many investors expect stocks to keep rising, a multitude of factors has prompted them to anticipate slower gains and more persistent volatility. 
Rising headline inflation numbers, over 5% for the past three months and soaring energy prices, at a time when economic growth is slowing and the U.S. Federal Reserve is looking to scale back asset purchases and hike rates are all contributing to general market malaise. 
In Asia, markets fell into the weekend with Tokyo's Nikkei 225 (-2.31%), Hong Kong's Hang Seng (-0.36%), Seoul's Kospi Index (-1.62%) and Sydney’s ASX 200 (-2.00%) were all down at the close on Friday. 

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1. The Energy Crisis Could Preface an Even Larger Financial One

  • Rising energy prices retraces the run-up to the 2008 Financial Crisis 
  • Risk of stagflation, rising inflation and low growth looms, and it is unclear if repeated rounds of stimulus will have a rehabilitative or destructive effect on the markets 
In the months leading up to the 2008 Financial Crisis, oil was expensive, very expensive.
From a high of US$133.88 in June 2008, oil capitulated to US$39.09 by February of the next year.
Could the current “energy crisis” be a sign of a build-up to another financial crisis?
While oil’s price collapse during these past two pandemic years has been well documented, supply chain disruptions and alleged faster fuel demand recovery have since pushed the price of oil past US$80.
Part of the reason of course is that environmental concerns with regards to shale oil extraction and the near collapse of the price of oil (it was negative at one stage of the pandemic), saw shale companies dial back production.
One of the byproducts of shale oil extraction is also natural gas, the stuff used to heat homes and light stoves, and crucial in the winter months.
But getting the shale companies back on site isn’t simply a matter of moving man and machinery and the current shortages could play out for several years, even though one major sector has cut back consumption significantly – aviation.
The energy crunch has had wide ranging effects on the global economy, take tech giants Apple (+0.81%) and Tesla (-0.03%) which can’t get critical components as key Chinese suppliers shut factories in response to China’s power shortage.
And if factories can’t produce, it means that workers can’t get paid and economic growth stalls – which could lead to a worst-case scenario for the global economy – stagflation – a situation of low growth and soaring inflation.
Some companies though, stand to gain.
With their share prices battered by the pandemic, the list of producers, include Royal Dutch Shell (+1.49%), BP (+0.27%) and Exxon Mobil (+3.59%) likely to benefit, as well as ConocoPhillips (+3.44%) and Haliburton (+3.05%), those in the materials and metals trade are likely to be hit the most.
Materials and metals are an extremely energy-intensive business, and some of the biggest names in the business could get squeezed, including Chinese stocks like Aluminum Corporation of China (-0.37%), Baoshan Iron & Steel (+1.05%) and Zhejiang Longsheng Group (+0.97%).
In Europe, cement maker Holcim (-0.66%) and steelmaker ArcelorMittal (-4.81%) could come under pressure, while in the U.S., steel company Nucor Corp. (-0.85%) and paint maker Sherwin-Williams (+1.90%) face headwinds.
But on a broader macro scale, the risks that come from soaring energy prices, especially if they persist could threaten to derail the current economic recovery narrative, especially at a time when central banks are looking to raise rates and taper asset purchases. 

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2. Evergrande Bond Investors Bet on Red

  • Distressed debt investors are playing a dangerous game by betting on the bonds of Evergrande Group (-3.91%)
  • Evidence is growing that Evergrande Group is likely to favor onshore creditors ahead of offshore dollar-denominated bonds which may eventually default 
Like crows swooping down on carrion, distressed debt funds and plucky investors are descending on dollar bonds of embattled Chinese real estate developer Evergrande Group, betting that Beijing will be forced to rescue the world’s most indebted company.
And who can blame them?
Trading at just cents on the dollar, the yields on Evergrande Group’s bonds are astronomical compared to the paltry returns from the wider bond market that has enjoyed an abundance of liquidity and strong demand.
Even typically conservative investors like pension funds and insurers, that had earlier distanced themselves from Evergrande Group on concerns of contagion, have also started to nibble around the edges, as their obligations soar at a time of low yields.
But Evergrande Group bond investors are playing a dangerous game of chicken, as last week, the real estate developer failed to make a US$83.5 million interest payment on a dollar-denominated bond, triggering a 30-day grace period before a formal default.
The Shenzhen-based company has made no announcement on the missed interest payment and Beijing has maintained its Great Wall of Silence.
Nonetheless, speculation that Beijing will “lead” a restructuring of Evergrande Group from behind the scenes has fueled trading of Evergrande Group’s dollar bonds in recent sessions.
But the clue to the risks surrounding Evergrande Group’s dollar bonds lies in their very label – “dollar bonds.”
Just US$20 billion of Evergrande Group’s staggering US$305 billion in liabilities lies offshore in dollar-denominated bonds, a drop in the ocean.
And given how the bulk of Evergrande Group’s borrowings are from state-owned Chinese banks, the ability to sell assets at doubtful prices to creditors or other state-owned companies provides a potential avenue out of the debt crisis for the company, but only onshore.
That isn’t necessarily the case for Evergrande Group’s offshore bonds and has become evident in recent weeks.
For instance, last week, Evergrande Group said that its wealth management unit had made a 10% repayment on wealth management products, largely owned by onshore retail investors and due on September 30, even as it ignored offshore payments.
Evergrande Group is understandably looking to prioritize onshore obligations, especially in an effort to stave off any social unrest, but that may mean that offshore Evergrande Group bond investors will ultimately be left high and dry.
Legally, there is structural subordination of obligations as well, lenders to Evergrande Group’s onshore subsidiaries are likely to get paid before lenders to the parent company or any offshore debt issuer.
The trade in Evergrande Group’s dollar-denominated bonds may be tempting, but investors need to ask themselves whether they’re just playing “pass the parcel” on a ticking timebomb.  

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3. Bitcoin's Biggest Jump Since July Leaves Traders Puzzled

  • Inexplicable Bitcoin rally said to have been fueled by Fed Chairman Jerome Powell's comment that the U.S. central bank has "no intention" to ban cryptocurrencies 
  • Prospect of regulation of stablecoins and no imminent ban of cryptocurrencies in the world's largest economy used to explain recent rally in cryptocurrencies 
The sudden jump in Bitcoin’s price last week, even as equities and risk assets struggled amidst a worsening energy crisis has left analysts turning to tea leaves, goat entrails and tarot cards to try and piece together a possible explanation behind the explosive rally.
Likely though, the most plausible explanation behind the recent rise in Bitcoin is the simplest one – that’s cryptocurrency for you.
As any seasoned cryptocurrency trader will attest, the fractionalized and decentralized market for cryptocurrencies make them particularly susceptible to volatile price swings in either direction and vulnerable to being championed by any narrative that gains popularity.
Some have suggested that U.S. Federal Reserve Chairman Jerome Powell’s comments on Thursday, that the central bank had “no intention” to ban cryptocurrencies was behind the sharp rally, while the technical analysis-inclined suggested that the push past closely watched price levels and moving averages was responsible.  
Seasonal bullishness may also factor in, as some have noted that October has tended to be a typically buoyant season for cryptocurrency markets, signally a shift to risk-on trading in cryptocurrencies for the next few weeks as investors rotate out of stocks and bonds into more non-traditional assets.
Cryptocurrencies had been trading sideways for weeks, with robust regulatory action from the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission putting a damper on sentiment.
But the pronouncement by Powell at a Congressional hearing on Thursday, that the central bank wasn’t going to ban cryptocurrencies, but might regulate stablecoins helped to turnaround sentiment.
Regulating stablecoins would be a welcome move for the cryptocurrency sector, which relies heavily on the digital halfway house between fiat and cryptocurrencies to execute everything from decentralized finance or DeFi, to sitting out market volatility and waiting for buying opportunities.

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Oct 03, 2021

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