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Novum Alpha - Weekend Edition 16-17 October 2021 (10-Minute Read)

Another week, another time-honored axiom is being challenged in the financial markets - this time it's the saying to "not fight the Fed." Despite growing signs that the U.S. Federal Reserve will taper asset purchases as soon as next month, optimism has seen everything from cryptocurrencies to commodities chase higher highs.

A wonderful weekend to you as markets take a turn for the better, buoyed by robust corporate earnings and confident that central banks will be able to reign in inflation.  

In brief (TL:DR)

  • U.S. stocks finished fantastically on Friday with the Dow Jones Industrial Average flat (+1.09%), the S&P 500 (+0.75%) and the tech-centric Nasdaq Composite (+0.50%) all up on robust corporate earnings and a belief that stocks can push fresh highs. 
  • Asian stocks pushed higher Friday after a rally on Wall Street spurred by robust corporate earnings and as the People's Bank of China, the Chinese central bank, sought to reassure global investors that Beijing would be able to contain the fallout of the Evergrande Group crisis.
  • Benchmark U.S. 10-year Treasury yields surged to 1.575% (yields rise when bond prices fall) even as the Fed may start tapering asset purchases as soon as next month. 
  • The dollar held a gain. 
  • Oil continued to rise with November 2021 contracts for WTI Crude Oil (Nymex) (+0.52%) at US$82.28 in line with a broader ascent in commodity prices. 
  • Gold continued to slide with December 2021 contracts for Gold (Comex) (-1.65%) at US$1,768.30 as commodities, cryptocurrencies and equities trended higher. 
  • Bitcoin (+2.10%) rose to US$61,062 into the middle of the weekend with outflows leading inflows and confirmation of a U.S. Bitcoin ETF (albeit trading in futures) could start trading next week (outflows typically signal that investors are looking to hold Bitcoin in anticipation of higher prices). 

In today's issue...

  1. Does anyone still believe inflation is transitory? 
  2. Could Singapore Usher in a New Era of Wealth Taxes? 
  3. Should you buy the U.S. Bitcoin ETF?



Market Overview

Another week, another time-honored axiom is being challenged in the financial markets - this time it's the saying to "not fight the Fed." 
Despite growing signs that the U.S. Federal Reserve will taper asset purchases as soon as next month, optimism has seen everything from cryptocurrencies to commodities chase higher highs. 
And despite a rough time for stocks last month, the S&P 500 shook off the gloom to post a resoundingly up week, with reopening themes like automakers and raw materials producers posting the strongest gains. 
Whereas the thrust and parry of the pandemic trade may have been a belief that the Fed would keep the liquidity taps flowing, investors are somehow approaching the view that stocks in and of themselves have reached their own terminal velocity. 
In Asia, markets finished higher on Friday with Tokyo's Nikkei 225 (+1.81%), Hong Kong's Hang Seng (+1.48%), Sydney’s ASX 200 (+0.69%) and Seoul's Kospi Index (+0.88%) all up into the weekend. 

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1. Does anyone still believe inflation is transitory?

  • Growing signs that even central bankers no longer believe that inflation is transitory 
  • Unclear what policy tools central banks have left to combat inflation should it start to get out of control, especially given the relatively high levels of sovereign debt 
“If you tell a lie big enough and keep repeating it, people will eventually come to believe it.”
– Joseph Goebbels, Nazi Propaganda Minister
For months, central bankers had told us to expect inflation to rise.
Driven by the twin forces of supply chain bottlenecks and pent-up demand, price increases were expected to be furious, but also fleeting.
Or at least that’s what central bankers would have us believe.
Even as business and consumer confidence has waned and job growth underwhelmed, the spike in energy and commodity prices and supply chain bottlenecks aren’t sorting themselves out the way that central bankers had told us that they would.
And that in turn has given rising to growing concern about inflation pressure.
Even the central bankers themselves are having second thoughts on the allegedly transient nature of inflation, with major central banks like the Bank of England, wavering from their earlier more dovish stance.
What’s resulted has been a precipitous fall in equity prices and rising bond yields (yields rise when bond prices fall), which has presented itself as a double whammy for investors stuck with a traditional 60/40 stock and bond portfolio.
The change in relationship between equities and bonds, from a negative to a positive correlation, means that there is no longer a rise in bond prices and fall in yields to offset the pain if equity prices fall.
Some analysts are worried that slowing growth and soaring energy prices could trigger the damaging stagflation of the 1970s, which required significant increases in interest rates to curb soaring inflation.
But can central banks even afford to raise rates?
The last time the world experienced stagflation, debt levels were relatively low, but the pandemic has seen global debt soar by as much as 14% last year, to a record US$226 trillion and raising interest rates would almost certainly trigger default from some sovereigns.
The U.S. is fortunate in the sense that because the dollar remains the global reserve currency, it could still afford to raise rates and simply borrow more to pay off the increase, but doing so undermines the very purpose of raising rates as it would simply contribute to more inflation.
In other words, central banks may be running out of tricks up their sleeves to reign in the inflation genie.
Complicating matters, the pandemic made investors out of the average American, with more household wealth, and by extension confidence to consume, tied to already overvalued equity markets, than at any point in history.
And that means that Fed may not have the ability to curb runaway equity prices without simultaneously taking down the entire U.S. economy with it, where a full 70% depends on consumption.  

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2. Could Singapore Usher in a New Era of Wealth Taxes?

  • Singapore government joins a growing list of countries struggling with soaring inequality 
  • Prospect of further wealth taxes needs to be approached with caution in the city-state known for its stability and low taxes 
In the city-state of 5.6 million, Singapore’s government leaders are growing increasingly concerned that rising inequality could breed resentment and have brought up a topic that was not so long ago tabooed amongst the elite of the island – wealth taxes.
Long a haven for the ultra-wealthy, Singapore’s strong stable government, rule of law and low taxes have drawn in the likes of Facebook (-1.15%) co-founder Eduardo Savarin and Sir James Dyson, the eponymous founder of the vacuum cleaner and hair dryer brand that bears his name.
And while Savarin and Dyson may make headlines for calling Singapore home, a far more discreet legion of millionaires and billionaires have sent property prices in the Asian financial center soaring as well, throwing down roots on the tropical island.
A hub for private banking, family offices and asset management, the recent bout of political instability in Hong Kong has only helped to burnish the attractiveness of Singapore as an alternative financial center to park funds.
But the arrival of the global elite has also bristled Singapore’s native population, where over 80% still live in government-subsidized housing called HDB flats and many have seen their incomes destroyed by the pandemic.
Singapore already taxes real estate and cars, but with the pandemic seeing unprecedented fiscal spending, there is a pressure to do more, not just to combat inequality, but also to help replenish depleted coffers.
The city state already taxes cars and properties at some of the highest rates globally, but doesn’t have a capital gains tax and still maintains one of the lowest corporate tax rates in the world, at a flat 17%.
But the Singapore government is faced with a tricky balancing act - tax the wealthy too heavily, and they are likely to leave, being members of a global and extremely mobile elite, but do nothing, and risk social instability. 
Yet Singapore is hardly the only country in the world to face a widening wealth gap.
Governments around the world are struggling to combat inequality that has only been exacerbated by the pandemic, and while countries like China can pursue their “common prosperity” push with seemingly reckless abandon, it may not be as straightforward for others. 

3. Should you buy the U.S. Bitcoin ETF?

  • U.S. Bitcoin ETF is a pure cash-settled derivatives product that "tracks" the price of bitcoin imperfectly 
  • Investors may be better off buying bitcoin directly if they are just looking to buy and hold the underlying cryptocurrency 
Diet soda promises all of the flavor, but none of the calories. Yet in reality, diet anything falls short on both counts, it rarely tastes as good as the real thing, nor does it help with the calories as it triggers you to eat more of other stuff because it leaves you feeling unsatiated.
Enter the U.S. Bitcoin ETF.
On the surface it looks like any other ETF, just that it tracks the price of bitcoin.
But look beneath that veneer and it becomes immediately apparent the U.S. Bitcoin ETF is a diet product – none of the flavor or fullness of bitcoin.
After almost a decade of wrangling with regulators, the ETF industry may now have a U.S. ETF that tracks the price of bitcoin, yet ordinary investors may be better off just buying the real thing.
And that’s because the U.S. Bitcoin ETF isn’t buying bitcoin as its underlying asset, it’s buying CME Group’s bitcoin futures product, which itself is a cash-settled product that doesn’t create any demand for the underlying bitcoin itself.
Although bitcoin and bitcoin futures may sound like one and the same thing, there are key differences.
Futures track bitcoin’s spot price indirectly through the use of cash-settled bitcoin futures contracts on the Chicago Mercantile Exchange and often require investors to put down cash to trade as a form of collateral.
Traders often use futures to bet on price movements, such as shorting the price of bitcoin or to hedge other bets.
While for the most part, the prices of bitcoin and its futures tend to trade in a line, this isn’t always the case, and that’s known as the spread.
A simple basis trade involves buying the actual bitcoin and selling the futures product to capture that spread, but that’s assuming the futures product is for physical delivery, which in the case of the U.S. Bitcoin ETF and the CME Group’s bitcoin futures product, it is not.
Add to that, futures involve complicated concepts like contango, where the futures price of bitcoin may be higher than the spot price, and backwardation, when the spot price of bitcoin is higher than the price of the bitcoin futures and investors may be getting far more than they bargained for, yet be receiving far less than they wanted. 

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Oct 16, 2021

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