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Novum Alpha - Daily Analysis 8 November 2021 (10-Minute Read)

The inflation debate continues to shadow the markets that had taken some comfort from a strong earnings season despite higher inflation and supply chain snarls.

 
A magnificent Monday to you as markets make hay while the sun shines! 
 

In brief (TL:DR)

 
  • U.S. stocks finished higher on Friday with the Dow Jones Industrial Average (+0.56%), the S&P 500 (+0.37%) and tech-centric Nasdaq Composite (+0.20%) all up on positive sentiment from Pfizer's new antiviral treatment for Covid-19. 
  • Asian stocks were steady Monday as investors keep watch on how price pressures impact monetary policy and the pace of economic recovery. 
  • Benchmark U.S. 10-year Treasury yields rose two basis points to 1.47% (yields rise when bond prices fall), but were otherwise lower than last week, despite the Fed's tapering. 
  • The dollar rose.
  • Oil advanced with December 2021 contracts for WTI Crude Oil (Nymex) (+1.30%) at US$82.33 as traders weighed the odds of a release of crude from the U.S. Strategic Petroleum Reserve after OPEC+ resisted a plea from President Joe Biden to boost supplies more quickly. 
  • Gold rose with December 2021 contracts for Gold (Comex) (+0.21%) at US$1,820.60. 
  • Bitcoin (+5.04%) surged to US$65,210 on an overall rise in risk-on sentiment with outflows from exchanges racing ahead of inflows. 

 

In today's issue...

 
  1. A U.S. Economic Rebound is Rallying Stocks
  2. Of Chinese Emperors and Economy
  3. A Spot for your Bitcoin ETF?
 

Market Overview

 
The inflation debate continues to shadow the markets that had taken some comfort from a strong earnings season despite higher inflation and supply chain snarls.
 
Further on the economic front, China posted a record monthly trade surplus in October as exports surged, underscoring support for the Chinese economy that’s slowed sharply in recent months.
 
In Asia, markets were lower Monday with Tokyo's Nikkei 225 (-0.07%), Seoul's Kospi Index (-1.02%), Hong Kong's Hang Seng (-0.35%) and Sydney’s ASX 200 (-0.19%) were all down in the morning trading session. 
 
 

1. A U.S. Economic Rebound is Rallying Stocks

 
  • U.S. equities are doing precisely that, like Captain Cook, wandering forth into lands unmapped and highs never reached before as the U.S. economy marks a strong rebound.
  • Earnings of companies listed on the S&P 500 rose about 40% in the third quarter of 2021, most companies have successfully navigated potential headwinds by relying on pricing power.
 
Every aircraft has a so-called flight envelope, the limits to which the airframe has been tested by pilots and beyond which the manufacturer no longer guarantees safe operation of the product – uncharted territory.
 
And U.S. equities are doing precisely that, like Captain Cook, wandering forth into lands unmapped and highs never reached before as the U.S. economy marks a strong rebound and corporate earnings fuel that narrative of a market that can make fewer and fewer mistakes.
 
Including dividends, the returns from the benchmark S&P 500 this year has been 27%, according to data from Goldman Sachs (-0.24%), well above many active manager returns.
 
Last week, U.S. markets rallied 2%, their best performance since June and companies that were battered by the pandemic are seeing a strong resurgence.
 
From casinos to airlines, cruise operators to hotels, Pfizer’s (+10.86%) announcement that a powerful antiviral pill that successfully reduces hospitalization rates from Covid-19 by 90% provided a powerful drug to the markets as well as stocks surged on a wave of optimism.
 
Adding to the optimism, a US$1.2 trillion infrastructure spending bill which many (more cynical) analysts had wagered would get stuck in Washington, has been passed late on Friday that could provide even more fuel for the world’s biggest economy.
 
The Pfizer antiviral drug could potentially be a gamechanger for not just the U.S. economy, but the global one as well.
 
Part of the struggle for economies globally is the strain that Covid-19 puts on the healthcare system, whereas if the pandemic can be treated similar to the common cold, the prospect of a speedy return to normalcy increases.
 
Earnings of companies listed on the S&P 500 rose about 40% in the third quarter of 2021, compared to the same period last year and even though supply chain disruptions are lingering, most companies have successfully navigated potential headwinds by relying on pricing power.
 

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2. Of Chinese Emperors and Economy

 
  • For billions of Chinese, labels like “democracy” and “communism” bear little significance to their everyday existence as much as the price of food and fuel.
  • As generations of Chinese will attest, the problem that happens so often with emperors is how do you tell the Son of Heaven that he may be wrong?
 
Chinese leader Deng Xiaoping once said, “It matters not if a cat is black or white, but that it catches mice.”
 
For billions of Chinese, labels like “democracy” and “communism” bear little significance to their everyday existence as much as the price of food and fuel.
 
One saying when remnants of the Ming Dynasty were attempting to overthrow the Qing Dynasty was, “the people are happy, the economy is prosperous, do you think they care who the emperor is?”
 
Such devolution of power is anathema to proponents of western style democracy, yet a brief study of Chinese history will reveal, has been the habit and inclination of the Middle Kingdom since Emperor Qin unified China under one banner.
 
Ahead of the Sixth Plenum session of China’s Communist Party, Chinese President Xi Jinping will likely be moving himself into position for an unprecedented third term in office and effectively become emperor for life.
 
The first official declaration on Chinese history in four decades is set to top the agenda when the ruling (and only legal) party huddles this week before a twice-a-decade congress next year that is widely expected to coronate Xi.
 
Mao Zedong and Deng Xiaoping’s historical proclamations (because victors typically have the benefit of declaring the past as fact) came at critical junctures in China’s trajectory, enabling their authors to dominate party politics till they drew their final breaths.
 
Issuing his own magnum opus would not only put Xi on par with these titans of Chinese politics, but would also signal big changes afoot for the economy that investors will need to be cognizant of.
 
In past historical proclamations, Mao, even before the Communist Party overran China, declared that all legitimacy for ruling the country drew from him.
 
Deng on the other hand denounced the decisions of Mao, without condemning the Party, and ushered in a period that would move away from the cult of personality, as well as liberalize and reform the economy.
 
But unlike his predecessors who self-critiqued Party missteps, Xi is likely to spin a yarn of a century of success, glossing over failures while highlighting victories and outlining his vision for a post-modern Marxist society, or at least that what Chinese state media seems to be suggesting.
 
And this provides somewhat of a conundrum for investors who remain bullish on China’s prospects.
 
A simple review of China’s economic history under the Communist Party has seen predictable cycles of centralization, leading to economic chaos (Mao), followed by decentralization and prosperity (Deng), which would mean that the next period would be akin to Mao’s.
 
There are signs in China that this is already happening.
 
A crackdown on profits, industry sectors and billionaires, the introduction of “Xi Jinping Thought” into the curriculum, reviving the cult of personality that Deng so despised, as well as the encroachment of the state into industry, all suggest a potential backslide of the world’s second largest economy.
 
Despite Xi claiming that the rejuvenation of the Chinese nation is a “historical inevitability” there is nothing historical or inevitable about it.
 
Since millennia, the Chinese nation has waxed and waned in accordance with periods of centralization and decentralization, embracing liberal policies and concentrating power in the state.
 
And while China remains the factory to the world now, there is no guarantee that it will be so indefinitely.
 
As the leader of one-fifth of the world’s people, Xi is on a mission to redistribute the nation’s wealth to build an allegedly fairer Marxist society.
 
So far, those redistribution measures have been successful in making the Chinese nation collectively poorer, with about US$1 trillion worth of market cap from Chinese stocks globally being redistributed into the dumpster.
 
In Xi’s utopian vision of China, everyone has been affected, from delivery drivers and afterschool tutors to tech giants and celebrities, with global investors being dragged down along with the purges.
 
George Soros, who famously called time on Britain’s exchange-rate mechanism with Germany and made a cool billion in the process, suggests that Xi doesn’t understand the market economy and investors in the country face a rude awakening.
 
As generations of Chinese will attest, the problem that happens so often with emperors is how do you tell the Son of Heaven that he may be wrong?
 

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3. A Spot for your Bitcoin ETF?

 
  • The launch of the bitcoin futures ETF in the U.S. was still a watershed moment, and one step closer to the Holy Grail – a bitcoin spot ETF, or at least that was the refrain from panelists at last Thursday’s Bloomberg Financial Innovation Summit.
  • Spot bitcoin ETFs already trade in other countries, including Canada, but the U.S. Securities and Exchange Commission remains hesitant to approve a spot bitcoin ETF, on concerns that the cryptocurrency is susceptible to manipulation.
 
“Out, damned spot; out, I say. One, two,—why, then ’tis time to do’t.”
 
– Lady Macbeth, Macbeth by William Shakespeare, Act 5, Scene 1, 26-40
 
While the excitement of a futures-based bitcoin ETF helped to send the benchmark cryptocurrency to fresh all-time-highs, that the U.S. bitcoin ETF was not underpinned by the actual digital asset left many feeling somewhat dissatisfied.
 
Nonetheless, the launch of the bitcoin futures ETF in the U.S. was still a watershed moment, and one step closer to the Holy Grail – a bitcoin spot ETF, or at least that was the refrain from panelists at last Thursday’s Bloomberg Financial Innovation Summit.
 
Fund flows are already shifting out of gold ETFs, US$10 billion departed in the week that the ProShares Bitcoin Strategy ETF was launched, and more is expected.
 
A spot bitcoin ETF would at least hold the underlying bitcoin and would at least serve as an institutional onramp for investors who wanted actual bitcoin exposure, according to Michael Saylor of MicroStrategy (-0.31%), which holds significant amounts of its balance sheet in bitcoin.
 
According to Saylor, futures-based ETFs are an inferior offering, but are the best thing that institutional investors can get right now.
 
To be sure, investors in a bitcoin ETF need to contend with issues that many may not have anticipated, including concepts such as backwardation and contango, phenomena peculiar to futures which track the underlying asset.
 
Because futures are an imperfect means to track the value of an underlying asset, investors will lose more in the long run, thanks to tracking error and roll over costs (the cost of selling contracts and buying the forward month contracts in the case of futures).
 
Spot bitcoin ETFs already trade in other countries, including Canada, but the U.S. Securities and Exchange Commission remains hesitant to approve a spot bitcoin ETF, on concerns that the cryptocurrency is susceptible to manipulation.
 
The concern however is difficult to reconcile with the approval of a bitcoin-futures ETF, because those same issues with respect to manipulation are just as live whether the underlying asset of an ETF is the actual asset itself or its futures contract.
 
If nothing else, a futures-based bitcoin ETF is even more susceptible to manipulation because open interest can be gamed to create false expectations of rallies or corrections, based on forward month contracts.
 
 

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Nov 08, 2021

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