Novum Alpha - Daily Analysis 7 January 2022 (10-Minute Read)
A fantastic Friday to you as markets continue to flounder on the prospect of an increasingly hawkish U.S. Federal Reserve.
In brief (TL:DR)
In today's issue...
An overtly hawkish stance from the Fed has roiled financial markets at the start of a new year, with investors reassessing how to price assets in an environment of rising interest rates.
The removal of crisis-era accommodation marks a shift not seen in at least three years, a time that also saw a spike in volatility.
Investors are also looking for signs that more Americans are returning to the labor force and helping employers to fill a near-record number of open positions.
In Asia, markets were mixed Friday with Tokyo's Nikkei 225 (-0.33%) down, while Sydney’s ASX 200 (+1.22%), Seoul's Kospi Index (+1.01%) and Hong Kong's Hang Seng (+0.56%) were up in the morning trading session.
1. Cathie Wood's Ark Takes on Water
Just as a rising tide lifts all boats, an ebbing tide can beach even the mightiest ship as Cathie Wood’s flagship ARKK is discovering.
Since 2014, Wood has established Ark Invest as a pioneer in the rapidly-growing market for actively managed ETFs, capturing the imagination of legions of loyal retail investors and soaking up billions of dollars through her ability to sell an investment narrative married to a savvy adoption of social media.
Although ARKK has delivered annual gains of almost 30% since its inception to the end of September, in all likelihood, the average investor is probably underwater, because even though ARKK’s long-term record is stupendous, many of those gains came when it had a much smaller asset base.
Just a week into the year and ARKK has already shed 9%, with its overweight positions in disruptive companies in emerging technologies taking a battering on concerns that the U.S. Federal Reserve is turning hawkish.
This year alone, investors have pulled some US$300 million on a net basis from the Ark Innovation ETF as its bets on riskier tech companies have soured.
The US$14.4 billion ARKK is now some 45% off its peak last February and focuses on areas related to DNA technologies, automation, robotics, energy storage, artificial intelligence and fintech.
While many laud Wood’s concentrated wagers on small, potentially disruptive companies, critics deem the approach reckless.
But Wood may ultimately still have the last laugh.
With some of the best research in the financial services industry, Wood and her small team of around 38, have a strong reputation for future-proofing portfolios, regardless of the volatility in the interim.
When naysayers were doubting electric vehicle maker Tesla’s ability to deliver on its production promises, Wood loaded up on shares of the company, which has ultimately proved the doubters wrong and had a breakout 2022 smashing all production records and estimates.
Wood also knows when to cash in, selling shares of Tesla over the past week to take some money off the table, even as the electric vehicle maker still comprises the largest holding of ARKK, at 8.67% based on data provided by Ark Invest.
ARKK investors need to accept that while some valuations may have gotten somewhat frothy thanks to the flood of liquidity in the financial markets, volatility more often than not reflects a disconnect between understanding the disruptive nature of future technologies and being able to price them accordingly.
And the next period could be a true test of faith for ARKK investors, as a backdrop of inflationary pressures, rising bond yields and the prospect of interest rate rises could put additional pressure on the investment case for ARKK.
ARKK may ultimately still provide returns, but these returns may require investors to sit through a significant degree of volatility before Wood’s prescience pans out.
2. Inflation has Commodities Correlating with Bonds
It’s been oft said that correlation does not equate to causation, but a prospective rise in interest rates has seen bond yields rise alongside commodities with the latter two trading at the highest levels of synchronicity in months.
The last time commodities were so closely correlated with bond yields was when the Delta variant of the coronavirus reared its ugly head and investors shunned haven assets like Treasuries in favor of risk-on commodities and equities.
This time though, the prospect of higher inflation and the specter of a more hawkish Fed is seeing yields soar on anticipation that the Fed will be more aggressive in its rate hikes – yields rise when bond prices fall.
While the commodity investment case comes on the back of expectations that rising inflation and continued supply chain disruptions will act as a tailwind for commodity prices.
Minutes of last month’s U.S. Federal Reserve policy meeting reveal a central bank deeply concerned over inflation and traders are now pricing in an 80% possibility of a Fed rate hike as soon as March.
And while equities were pummeled on release of the Federal Open Market Committee meeting minutes, commodities rallied.
At least part of the commodity rally can be explained to the unexpectedly faster clip that the economy is growing, with yields and commodities typically the first assets to price that in, especially for copper, a key component for manufacturing processes.
But the Fed’s moves to increase borrowing costs, at a time when spikes in the price of oil, metals, food and other raw materials are contributing to inflationary pressure may be counterproductive to the central bank’s aim to reign in price rises.
To be fair, real yields are currently deeply negative, and that’s offered a strong incentive for investors to seek returns in riskier assets, from commodities to cryptocurrencies – the main difference is that anticipated increases in borrowing costs could see yields turn positive once again and inflation could abate, which is where the bear case for commodities could loom.
Traders are pouring into commodities such as copper and oil to hedge against inflation, yet at the same time driving up the prices of these commodities that creates a self-perpetuating feedback loop that seems to suggest a commodity super cycle where none exists.
Find out more about Novum Alpha as leading luxury portal Luxuo.com interviews our CEO & General Counsel, Patrick Tan...
3. Bitcoin's Rocky Road to a Hundred Thousand
Whilst Shakespeare may have made famous the adage that “the course of true love never did run smooth,” cryptocurrency enthusiasts could take a leaf out of the bard’s scripts with “the course of $100k bitcoin never did run smooth.”
In 2017, critics famously ridiculed Fundstrat’s Tom Lee for forecasting that bitcoin would rise to US$25,000, mocking him when the cryptocurrency eventually collapsed to as low as US$3,400 just a year later.
As if that experience had not scared off other pundits who have suggested that bitcoin’s price could go anywhere from US$100,000 to forecasts of a million – the danger, as always, when it comes to trying to predict the price of bitcoin is that no one really knows.
Yet that hasn’t stopped people from trying to divine the future price of bitcoin, using everything from complex models to goat entrails and while the cryptocurrency has suffered a drubbing this week on the prospect of the Fed hiking rates as early as March, bitcoin bulls are still calling for the cryptocurrency to hit US$100,000 at some point this year.
Given how completely unpredictable the price of bitcoin has proved to be, it’s not so much that it can’t hit a hundred thousand, it’s just that the macroeconomic environment makes it somewhat more challenging, especially given a suddenly more hawkish Fed.
There’s no doubt that cryptocurrencies benefited from the Fed’s largesse and some of the correction that we’re seeing has to do with the Fed pulling in the reigns of its otherwise profligate spending on asset purchases.
But at the same time, the Fed is tightening in response to inflationary pressures, which feeds into bitcoin’s narrative as a supposed hedge against inflation.
According to Bloomberg Intelligence’s Mike McGlone, bitcoin is evolving from a risk asset into a digital reserve asset in a world that is already going that way, writing in a note that the cryptocurrency is “heading toward US$100,000.”
“Cryptos are tops among the risky and speculative. If risk assets decline, it helps the Fed’s inflation fight. Becoming a global reserve asset, Bitcoin may be a primary beneficiary in that scenario.”
While earlier this week, Goldman Sachs analyst Zach Pandl wrote that bitcoin could hit as much as US$100,000 if it continues to take market share away from gold, a traditionally viewed hedge against inflation.
Bitcoin however has not sung from the song sheet of its alleged inflation-hedging properties, instead it’s crooned to its own tune, with the 100-day correlation between bitcoin and the S&P 500 at 0.44, the highest since the fourth quarter of 2020 (a correlation of 1 means that the two assets move in perfect unison, whereas -1 would suggest that they move in exact opposite directions).
These conflicting narratives – risk or haven asset? – mean that bitcoin investors will need to steel themselves for the inevitable abundance of volatility that will necessarily be a hallmark and price of entry into the nascent asset class.
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Jan 07, 2022
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