Novum Digital Asset Alpha – Daily Analysis 20 August 2020 (8-Minute Read)

Turns out Thursday is the turning point for markets, so hang in there, it’s going to get rough.

In brief (TL:DR)

  • American stocks took a breather rolling into Wednesday, with the S&P 500 (-0.44%), tech-heavy Nasdaq Composite (-0.57%) and blue-chip Dow Jones Industrial Average (-0.31%) all down. 
  • Asian stocks took their cue from Wall Street and opened largely lower. 
  • U.S. 10-year Treasuries slid, as yields rose to 0.674% from 0.665% in the previous session (yields generally rise as prices fall), dovetailing with a fall in the dollar.  
  • Oil was more or less unchanged with WTI Crude Oil (Nymex) (-0.44%) at  US$42.52 from US$42.71 a day earlier, slipping slightly on concerns over a return in demand. 
  • The dollar reversed losses on Wednesday as investor sentiment grew cautious, and built on gains after a 5-day selloff. 
  • Gold pared gains on Wednesday, slipping below US$2,000 again with Gold (Comex) (-2.32%) at US$1,958.70 from US$2,005.40 in the previous session, as the precious metal followed a decline in stocks. 
  • Bitcoin (-1.84%) continued to slide, along with the broader market and now trades at US$11,750 from US$11,950 (GMT 0230) the day before, but there is increasing evidence that investors are taking the opportunity to buy and hold, with outflows from exchanges far outpacing inflows (outflows typically suggest that Bitcoin investors anticipate greater price appreciation for Bitcoin). 

In today’s issue…

  1. Are We In A Bubble Or Missing Out On the Biggest Rally Of This Decade?
  2. Bank on Target – How One Retailer Was Poised To Win Big Regardless
  3. Bitcoin Couldn’t Sustain Above US$12,000, What Next?

Market Overview

Does a tree that falls in the woods make a sound, if no one is there to hear it? 
And no one seems to be listening to the growing concerns that the economy is sounding.
With Congress twiddling its thumbs and the Fed scratching its head on what to do next, investors are left wondering if they should head for the exits or double down.  
Asian markets were all down sharply in the morning session, with Tokyo’s Nikkei 225 (-0.76%) Seoul’s KOSPI (-2.43%), Hong Kong’s Hang Seng Index (-1.96%) and Sydney’s ASX 200 (-0.95%) all in the red. 
Minutes of the Fed’s policy meeting that were released do not bode well. If the titans of central banking are unsure of how to rescue the U.S. economy, despite acknowledging that it needs help, markets are in for a rough ride very soon. 
The Fed conceded that the U.S. needed greater support recovering from the coronavirus pandemic but were hazy about when they should deploy their tools and even what tools to deploy.
Facing down an economic tsunami, the lifeguards of the American economy are deciding what color bathing suits to wear. 
Fed officials expressed limited enthusiasm for yield curve control, a policy that typically involves targeting rates and pledging to buy longer-term bonds, which does not bode well for markets expecting the Fed to intervene under almost all circumstances. 
The economy is calling out for help, but it’s not making a sound.

1. Are We In A Bubble Or Missing Out On the Biggest Rally Of This Decade?

  • S&P 500 at record level but gains are uneven, reflecting some degree of discretion in picking winners and losers in stocks
  • Measured against bond yields, stocks are not at their most expensive, although using price-to-earnings ratios they are
  • Easy money has not led to indiscriminate buying 
The S&P 500 set an all-time record on Monday. 
I’ll let that sink in for a minute. 
If you live near an airport, take a look up at the sky, notice anything different? Go to a restaurant (if you can), have a drink at a bar, or head to a car dealership, can you taste the difference between now and before the pandemic? 
Everywhere you go, no matter which part of the world you’re in, surely you must have noticed that something’s wrong. 
Yet despite economic conditions which are worse than at any time since the Great Depression, stocks and all manner of assets are surging to record levels. 
Already, the S&P 500 has erased all traces of losses for this entire year. 
Which is why some are suggesting that we’re in a bubble, but are we? 
Market bubbles typically involve rapidly rising prices that suck in buyers hoping to make a quick killing. 
“Investors” who carry out scant due diligence and don’t worry about the long term prospects of what they’re buying into, fuel prices in a bubble. 
Standard valuations are always dismissed as no longer relevant, particularly for “growth” stocks, and the bubble is usually inflated by the widespread availability of cheap money. 
Sound familiar? 
Except that qualitatively, the stock market today does reflect economic conditions and prospects. 
Take oil stocks for instance, which are languishing.
Retailers are either going bust or preparing to go bust and banks are still down a whopping 30% this year alone. 
Travel and tourism stocks, including airlines and hotels can be had for pennies on the dollar compared to their previous valuations. 
And the worst junk bonds (high yield bonds) have missed out on the easy money entirely, with their yields having to be held high to summon the Michael Milken spirits. 
If investors are being indiscriminate about their buying of assets, the stock prices of the companies most exposed to the coronavirus pandemic don’t seem to reflect that. 
Yet it’s undeniable as well that signs of excess are everywhere, with the forward price/earnings ratio of the S&P 500 at October 1999 levels, just months before the dotcom bubble peaked. 
But by other measures, especially when weighed against the holding cost of near-zero yielding bonds, stocks aren’t expensive at all. 
To be sure, lower interest rates help all assets, filtering through from Treasuries and corporate bonds, to risky shares. 
Ceteris paribus, a stream of future income, for instance by way of a dividend or future earnings, is far more valuable with lower interest rates. 
But against this backdrop is the artificial set of circumstances that markets now exist under.  
Central banks are in siege mode.
With the economy in crisis, the normal functioning and role of the central bank has been put on hold, in order to prevent an economic apocalypse. 
Government bonds are sensitive to the outlook for interest rates and inflation, not economic growth, so they benefit from cheaper money and don’t suffer as much from economic shocks. 
And lower rates also means that profits further in the future matter more to the share price of companies, especially those which are able to generate income regardless of the circumstances, and that’s why they are able to price themselves higher. 
Which is why growth stocks, particularly technology firms, which have proved resilient, have hit such high valuations.
Because their future earnings are expected to be higher and immune to economic weakness, tech firms are finding themselves justifiably more expensive thanks to low rates. 
And it’s not as if all tech stocks have done well during the coronavirus pandemic.
Some have suffered, including Intel and Uber Technologies. 
So to assume that markets are in a bubble right now isn’t entirely accurate, but investors could also still be wildly wrong in their bets. 
If the Fed signals that it won’t keep throwing everything at the economy at the first sign of weakness, risk-on investments such as stocks could very quickly tank, growth prospects be damned. 
And a quick turnaround in the coronavirus pandemic could also see today’s winners very quickly become tomorrow’s losers. 
For a few days at the start of this month, positive sentiment on the back of a potential coronavirus vaccine saw bond yields rising, a pullback in growth stocks and a comeback for airlines, cruise companies and hospitality firms most badly hit by the pandemic. 
A rapidly receding coronavirus may see a quick rotation into the laggard sectors of the economy and a quick dumping of growth stocks to either lock-in profits or to rotate into other sectors. 
Investors aren’t just buying everything because money is cheap.
On the contrary, the market has already picked its winners and losers, almost rationally. 
Right now at least, valuations are high, but viewed against a backdrop of depressed bond yields, we’re not in Oz just yet.
Should prices stretch even further from where they are today though, then the yellow brick road that leads us down this path may yet reveal that the Wizard of Oz is really just an old man pulling levers behind an emerald curtain. 
Let’s hope it doesn’t come to that. 

2. Bank on Target – How One Retailer Was Poised To Win Regardless

  • Target posts record second quarter results, boosted by early efforts at restructuring and being among the few stores that was allowed to remain open during the coronavirus pandemic lockdown
  • Stickiness of retail behavior and the popularity of curbside pickup should see Target continue to do well moving forward 
When faced with a strong competitor you only really have two choices – adapt or die. 
And in the case of Target (+9.13%), they chose to adapt. 
Long before the coronavirus pandemic became a thing, one of America’s top retailers, was already embracing a rapidly changing retail landscape dominated by e-commerce juggernaut Amazon (-1.19%). 
Step into any Target in the United States and you’ll know why the store with the red dot was always fixing for a win. 
The lights are bright, the aisles are wide and the store is constantly kept fresh.
Near the front of any Target, there’s almost always two things – a Pizza Hut and a Starbucks (-0.10%) and those smells are tattooed into the brain of anyone walking in or stepping out of any Target. 
These physiological cues may seem subtle, but they are there alright, and coupled with Target’s move to curbside delivery as well as sprucing up its digital store offering, it was perhaps better placed than any other retailer to face the coronvirus pandemic head on. 
In the early days, Target realized that selling food was a huge money maker and its offers on wines and other alcoholic beverages have made it a go-to for many a merry maker. 
These measures combined have seen Target put in a stellar second quarter, one which this blog had predicted as far back as May this year and repeated again in June
To be sure, Target benefited strongly from being able to stay open (it sells food) throughout the pandemic, selling groceries and other household staples. 
And some of the factors powering Target’s continued growth moving forward are just as relevant now as they were during the pandemic. 
As an upper-middle tier retailer, it allows shoppers who are concerned about stretching their budgets, but worried about job security, to continue to shop at Target with dignity, downgrading perhaps from say, Whole Foods.  
And for those aspiring to move up from say, Walmart, Target fits the bill as well. 
Being one of the few stores that was open during the coronavirus pandemic, some of the behaviors (for instance being the only store that many Americans could go to during the lockdown) inculcated as a result of lockdowns, such as visiting a Target, are likely to stick. 
And Target doesn’t operate a whole bunch of stores either – 1,900, meaning its move towards e-commerce and online sales didn’t have to come at the cost of closing existing stores. 
Given Target’s propensity for innovation, expect that it will see another uptick once Congress gets its act together before the election and issues another round of much-needed stimulus – a portion of those checks will be headed towards Target. 

3. Bitcoin Couldn’t Sustain Above US$12,000, What Next?

  • Bitcoin takes a breather below US$12,000 
  • Long term macroeconomic trends still bode well for the world’s first cryptocurrency, short term pullbacks are excellent opportunities for retail investors to enter the market  
The thing about trying to entice a squirrel out of the woods is that you have to lure it out with nuts and not make any sudden moves, else it’ll get scared away. 
Because just as most Bitcoin bulls would love for the cryptocurrency to surge in a vertical upswing, such sudden moves, while attracting gamblers into the space, may also scare away the more conservative and the more cautious. 
Cryptocurrencies already suffer from a bad rap. 
Long associated with criminal activity and scams, boom and bust cycles in cryptocurrencies are certainly not for the faint of heart. 
Which is why the recent pullback in Bitcoin to just below US$12,000 may be a welcome respite from its recent bullishness. 
Bitcoin saw inflows into cryptocurrency exchanges leading outflows in the 24 hours running up to the most recent pullback, suggesting some degree of profit-taking that put pressure on Bitcoin’s ascent.
The US$12,000 level continues to be a level of resistance, that will need to see sustained clearance before a move higher can be made to US$13,800, the next significant level of resistance.
Given that Bitcoin’s pullback coincided with a record close for the S&P 500, helps to also fuel the narrative that Bitcoin is an asset, uncorrelated with other asset classes and helps fuel demand for the cryptocurrency as a hedge against portfolio volatility. 
Yet with record levels of stimulus already in the financial system and more on the way, these short-term pauses for Bitcoin may also present an excellent opportunity for those looking to get in. 
The macro factors for a bet on Bitcoin haven’t changed.
Inflation still looms large as a threat on the horizon, and a recent survey by Fidelity Investments suggests that as many as 36% of institutional investors own digital assets, with Bitcoin still being far and away the most popular cryptocurrency.
A number of high profile investors have also come forward to bet big on Bitcoin, including billionaire macro hedge fund investor Paul Tudor Jones. 
So a pause in the rise of Bitcoin, if nothing else, is a good thing, best not to scare away the squirrels with any sudden move. Retail investors can get very skittish by sudden moves. 

Novum Digital Asset Alpha is a digital asset quantitative trading firm.

Exclusive access to Novum Digital Asset Alpha’s Daily Analysis is made in conjunction with Bitcoin Malaysia.

The information and thoughts laid out in this analysis are strictly for information purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws.

It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.

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