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Novum Alpha - Weekend Edition 23-24 October 2021 (10-Minute Read)

The world is running out of stuff and fast. Either the stuff hasn't been made yet, or if it's been made, it's stuck offshore on a ship which can't dock because there's a shortage of dock workers. 

A wonderful weekend to you as markets manage to wind their way higher at the end of the week.  
 

In brief (TL:DR)

 
  • U.S. stocks closed a mixed bag on Friday with the Dow Jones Industrial Average (+0.21%) the only index up, while the S&P 500 (-0.11%) and tech-centric Nasdaq Composite (-0.82%) were lower on concerns that the U.S. Federal Reserve could raise rates ahead of schedule on inflation concerns. 
  • Asian stocks closed up Friday, as the People's Bank of China gave further reassurance that it would be able to contain the fallout of the China Evergrande Group debt crisis. 
  • Benchmark U.S. 10-year Treasury yields closed lower 1.636% (yields fall when bond prices rise) with traders betting that the Fed would be forced to pare back asset purchases as soon as next month on inflation pressure. 
  • The dollar held a decline. 
  • Oil was higher with December 2021 contracts for WTI Crude Oil (Nymex) (+1.53%) at US$83.76 on signs that demand will continue to be robust. 
  • Gold rose with December 2021 contracts for Gold (Comex) (+0.81%) at US$1,796.30. 
  • Bitcoin (-0.45%) slipped to US$61,191 in the middle of the weekend and all eyes will be on trading activity for the ProShares Bitcoin Strategy ETF on Monday as profit taking saw a correction in the benchmark cryptocurrency.

In today's issue...

 
  1. Supply Chain Snarls Fail to Dampen Sentiment for Stocks
  2. Is Airbus set to soar again? 
  3. It's Not Just Bitcoin That's Finite, Its Futures Are Too

 

 

Market Overview

 
The world is running out of stuff and fast. 
 
Either the stuff hasn't been made yet, or if it's been made, it's stuck offshore on a ship which can't dock because there's a shortage of dock workers. 
 
Ahead of the holiday peak shopping season, global supply-chain constraints and shortages have led to elevated inflation and U.S. Federal Reserve Chairman Jerome Powell is preparing markets for longer-than-expected inflation, with the central bank potentially needing to do something about it. 
 
U.S. equities ended weaker on Friday on hawkish comments by Powell and investors are concerned that the central bank will be forced to pull back stimulus even as there are signs the economic recovery may be slowing somewhat. 
 
In Asia, markets finished fine on Friday with Tokyo's Nikkei 225 (+0.34%), Hong Kong's Hang Seng (+0.42%) and Sydney’s ASX 200 (+0.00%) higher, while Seoul's Kospi Index (-0.04%) was down marginally, headed into the weekend. 
 
 

1. Supply Chain Snarls Fail to Dampen Sentiment for Stocks

 
  • Equity investors shrug off supply chain concerns, buoyed by robust corporate earnings 
  • Ample profit margins have reassured investors that companies have plenty of headroom to cater for supply chain issues and inflationary price pressures 
 
North America and Europe haven’t yet gotten into peak shopping season and already the shelves are empty and the season’s hottest toys and games may end up stuck on a ship instead of stuffed into a stocking.
 
With supply chain woes threatening to drag on, China’s energy crisis is contributing to slower factory production that is rippling across the rest of the world.
 
Yet somehow, investors appear to be unperturbed by supply chain and labor market issues that are increasingly looking like white noise to stock market bulls.
 
Robust demand in a rapidly opening economy has seen shares soar some 5% in October alone, a month that many bears had warned would be a tough one.
 
Corporate earnings have revealed that whatever problems the pandemic and supply chains are throwing at companies, they’ve had minimal impact on profit margins.
 
Markets are also adjusting for inflation, and despite regular challenges, the S&P 500 gained 1.65% to the end of this week, reaching its first record since the start of September, while the blue chip Dow Jones Industrial Average delivered 1.1%.
 
Even warnings over potential decline in ad spending did little to dent the tech heavy Nasdaq 100 which managed to put on 1.4% for the entire week, despite ending lower on Friday.
 
So why do investors remain sanguine on stocks despite more than enough news to dampen the mood?
 
For one thing, U.S. consumption remains robust, with American Express (+5.42%) revealing on Friday that a measure of credit card spending reached a record in the third quarter, following similarly strong card usage numbers from major banks.
 
Despite supply chain woes and higher prices, investors appear to be betting that American consumers, which make up 70% of the U.S. economy, will be willing to continue spending.
 
And despite the logistical nightmare of supply chain disruptions, so far, companies appear to be taking it in their stride, with over 82% of firms beating the profit estimates of analysts, according to Bloomberg data.
 
Against this backdrop, it’s no wonder that investors remain hot on stocks. 
 
 

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2. Is Airbus set to soar again?

 
  • Airbus (-1.44%) plans to ramp up production of its A320 single-aisle family of aircraft 
  • Pickup in domestic travel ahead of international travel will likely bode well for Airbus which has dominance in the short haul passenger jet market 
 
A trip to the boneyards in Arizona or near Ayers Rock in Australia reveals a surprising type of aircraft in abundance – long haul wide-bodied airliners, laid up and waiting for a day when the pandemic is well and truly in the rearview mirror.
 
When the Covid-19 pandemic first hit, countries rushed to seal off their borders and the world’s long haul commercial airline fleet suddenly found itself fueled up with nowhere to go.
 
Airlines like Cathay Pacific (+2.38%) and Singapore Airlines (+01.15%), which rely heavily on long haul international travel were eviscerated.
 
But domestic travel was far less badly affected.
 
In large countries like the United States and China, domestic travel was restricted, but not prohibited.
 
And as vaccines have allowed not just domestic borders, but global ones to open up, local travel has been the first to recover as well.
 
Airbus has signaled its confidence in the recovery of the aviation industry by setting out plans for a steep ramp-up in the production of the world’s most popular single-aisle passenger jets.
 
The A320 family of aircraft has proved so popular that it’s estimated Airbus dominates the market for single-aisle aircraft, with over 60% market share.
 
IATA estimates global passenger numbers will recover to 52% of their pre-pandemic levels this year, while it expects those levels to be surpassed by 2023, once borders fully reopen.
 
Industry analysts say the recovery in air travel will be led by short-haul journeys as domestic travel, notably in the U.S. and China, rebounds ahead of international travel, which favors Airbus over its archrival Boeing (-0.64%).
 
Boeing’s 737 Max has been plagued by two deadly crashes and development problems, whereas the A320 family of aircraft from Airbus has proved reliable and fuel efficient, an important consideration as recovering airlines look to refresh their fleets against a backdrop of soaring fuel costs.
 
Nonetheless, Airbus still faces some challenges in its push to aggressively ramp-up production.
 
Like companies around the world, supply chain issues may reign in Airbus’s ambitious production plans, and should air travel pick up far faster than anticipated, will lay bare any weaknesses in long, intricate, and often heavily optimized, supply chains. 
 

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3. It's Not Just Bitcoin That's Finite, Its Futures Are Too

 
  • U.S. bitcoin ETF fast running out of its underlying asset 
  • Bitcoin futures exchange rules prevent over-concentration of bitcoin futures, meaning that the tracking error for the ProShares Bitcoin Strategy ETF could increase 
 
It’s a well-known and well-worn fact that there will only ever be 21 million bitcoin ever minted, but what about bitcoin futures?
 
Just days after the launch of the ProShares Bitcoin Strategy ETF, seemingly insatiable demand for the first U.S. bitcoin ETF is already running into a shortage of its underlying asset – bitcoin futures,.
 
Under CME Group (+1.47%) rules, the number of front-month contracts that any trading counterparty can hold is capped at 2,000, yet after just two days of trading, ProShares Bitcoin Strategy ETF owns almost 1,900 contracts for October.
 
In order to avoid hitting the limit, ProShares, which has already hoovered up US$1 billion through its bitcoin ETF, has also amassed 1,400 contracts for November, but is fast running out of headroom.
 
Beyond the front month, CME Group regulations also prohibit any single trading counterparty to hold more than 5,000 contracts in any other month before hitting the exchange’s accountability limit, which could include certain regulatory requirements or further trading limits.
 
While spreading out its holdings into longer-dated contracts as ProShares has done is the immediate solution for its Bitcoin Strategy ETF, it’s not a long-term solution for a product that promises to track the underlying price movement of bitcoin.
 
Forward month futures contracts are susceptible to contango, where the futures price is higher than the current spot price, but also backwardation, where the current price of the underlying asset is higher than its futures price.
 
Both phenomenon borne out of the futures market would significantly affect the ability of ProShares Bitcoin Strategy ETF to accurately track the underlying price movement for bitcoin.
 
The risk is that as the ETF starts taking on tracking error, it is forced to obtain bitcoin price exposure at progressively higher and higher prices as it goes further out on the futures curve, which is currently in contango and sloping upwards.
 
This in turn could trigger a self-perpetuating feedback loop that could spillover into bitcoin spot markets and rally the cryptocurrency even higher.
 
As ProShares runs out of near-month futures contracts that it can hold, it is forced to purchase more long-dated long bitcoin futures (obligation to buy), driving up their price and the implied future price of bitcoin.
 
If traders see that activity as bullish, they may take on more spot bitcoin, driving up the price of bitcoin in the spot markets which in turn attracts more buying interest in the ProShares Bitcoin Strategy ETF which in turn forces the purchase of more long bitcoin futures, leading to a self-perpetuating feedback loop. 
 
 

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Oct 23, 2021

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