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Novum Alpha - Daily Analysis 20 October 2021 (10-Minute Read)

The earnings season has taken some of the spotlight away from concerns about a slowing pandemic recovery, price pressures stoked by energy costs and the prospect of reduced central bank support.

 
A wonderful Wednesday to you as markets wind themselves up higher despite myriad risks. 
 

In brief (TL:DR)

 
  • U.S. stocks closed higher Tuesday with the Dow Jones Industrial Average (+0.56%), the S&P 500 (+0.74%) and the tech-centric Nasdaq Composite (+0.71%) all up as strong earnings offset inflation fears and concerns over fiscal and monetary tightening. 
  • Asian stocks climbed Wednesday, tracking a U.S. rally as a focus on corporate earnings bolstered investor sentiment.
  • Benchmark U.S. 10-year Treasury yields advanced about two basis points to 1.66% (yields rise when bond prices fall) as the correlation between stocks and bonds normalizes. 
  • The dollar slipped amid bets other central banks will boost interest rates before the Federal Reserve.
  • Oil held near its highest level in seven years amid the global energy crunch with November 2021 contracts for WTI Crude Oil (Nymex) (-0.36%) at US$82.66.
  • Gold was little changed with December 2021 contracts for Gold (Comex) (+0.03%) at US$1,771.00. 
  • Bitcoin (+3.20%) rose to US$63,803 and tested a new all-time-high as the first U.S. bitcoin ETF commenced trading, with outflows rising against inflows as traders searched for direction on where bitcoin will go next (outflows typically signal that investors are looking to hold Bitcoin in anticipation of higher prices). 
 

In today's issue...

 
  1. WeWork Comes Full Circle to Go Public via a SPAC
  2. China’s Property Sector Shrinks Faster Than Clothes in a Dryer
  3. I Can’t Believe It’s Not Bitcoin
 

Market Overview

 
The earnings season has taken some of the spotlight away from concerns about a slowing pandemic recovery, price pressures stoked by energy costs and the prospect of reduced central bank support.
 
The focus in China remains on Beijing’s regulatory curbs and the slowdown in the property sector amid the debt woes at China Evergrande Group.
 
Meanwhile, the nation’s top economic planner is studying ways to intervene in the coal market as the government tries to rein in rising prices and curtail shortfalls.
 
In Asia, markets climbed Wednesday, tracking a U.S. rally as a focus on corporate earnings bolstered investor sentiment with Tokyo's Nikkei 225 (+0.16%), Hong Kong's Hang Seng (+1.18%) and  Sydney’s ASX 200 (+0.75%) up, while Seoul's Kospi Index (-0.20%) was down in the morning trading session.
 

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1. WeWork Comes Full Circle to Go Public via a SPAC

 
  • Snazzy edgy décor that fostered mingling among employees from different companies, WeWork became synonymous not for providing plug-and-play office space, but collaboration spaces as well.
  • A global pandemic later, and many who had figured the work-from-home revolution would put the final nail in WeWork’s coffin have been surprised by how the co-working space provider has turned things around.
 
WeWork championed a revolution in what the future of work could look like. Snazzy edgy décor that fostered mingling among employees from different companies, WeWork became synonymous not for providing plug-and-play office space, but collaboration spaces as well.
 
Whether you were a one-man startup or a small business, the flexibility and facilities of a WeWork were attractive and at the time, revolutionary.
 
But a charismatic and profligate founder saw the company hemorrhage money and peculiar corporate shareholding structures that gave its CEO Adam Neumann unprecedented levels of control and influence saw a plethora of conflicts of interest right up to its abortive public offering.
 
A global pandemic later, and many who had figured the work-from-home revolution would put the final nail in WeWork’s coffin have been surprised by how the co-working space provider has turned things around.
 
Costs have been slashed and operations rationalized, while companies looking to downsize their offices have found that the flexibility afforded by WeWork has complemented their pandemic workspace strategies, but is it enough?
 
And after almost two years WeWork now looks finally set to trade on the public markets for a far more modest US$9 billion, instead of its initial target US$47 billion IPO and will be doing so quietly by way of the acquisition of a blank check company.
 
Although much of the excess that marked the Neumann era, including the private jets and wild parties, have been cut out of the company, it’s still bleeding billions of dollars.
 
WeWork revealed that it had lost US$3.2 billion last year, despite trimming capital expenditure and losses appear to be deepening.
 
And although the flexibility of a WeWork may ensure an inflow of new customers, the company’s US$1.2 billion revenue for the first half of this year and projected US$1.5 billion for the second half is well short of its US$3.2 billion projection for the entire year.
 
Nevertheless, frothy markets might still see WeWork gain as investors consider the future of work in a post-pandemic landscape.
 
Trends such as video conferencing, reduced business travel and flexible work arrangements appear to be durable and may help to fuel WeWork’s business post pandemic.
 
But whether it will be enough to turnaround the company into profitability is less clear.
 

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2. China's Property Sector Shrinks Faster Than Clothes in a Dryer

 
  • China’s all-important property and construction industries have shrunk in the third quarter for the first time since the start of the pandemic, weighed down by a slump in real estate.
  • Power shortages and falling property real estate prices are eating into household wealth, of which real estate is estimated to constitute as much as 70%, and undermining consumer sentiment.
 
Making up a full 40% of the Chinese economy and 29% of GDP, China’s all-important property and construction industries have shrunk in the third quarter for the first time since the start of the pandemic, weighed down by a slump in real estate.
 
The real estate sector is integral to the Chinese economy, supporting sectors as varied as furniture to commodities, household appliances to materials.
 
But output in the real estate industry, a key driver of the Chinese economy, shrank by 1.6% year-on-year, according to a supplemental report on GDP released yesterday by China’s National Bureau of Statistics.
 
Over the same period, construction fell by 1.8%, also marking the first time the industry has declined since the pandemic, and in a sector that has only seen growth since data was first promulgated in 1992.
 
Making matters worse for China’s embattled property and construction sectors, an escalating debt crisis at Evergrande Group and other developers, coupled with struggles to gain access to fresh sources of credit has dented consumer confidence to buy homes.
 
Property sale restrictions that cap prices as well as tight curbs on the leverage that developers can get access to for new projects has also seen the combined sales of China’s top 100 developers plummet 36% year-on-year in September.
 
Government infrastructure spending is slowing as well, which is eating into builders’ bottom lines.
 
But Beijing may need to delay China’s painful structural reforms, especially ahead of a key political plenary next year which will see Chinese President Xi Jinping undertake an unprecedented third term in office.
 
Power shortages and falling property real estate prices are eating into household wealth, of which real estate is estimated to constitute as much as 70%, and undermining consumer sentiment.
 
China’s push to turn into a consumption-based economy will suffer major setbacks should Chinese become fearful to spend.
 
The Chinese stock market, long seen as a reliable source for capital gains, has also suffered from Beijing’s crackdown on a plethora of companies, from real estate to technology. 
 
In response, the Chinese central bank, the People’s Bank of China, has urged the country’s banks to lend more freely again and approve mortgages more speedily.
 
The PBoC has also said that it expects to be able to contain the fallout of the Evergrande Group’s staggering US$305 billion in liabilities, the vast majority of which are thankfully onshore and therefore can be dealt with by Beijing should it choose to do so.
 
Production halts at factories and power shortages as Beijing pushes industries to move away from pollutive energy sources such as coal are having a direct impact on Chinese incomes and threatening to lead to a sharp economic contraction.
 
GDP growth in the third quarter was 4.9%, well shy of the previous quarter’s 7.9% and based on current trends, could see the Chinese economy shrink next year for the first time since market reforms were enacted under former Chinese leader Deng Xiaoping.
 
There is a sense in Beijing that Communist Party apparatchiks may have gone too far, too fast and are now trying to backpedal on many fronts.
 

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3. I Can't Believe It's Not Bitcoin

 
  • Whether it’s Grayscale Bitcoin Trust or the shiny new futures-based ProShares Bitcoin Strategy ETF, if investors want to buy bitcoin, they should setup their private wallets and just go ahead and buy it.
  • After much anticipation, the ProShares Bitcoin Strategy ETF started trading yesterday, but it is NOT an ETF backed by actual bitcoin, instead it is backed by futures tied to the cryptocurrency.
 
Substitute spread isn’t butter. Substitute sweetener isn’t sugar. Substitute milk didn’t come from a cow.
 
So if you want the real thing, just get the real thing.
 
And nowhere is this more pertinent than when it’s come to bitcoin.
 
Whether it’s Grayscale Bitcoin Trust or the shiny new futures-based ProShares Bitcoin Strategy ETF, if investors want to buy bitcoin, they should setup their private wallets and just go ahead and buy it.
 
Because when they buy a futures-based bitcoin ETF product, they’re not getting bitcoin, not by a longshot.
 
After much anticipation, the ProShares Bitcoin Strategy ETF started trading yesterday, but it is NOT an ETF backed by actual bitcoin, instead it is backed by futures tied to the cryptocurrency – the same way dating the cousin of Beyonce isn’t the same as dating the diva herself.
 
What’s the difference though you may ask?
 
While the vast majority of commodity based mutual funds and ETFs are backed by futures, that’s because of practical difficulties with actual physical storage.
 
Also, with almost all commodities, most of the trading action and liquidity tends to happen in the futures market, not the spot, whereas with bitcoin it’s the opposite.
 
Futures-based ETFs also come with the cost of carry.
 
When commodity futures are in contango (the price of long-dated contracts trade above the forward month contracts), there is a significant cost to roll futures contracts from one month to the next (because there is a price difference) and that cost is passed on to investors.
 
While futures generally trade in contango (long-dated futures are higher than nearer-dated ones), this isn’t always the case and backwardation can occur, when deferred month contracts trade below front month contracts, which helps ETFs that track futures because they earn a positive roll yield. 
 
And while most futures contracts tend to converge with the spot price towards expiry, this isn’t always the case either, especially for bitcoin.
 
But most importantly, a futures-based bitcoin ETF may fail to do what it was designed to, track the price of bitcoin.
 
If past precedents are any guide, even a commodity like oil, which is volatile, but nowhere near as volatile as bitcoin has proved challenging for an oil futures-based ETF to track.
 
The United States Oil Fund, which invests in crude futures purports to have an average daily percentage change that’s just 10% of the comparable move in benchmark oil contracts over 30 trading days, but as recently as Monday, was about 90% off the mark.
 
Imagine what it would be like for a futures-based bitcoin ETF.
 

 

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Oct 20, 2021

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