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Novum Alpha - Daily Analysis 5 October 2021 (10-Minute Read)

Global stocks have dropped more than 5% from a record in early September, hurt by a looming reduction in U.S. Federal Reserve stimulus, spiraling energy costs and the possibility of slower growth in China due to Beijing’s property-sector crackdown.

 
A terrific Tuesday to you as stocks extend slide on risks from inflation and China.
 

In brief (TL:DR)

 
  • U.S. stocks closed Monday in the red with the Dow Jones Industrial Average (-0.94%), the S&P 500 (-1.30%) and the tech-centric Nasdaq Composite (-2.14%) all down on concerns over inflation and China risks. 
  • Asian stocks continued the selloff on Tuesday amid worries that surging prices for raw materials such as crude oil will stoke inflation and sap economic momentum.
  • Benchmark U.S. 10-year Treasury yields were steady at 1.47% (yields fall when bond prices rise) but with yields likely to face upward pressure as concerns over inflation mount. 
  • The dollar reversed an overnight loss.
  • Oil stabilized near the highest since 2014 with November 2021 contracts for WTI Crude Oil (Nymex) (+0.31%) at US$77.86 following OPEC+’s decision to maintain a gradual supply hike even as a natural-gas crisis boosts crude demand.
  • Gold was lower with December 2021 contracts for Gold (Comex) (-0.17%) at US$1,764.60.
  • Bitcoin (+2.98%) rose to US$49,242, making a push back toward $50,000 for the first time since El Salvador’s troubled rollout of the largest cryptocurrency as legal tender at the start of September.
 

In today's issue...

 
  1. China Evergrande Group’s Fire Sale
  2. Investors are Increasingly Discovering that 60/40 Doesn’t Work Anymore
  3. Bitcoin at US$50,000 Back in Play
 

Market Overview

 
Global stocks have dropped more than 5% from a record in early September, hurt by a looming reduction in U.S. Federal Reserve stimulus, spiraling energy costs and the possibility of slower growth in China due to Beijing’s property-sector crackdown.
 
A global selloff in stocks continued in Asia on Tuesday amid concern that surging prices for raw materials such as crude oil will stoke inflation and sap economic momentum.
 
In Asia, markets tumbled into Tuesday as traders weighed prospects for a pickup in growth against concern over inflationary pressures with Tokyo's Nikkei 225 (-2.94%), Hong Kong's Hang Seng (-0.84%), Sydney’s ASX 200 (-0.82%) and Seoul's Kospi Index (-2.31%) all down.
 

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1. China Evergrande Group's Fire Sale

 
  • Evergrande suspended its shares from trading in Hong Kong on Monday as the world’s most indebted real estate developer braced itself for the possible sale of its property management unit.
  • What that means of course is that Evergrande Group’s default could have far wider implications on the Chinese economy, where a full 29% of GDP is derived from the property sector.
 
In growing signs that Beijing won’t stand idly by as China Evergrande Group implodes and takes down the Chinese economy with it, the embattled property developer is taking a page out of the playbook for other high profile, large Chinese bankruptcies, entering into last minute “married” deals to sell assets in a bid to raise cash and prevent a messy default.
 
Yesterday, the world’s most indebted real estate developer suspended shares from trading in Hong Kong ahead of a possible sale of its property management unit.
 
So far at least, most of the assets that Evergrande is looking to dispose have found buyers who aren’t trying to lowball the real estate developer and have raised expectations that a vast restructuring of its crippling debt may be on the cards.
 
Evergrande’s shares have lost over 80% of their value this year alone and its offshore debt is trading at highly distressed levels, with a 2022 dollar-denominated bond only managing to garner US$0.26 on the dollar.
 
A coupon payment of US$83.5 million that was due on an offshore bond on September 23 has seen no payment, but that debt has 30 days before being considered to be in default.
 
Evergrande has however not made any official statement with respect to the missed payment.
 
But not all of Evergrande’s liabilities are owed solely to lenders.
 
For months, the real estate giant has sought to offload assets to raise cash, and between December of last year and June of this year, interest-bearing debt was slashed to US$89 billion, from US$111.22 billion previously.
 
What that means of course is that Evergrande Group’s default could have far wider implications on the Chinese economy, where a full 29% of GDP is derived from the property sector.
 
During the same period when Evergrande was slashing its interest-bearing liabilities, its obligations to contractors and other businesses, including real estate buyers and investors soared.
 
And that helps to increase the odds that Beijing will step in to ensure an orderly dismantling off Evergrande Group.
 
While Beijing has been loathe to bailout a private company, it may have little choice in the matter because a broad default of Evergrande Group could see multiple businesses across a myriad of sectors that provide employment and ensure social stability collapse along with it.
 
Ahead of Chinese President Xi Jinping’s push next year for an unprecedented third term, Communist Party officials will no doubt be looking to avoid any social unrest and the collapse of China Evergrande Group could be just such a trigger.
 

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2. Investors are Increasingly Discovering that 60/40 Doesn't Work Anymore

 
  • Last month, the typical negative correlation between equities and government bonds broke down, inflicting the largest losses for 60/40 portfolios since the pandemic rout of last year.
  • Considering that inflation could hit as high as 5% this year, the real rate of return of 60/40 could be negative for several years. 
 
So many things about life have changed from four decades ago. From the way we communicate, to the way we work, to what we eat.
 
Yet why haven’t our investment portfolios kept up with the times?
 
A growing number of investors are asking themselves that very question as the traditional mix of 60% stocks and 40% bonds in a typical investment portfolio suffers its work setback since the start of the pandemic.
 
Last month, the typical negative correlation between equities and government bonds broke down, inflicting the largest losses for 60/40 portfolios since the pandemic rout of last year.
 
Signs that inflationary pressure is likely to be persistent has weighed on consumer and business sentiment, prompting the first monthly loss in the benchmark S&P 500 since January.
 
U.S. Treasury yields have risen as well (bond prices fall when yields rise) as investors anticipate that the U.S. Federal Reserve will need to pare back its asset purchases or raise rates next year, to tame inflationary spirits.
 
As a result, the typical 60/40 portfolio saw a loss of 3.5% in September.
 
At a time when retirement obligations are rising, the 60/40 portfolio was supposed to have provided pensioners and older savers with a stable income in their golden years.
 
Instead, pensioners and retirees are having to contend with a vastly more challenging investment landscape than what they were promised four decades ago.
 
Exacerbating the problem is that although a 60/40 portfolio has returned 8% this year, both equities and bonds are richly priced, limiting the scope for future gains.
 
With rates so low now, it will be mathematically impossible for a 60/40 portfolio to repeat the performance for the past four decades.
 
To put that in perspective, last week, one of the world’s largest asset managers Vanguard, updated its forecast of expected 60/40 returns for the coming decade as a median annualized gain of 3.8% through to 2031.
 
Considering that inflation could hit as high as 5% this year, the real rate of return of 60/40 could be negative for several years. 
 
 

3. Bitcoin at US$50,000 Back in Play

 
  • Bitcoin is on the ascent again, after the shambolic rollout of the cryptocurrency as legal tender in El Salvador and the China's unilateral ban on all cryptocurrency transactions.
  • Despite the setback last Friday from China’s ban on cryptocurrency transactions, Bitcoin has since enjoyed the assurance that the U.S. Federal Reserve has no intention to ban cryptocurrencies.
 
Bitcoin is on the ascent again, after the shambolic rollout of the cryptocurrency as legal tender in El Salvador and the unilateral ban on all cryptocurrency transactions by the People’s Bank of China hammered the benchmark digital asset to its lowest level in months.
 
In the wake of the botched rollout of Bitcoin as legal tender in El Salvador last month, Bitcoin fell as much as 17%, with doubts being raised over its use case, given the rocky start and technical glitches that plagued the El Salvador experience.
 
Since then, El Salvadorans have taken to speculating in Bitcoin, using the ease with which the government app Chivo can be used to swap between dollars and Bitcoin to buy on the dip and sell on a rally.
 
Merchants outside of large multinational chains are also beginning to accept Bitcoin more willingly, in the hopes that they too can profit from some of the upside potential of the cryptocurrency.
 
And beyond El Salvador, the “growing institutional interest” according to Bank of America has seen the retail banking giant launch research coverage of cryptocurrency and digital assets.
 
In an interview on Bloomberg TV,
 
“If you look at the number of corporates mentioning crypto on their earnings calls, that’s gone from about 17 last year to about 147 in the most recent quarter.”
 
“This isn’t just Bitcoin anymore, this is digital assets and it’s creating a whole ecosystem of new companies, new opportunities, and new applications.”
 
Despite the setback last Friday from China’s ban on cryptocurrency transactions, Bitcoin has since enjoyed the assurance that the U.S. Federal Reserve has no intention to ban cryptocurrencies.
 
Nonetheless, Bitcoin continues to see considerable resistance at US$50,000 and will likely require several attempts at breaching that level for a sustained push higher.
 

 

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Oct 05, 2021

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