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Novum Alpha - Daily Analysis 26 October 2021 (10-Minute Read)

A relatively solid earnings season is helping to counter concerns that elevated inflation and tightening monetary policy will slow the economic recovery from the pandemic.

 
A terrific Tuesday to you as markets take a turn upwards. 
 

In brief (TL:DR)

 
  • U.S. stocks started the week higher with the Dow Jones Industrial Average (+0.18%), the S&P 500 (+0.47%) and tech-centric Nasdaq Composite (+0.90%) all up.
  • Asian stocks mostly rose Tuesday after a record S&P 500 close as corporate earnings and progress on U.S. President Joe Biden’s economic agenda helped sentiment even as the debate over inflation risks intensified.
  • Benchmark U.S. 10-year Treasury yields rose one basis point to 1.64% (yields rise when bond prices fall). 
  • The dollar edged up.
  • Oil was little changed with December 2021 contracts for WTI Crude Oil (Nymex) (+0.08%) at US$83.83 as investors weighed the outlook for U.S. stockpiles.
  • Gold held above US$1,800 an ounce with December 2021 contracts for Gold (Comex) (-0.09%) at US$1,805.10. 
  • Bitcoin (+1.51%) rose to US$62,775 on a rebound in risk sentiment with outflows increasing against inflows (outflows suggest that investors are looking to hold bitcoin in anticipation of higher prices). 
 

In today's issue...

 
  1. Tesla Tops a Trillion
  2. Bond Investors Are Fearful that Central Bankers Could Trip Up on Rates
  3. Bitcoin – Not as Decentralized as Would Appear?
 

Market Overview

 
A relatively solid earnings season is helping to counter concerns that elevated inflation and tightening monetary policy will slow the economic recovery from the pandemic.
 
Traders are also monitoring escalating Covid-19 cases in China and other parts of the world and whether Beijing will lock down vast parts of the country in a zero-tolerance Covid-19 policy, which will threaten to sever already stretched supply chains. 
 
Most Asian stocks rose Tuesday after a record S&P 500 close as corporate earnings and progress on U.S. President Joe Biden’s economic agenda helped sentiment even as the debate over inflation risks intensified.
 
In Asia, markets were mostly up Tuesday with Tokyo's Nikkei 225 (+1.76%), Sydney’s ASX 200 (+0.07%) and Seoul's Kospi Index (+0.65%) up, while Hong Kong's Hang Seng (-0.42%) was down in the morning trading session primarily on China-side risk. 
 
 

1. Tesla Tops a Trillion

 
  • The electric vehicle company turned a frown upside down as investors pushed Tesla’s stock above US$1,000 and given it a market capitalization of US$1 trillion.
  • The most recent rally in Tesla (+12.66%) was due primarily to the revelation that Hert, a car rental company that was not so long ago bankrupt, would be entering a US$4.2 billion deal to buy 100,000 Teslas.
 
The electric vehicle company that everyone said couldn’t, has proved naysayers wrong and turned a frown upside down as investors pushed Tesla’s stock above US$1,000 and given it a market capitalization of US$1 trillion.
 
To put that in perspective, Toyota (+1.77%) sold around 9.5 million vehicles in 2020 and 5 million in the first half of 2021 and has a market cap of less than a quarter of Tesla, at just US$239 billion.
 
Tesla on the other hand delivered just under 500,000 vehicles for all of 2020 and 386,050 for the first half of 2021, but sits on a market cap of US$1.01 trillion, or some four times that of Toyota.
 
So what are investors paying for?
 
The most recent rally in Tesla was due primarily to the revelation that Hertz (+10.04%), a car rental company that was not so long ago bankrupt, would be entering a US$4.2 billion deal to buy 100,000 Teslas.
 
Hertz’s move isn’t just significant for Tesla’s profits, but a huge fillip to electric vehicles going mainstream and there’s no better commercial for Tesla then taking one out on a rental.
 
The deal is a win-win for both companies, Tesla gets the EV-curious into the seat of a Model 3, while Hertz gets to associate its embattled brand with a cutting-edge electric vehicle maker, with plenty of brand cache.
 
Because Tesla’s are Instagram worthy, the amount of goodwill from the sale for both companies is hard to estimate at this point.
 
Hertz whose shares were at one point literally worthless, with the company warning potential buyers in its common stock offering that it was an almost certain outcome that the equity would be worthless and they would lose all their money, has since seen its stock rebound to US$27.17.
 
Investors who had scooped up Hertz on the cheap are now sitting on returns greater than 1,000%.
 
For Tesla investors, the Hertz sale could mean much more than publicity.
 
According to the Pew Research Center, some 40% of American car buyers say they would consider an EV for their next vehicle purchase and what better way to find out if an EV is right for them then renting one out for a week?
 

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2. Bond Investors Are Fearful that Central Bankers Could Trip Up on Rates

 
  • Yields have risen alongside inflation expectations and a presumption that the Fed could start tapering asset purchases as soon as November, but outside of that, there has been none of the taper tantrum that roiled markets in 2013.
  • But if investors are communicating back to central banks, what they appear to be communicating is a lack of confidence in central bankers to do the right thing.
 
The last thing that investors want is uncertainty.
 
Which is why the U.S. Federal Reserve has thus far done a commendable job in keeping markets calm through clear and consistent messaging.
 
From the get-go, U.S. Federal Reserve Chairman Jerome Powell has maintained that he expected inflation pressures to be transitory at worst.
 
And while Powell and his colleagues have conceded that prices have remained stubbornly high, with headline inflation pushing over 5% for five consecutive months, the Fed has not reacted in a knee-jerk manner, which has helped keep Treasury yields within a relatively tight band.
 
To be sure, yields have risen alongside inflation expectations and a presumption that the Fed could start tapering asset purchases as soon as November, but outside of that, there has been none of the taper tantrum that roiled markets in 2013.
 
But if investors are communicating back to central banks, what they appear to be communicating is a lack of confidence in central bankers to do the right thing.
 
A surge in global energy prices is sharpening inflationary pressures and leading investors to bet that central bankers will waver in their narrative that price rises are transitory and react abruptly with higher rates.
 
The result has been a surge in yields for short-dated bonds, which are highly sensitive to rate expectations, with the first major central bank to cave the Bank of England.
 
There is some concern that the BoE’s buckling to inflationary pressures, will spillover into other big bond markets.
 
Benchmark 2-year gilts have soared to 0.7% from just 0.1% two months ago, as financial markets price in hawkishness in the Bank of England.
 
2-year U.S. Treasury yields have nearly doubled to rise as high as 0.49% as the market has fully priced rate rises by the beginning of September next year.
 
Even in the eurozone, where the European Central Bank has long maintained composure in the face of rising price pressures, may now look to lift rates as soon as 2022.
 
The only major central bank holding out so far has been the Bank of Japan, where years of stagflation has seen Japanese central bankers more reluctant to rock the boat.
 
But the response in longer-dated sovereign debt has been far more muted, with investors appearing to be shifting from bets on reflation, to concerns over stagflation – low economic growth coupled with higher inflation.
 
A more dovish Fed that tolerates higher levels of inflation would be problematic for holders of long-dated Treasuries, like the 10-year and 30-year – that yields have been relatively stable in longer-dated debt suggests that investors are more concerned that central bankers will make mistakes in the very short term.
 

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3. Bitcoin - Not as Decentralized as Would Appear?

 
  • According to the U.S. National Bureau of Economic Research, the top 10,000 individual investors in bitcoin control about a third of all the bitcoin in circulation.
  • Mining concentration is even greater, with NBER finding that just 10% of miners control some 90% of bitcoin mining capacity, with about just 50 miners controlling half of all bitcoin mining capability.
 
While the blockchain may be designed based on decentralization, there was never any proviso to say that cryptocurrencies should be as well.
 
And given the development of cryptocurrencies had always been in fits and starts, it’s no surprise then that the holdings of cryptocurrencies would be concentrated.
 
Because there would be diehard early adopters and “believers” and those who took big bets on cryptocurrencies like bitcoin early on, it would be reasonable to believe that the holdings of bitcoin are far more concentrated than the decentralization of cryptocurrencies would lead us to believe.
 
According to the U.S. National Bureau of Economic Research, the top 10,000 individual investors in bitcoin control about a third of all the bitcoin in circulation.
 
While many have long wondered who the largest owners of bitcoin are since the early days of the cryptocurrency’s existence, it is especially difficult to determine the concentration of ownership as many of the addresses with the largest amounts of bitcoin aren’t individuals, but exchanges or other entities such as family offices, holding on to bitcoin for investors.
 
Nonetheless, NBER researchers used a data collection method that differentiated between addresses belonging to intermediaries and individuals and were able to find that the former controlled about 5.5 million bitcoin, or just slightly under a third of the estimated 16 million bitcoin currently in circulation.
 
According to the NBER an additional top 1,000 individuals controlled about 3 million bitcoin, with the concentration likely to be even greater.
 
Mining concentration is even greater, with NBER finding that just 10% of miners control some 90% of bitcoin mining capacity, with about just 50 miners controlling half of all bitcoin mining capability.
 
According to the NBER report,
 
“Our results suggest that despite the significant attention that Bitcoin has received over the last few years, the Bitcoin ecosystem is still dominated by large and concentrated players, be it large miners, Bitcoin holders or exchanges.”
 
“This inherent concentration makes Bitcoin susceptible to systemic risk and also implies that the majority of the gains from further adoption are likely to fall disproportionately to a small set of participants.”
 
What this does mean for individual investors is that the risks of a sharp correction are higher if a “whale” dumps a load of bitcoin onto unsuspecting markets and crashes the price of bitcoin in an instant.
 
Such a move would have profound implications on companies with significant amounts of bitcoin on their balance sheets, such as MicroStrategy (+3.83%).
 
But so long as the price of bitcoin continues to rise, the odds of that concentration being distributed remains slim, what is more worrying is if and when bitcoin makes a sharp correction, swings could be exacerbated by the influence of concentration.
 
 

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Oct 26, 2021

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