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Novum Alpha - Daily Analysis 7 October 2021 (10-Minute Read)

Investors remain on edge as they grapple with a panoply of risks, including tighter monetary-policy to tackle price pressures and the impact on Chinese growth of Beijing’s curbs on its debt-laden property sector as well as the global energy crunch.

 
A terrific Thursday to you as markets turnaround with breakneck speed.  
 

In brief (TL:DR)

 
  • U.S. stocks closed higher Wednesday with the Dow Jones Industrial Average (+0.30%), the S&P 500 (+0.41%) and the tech-centric Nasdaq Composite (+0.47%) all up, on the prospect of Washington finding a way out of the debt ceiling impasse. 
  • Asian stocks rose Thursday after progress on the U.S. debt-ceiling impasse lifted equities on Wall Street.
  • Benchmark U.S. 10-year Treasury yields ticked up to 1.54% (yields rise when bond prices fall).
  • The dollar remained higher.
  • Oil retreated from a seven-year high with November 2021 contracts for WTI Crude Oil (Nymex) (-0.92%) at US$76.72 in line with the prospect of Russia helping to ease the energy crisis. 
  • Gold was little changed with December 2021 contracts for Gold (Comex) (-0.12%) at US$1,759.70.
  • Bitcoin (+6.90%) surged to US$54,831 on signs that the cryptocurrency is decoupling with equities, with outflows leading inflows (outflows typically signal that investors are looking to hold Bitcoin in anticipation of higher prices). 
 

In today's issue...

 
  1. S&P 500 Mounts Biggest Comeback Since February
  2. Russia Becomes Unlikely Hero to Stabilize Gas Prices
  3. Bitcoin’s Recent Rally Burnishes its Portfolio Diversification Claims
 

Market Overview

 
Investors remain on edge as they grapple with a panoply of risks, including tighter monetary-policy to tackle price pressures and the impact on Chinese growth of Beijing’s curbs on its debt-laden property sector as well as the global energy crunch.
 
For now though, investors are looking primarily forward with U.S. President Joe Biden's plan to meet virtually with Chinese President Xi Jinping before the end of the year providing reason to believe that tensions should ease and with Russia offering to ease Europe’s energy crunch, a potential pathway to prevent runaway energy prices. 
 
Meanwhile, the European Central Bank is studying a new bond-buying program to prevent any market turmoil when emergency purchases get phased out.
 
In Asia, markets rose Thursday after progress on the U.S. debt-ceiling impasse lifted equities on Wall Street with Tokyo's Nikkei 225 (+1.68%), Hong Kong's Hang Seng (+2.27%), Sydney’s ASX 200 (+0.54%) and Seoul's Kospi Index (+1.73%) all up in the morning trading session. 
 

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1. S&P 500 Mounts Biggest Comeback Since February

 
  • Volatility has become part and parcel of the markets now, with everything from China’s crackdown on various sectors, to soaring energy prices, all having marked impact on sentiment and price action.
  • Given the excessive levels of liquidity and low yield environment, investors have but little choice to stay engaged as high levels of inflation will eat away at holding cash.
 
The way the markets move these days is enough to give you whiplash.
 
With more reversals and twists than a Korean soap opera, the benchmark S&P 500 erased a 1.3% decline on Wednesday, the first time since February that stocks mounted a full recovery from such a big loss.
 
Observers put the strong rebound to a possible end to political gridlock in Washington over the debt ceiling, with Republicans poised to offer Democrats a way out of the impasse.
 
Volatility has become part and parcel of the markets now, with everything from China’s crackdown on various sectors, to soaring energy prices, all having marked impact on sentiment and price action.
 
While the rebound is welcome news for equity bulls, it also reflects a challenging environment for investors with no clear directional push and macroeconomic uncertainties are weighing on medium term sentiment.
 
It doesn’t help that equities are commanding eye-watering valuations, but against this backdrop, threats to profitability abound, with supply chain disruptions, China’s real estate and energy crisis all leading to confusion over what investors can expect next.
 
Policy shifts are also more frequent and more sudden, taking financial assets along for a wild ride.
 
Take natural gas prices for instance, up as much as 40% at one stage before Russia’s President Vladimir Putin declared that the country was ready to help, plunging prices.
 
If the markets have become a roller coaster, investors appear to be hanging on for dear life.
 
Given the excessive levels of liquidity and low yield environment, investors have but little choice to stay engaged as high levels of inflation will eat away at holding cash.
 

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2. Russia Becomes Unlikely Hero to Stabilize Gas Prices

 
  • On Wednesday, gas markets swung sharply after Russian President Vladimir Putin said his country was prepared to stabilize soaring global energy prices that are threatening to derail the nascent recovery as well as curb industrial activity.
  • Putin disputes these allegations and has maintained that it was exceeding its contractual obligations for gas supplies through Ukraine this year.
 
In the fall of 1944, Nazi leader Adolf Hitler abruptly turned his armies who were just miles from taking Moscow, towards the oil-rich Caucasus region in the U.S.S.R.’s southwest flank.
 
The move would prove costly strategically, but the oil and natural gas fields were too tempting to pass up.
 
Decades later, those same oil-rich regions as well as parts of Siberia are still home to the world’s largest natural gas reserves and how Moscow decides to distribute that gas can have a significant impact on the price that the rest of the world pays to heat their homes and food.
 
On Wednesday, gas markets swung sharply after Russian President Vladimir Putin said his country was prepared to stabilize soaring global energy prices that are threatening to derail the nascent recovery as well as curb industrial activity.
 
Europe depends heavily on access to Russian gas, and Russia on its part, relies heavily on soaring energy prices to fund its economy.
 
U.K. and European gas prices shot up to 10 times their level from the beginning of the year before Putin hinted that Russian state-owned gas company Gazprom, could increase supplies to Europe to avert a full-blown energy crisis.
 
The move surprised observers.
 
Russia has had testy relations with Europe for some time, which was made worse by the Trump administration’s warmer relationship with Moscow.
 
But some gas traders are suggesting Moscow has been behind the recent spike in gas prices all along, by limiting supplies to Europe to the levels in long-term contracts and letting Gazprom’s storage facilities fall to very low levels.
 
Putin disputes these allegations and has maintained that Russia had been exceeding its contractual obligations for gas supplies through Ukraine this year.
 
Ukraine and other eastern European countries have pushed back and accused Russia of “weaponizing” gas supplies.
 
Russia may not be solely to blame as well.
 
Demand for natural gas is soaring, especially as the northern hemisphere winter approaches and China seeks alternatives to highly polluting coal to power its cities and warm its people, has resulted in a bidding war.
 
Rising energy prices are fueling concerns over inflation, which has put downward pressure on government bonds and seen the benchmark U.S. 10-year Treasury Note rise over 1.5% for the first time since June this year.
 

 

3. Bitcoin's Recent Rally Burnishes its Portfolio Diversification Claims

 
  • According to research by Morgan Stanley, even a 2.5% portfolio allocation into Bitcoin from a typical 60/40 stock and bond portfolio, could see an increase of as much as 0.48 in its Sharpe Ratio.
  • Although stocks and Bitcoin appeared to move in lockstep in September, as markets suffered their worst rout in weeks as energy prices soared, the benchmark cryptocurrency has since moved in the opposite direction.
 
Between 1% and 5%, that’s what the experts seem to recommend when it comes to the amount of Bitcoin a typical portfolio should hold.
 
According to research by Morgan Stanley, even a 2.5% portfolio allocation into Bitcoin from a typical 60/40 stock and bond portfolio, could see an increase of as much as 0.48 in its Sharpe Ratio (higher is better).
 
And although Bitcoin’s portfolio diversification credentials have long been viewed suspiciously by traditional portfolio managers, last week, it staked its credibility by moving opposite to the broader markets.
 
Although stocks and Bitcoin appeared to move in lockstep in September, as markets suffered their worst rout in weeks as energy prices soared, the benchmark cryptocurrency has since moved in the opposite direction.
 
Since the start of September, the S&P 500 has shed some 5% while Bitcoin has gained 10% and that decoupling could revive one of the longstanding promises of the cryptocurrency – diversification.
 
Bitcoin proponents have long held that the cryptocurrency can serve as a hedge to protect investment portfolios when equities selloff during times of uncertainty and turmoil.
 
The ability to act as ballast to a portfolio is in high demand right now as the macroeconomic landscape becomes increasingly uncertain.
 
U.S. Treasuries, typically relied on to perform a stabilizing role, have failed to act as a diversification tool against equities, due to a period of ultra-low yields thanks to central bank intervention as well as rising inflation.
 
But the path to diversification has not been smooth. Bitcoin remains highly speculative in nature, driven more by narrative than any technical model and can demonstrate negative correlation for short periods followed by periods of strong correlation with other risk assets.
 
For Bitcoin or indeed any cryptocurrency to act as a suitable hedge to a portfolio, investors will need to be far more proactive with their asset allocation than the typical 60/40 would have allowed.
 
The prevailing sentiment (for now) appears to have returned to Bitcoin’s role as an inflation-hedge, with stronger correlation to hard assets such as gold.
 
But that narrative can change in an instant and the cryptocurrency could just as readily be associated with tech or growth stocks in a heartbeat.
 
 

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Oct 07, 2021

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