The Breakdown - After Bloody Weekend, Crypto Market Sentiment Goes Full Bear

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Abra, and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, January 24th, and today we are talking about why after an extremely bloody weekend, the crypto market is going full bear. Before we get into today's topic, if you're enjoying the show, go subscribe to it, give it a rating, give it a review, or if you want to get deeper into the conversation, come join the Breakers Discord. You can find the link in the show notes, or you can go to bit.ly slash breakdown pod. We've got discussions going about everything from macro to markets and beyond, and I know that you'll have a good time there. Finally, disclosure as always, in addition to them being a sponsor, I also were.

Starting point is 00:01:05 with FTX. Now, the markets are, as you well know and will need no reminder, very, very painful right now. Arthur at Defiance Capital tweeted throughout my five years of crypto investing experience, this is the move that caught most pros in Wales offside the most, was not expecting a 60% drop from the peak without a single 20% bounce. Massive supply demand-driven sell-off without significant liquidation cascade. Jason Choi, who invests with Spartan, agreed, saying, plus one, I think most pros recognize that the froth was apparent and the headwinds well telegraphed. What caught most people offside seems to be the severity and magnitude of the drawdown. Most were expecting one to two year down chop at worst rather than good by 50% of value in a week.

Starting point is 00:01:54 So if you're feeling raw, the point is that you are not alone, but I want to go a little bit deeper in trying to understand what's going on. And I think we have to start. with the macro. The line of thinking I've been sharing is that the Fed fundamentally shifting from quantitative easing to quantitative tightening, not just rate hikes, but actual balance sheet reduction, has caused havoc with risk assets. And that's definitely true. Last week was brutal for equities. The NASDAQ lost 7% last week and is now, as of this morning, down 15% from its November high. Remember, half of all NASDAQ companies are tech companies, and 40% of NASDAQ has fallen 50% or more since November. Some companies are facing even more pain, with Robin Hood

Starting point is 00:02:39 down 11% today and 86% overall from all-time highs. Now, of course, most people's interpretation of this has been about inflation. The Fed is expected to raise rates three to four times this year to fight inflation and is moving again from balance sheet expansion or QE to balance sheet reduction or QT. Rising interest rates change the price of risk stocks like tech stocks. and by extension of other risk assets like crypto. Now, we've been over this quite a bit, but there is another macro element that's also invading the discussion in a major way,

Starting point is 00:03:13 and that is, of course, fear of an armed conflict in Ukraine. Now, the situation in the Ukraine probably deserves a whole episode. If you haven't had a chance yet, I'd go back and listen to a few of the recent shows on Hidden Forces. Dimitri's had some great guests talking about exactly this lately, But TLDR, Russia wants NATO to, one, pullback forces from Eastern Europe, and two, give guarantees that they won't extend membership to Ukraine, which would reverse a 2008 pledge to let Ukraine and Georgia in.

Starting point is 00:03:43 Remember that pledge in 2008 precipitated the Russian invasion of Georgia just a few months later. The U.S. and its allies have rejected this, and the situation has got increasingly tense. This morning, we woke to news that NATO allies were putting forces on standby and sending ships and jet fighters to Eastern Europe. Denmark is sending a frigate and four F-16 jet fighters to Lithuania. Spain is sending ships to the Black and Mediterranean seas and considering sending jets to Bulgaria. The Netherlands has sent two jets to Bulgaria and France is considering moving troops into Romania. The New York Times is also reporting that Biden is considering deploying several thousand U.S. troops plus warships and aircraft. President Biden was at Camp David over the weekend,

Starting point is 00:04:23 and Pentagon officials gave Biden a number of options for putting military assets into the region. On top of that, the State Department has ordered all family members of U.S. embassy personnel who are in Kiev out of Ukraine citing threat of Russian military action. And importantly, these latest moves are a shift. Up until very recently, the Biden administration has been trying to take a restrained stance. So, do people think this is adding to pain in the markets? And the short answer is absolutely. Kieran Murray tweets, just when it looked like the bond sell-off and cyclical rotations

Starting point is 00:04:54 were saturated war in Ukraine jitters step up to give bears more fodder. Pablo Heiman writes, Europe's stocks getting absolutely hammered because they're pricing possibilities of war with Russia versus Ukraine and NATO. Indirectly, this affects U.S. and world markets due to a spike in oil and natural gas. Alex Kruger, crypto and stocks obliterated again since the European Open. Crypto is not much lower as big buyer stepped in at 33K, war in Ukraine fears picking up sharply today. And by the way, this isn't just on Twitter. It's also the narrative in the popular press. Bloomberg Markets writes Ukraine risk royals treasuries to commodity as tensions rise. That piece points to destabilization for natural gas and wheat prices when Europe

Starting point is 00:05:34 is already in an energy crunch. Goldman Sachs analysts say that escalation could cause sanctions on Nord Stream 2, which is a Russia to Germany pipeline. This would potentially curtail flows to Europe and push prices up even farther. Chowang from the Defi Alliance or Alliance Dow, as it's now known, writes, trying to time the bottom is futile when the prevailing narrative is Ukraine, Russia. Oh, and by the way, despite Fed saber rattling on rates, inflation is still in the headlines as well. Bloomberg again writes red-hot inflation grips pockets of U.S., Midwest, and South with rates over 9%. Basically, the center of the country is getting slammed, and it's not hard to tell why. The economy there is twice as concentrated on manufacturing.

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Starting point is 00:07:58 Help support the breakdown and visit FTX.U.S. Today. That's FtX.us. All of this adds up to a very, very crappy macro scenario right now. In fact, the Hulbert Nasdaq newsletter sentiment index has investors more bearish right now than in March of 2020. Suu from Three Aros Capital tweeted, I was undeniably wrong about how much crypto could fall from macro contagion. Now, a few things as we dig into this. First, let's talk a minute on correlation. Chow Wang again wrote a really great little thread on why increased institutionalization has necessarily meant higher correlation. Quote, institutionalization of crypto means higher, not lower

Starting point is 00:08:46 correlation to legacy market. Higher correlation means fewer and fewer people actually have an edge timing the market. The game that most retail speculators should play, therefore, is long-term investing. Why does institutionalization lead to higher correlation? There's a few reasons. First, institutions typically have target percentage allocation for each asset class. If stonks go down, stock allocation goes down and crypto goes up, so they have to sell crypto to maintain the target. On the risk management side, when the market crashes, volatility typically rises, and their perceived portfolio risk rises, so they sell more in order to reduce portfolio risk. Medium-term statistical traders will notice this correlation and try to front-run them.

Starting point is 00:09:22 Then short-term high-frequency traders will notice this and try to front-run the medium-term folks, so the correlation self-reinforces. There is a ton of chatter about how stocks and Bitcoin and crypto as a whole are correlated, and I thought that was a good reminder of just exactly why. Now, one thing that many are pointing out is that it doesn't necessarily follow that rate hikes will lead to bare markets. Sue again from Three Arrow says, reminder that macro-induced downturns have more structural similarities to March 2020 than 2018, which was a crypto downturn during a very risk-on

Starting point is 00:09:54 environment. Another reminder that we had three rate hikes in 2017 during the biggest crypto rally ever. Scott Melker writes lots of chatter about markets and Fed tightening, but here are some facts. historical data would indicate hikes are priced in and market should actually perform well in the not-so-distant future. When hikes start in March, question mark. There have been 12 tightening cycles, and here's what happened. Stocks went up 11 times, down once. Yep. When midterm elections are happening, performance is even stronger, because politicians like to, you know, get re-elected. Caviard is that the bulk of midterm years have been

Starting point is 00:10:25 historically down and volatile, with prices ripping in the final three months and into the next year. Right before and after, the actual election goes full bull. This time could be different. The situation is not the same. There are endless variables. Just offering some historical context and data because I was quite surprised when I dug in. Of course, ultimately, it's not just rate hikes that the market is reacting to. It's the prospect of balance sheet reduction. Tasha, who's been getting a lot of pickup for her macro commentary writes, rate hikes don't kill risk assets. Reversal of quantitative easing does. Check what happened to stocks 2015 and 2018 when Fed turned off the tap. Arthur Hayes wrote about this. as well. The former Bitmac CEO wrote a piece on January 6 called Mailstrom, and while many were dismissive of it, Nick Batia summed it up this way. Hayes believes we are heading into a, quote, string of trading days as disastrous as 16th March 2020, as a result of, quote, the Fed reducing the growth of their balance sheet to zero percent and subsequently raising rates one to three times in 2022. Hayes also doesn't think investors get the relevance of macro, writing, my read on the sentiment of

Starting point is 00:11:31 Crypto investors is that they naively believe network and user growth fundamentals of the entire complex will allow crypto assets to continue their upward trajectory unabated. If others right, it could get bleak before it gets better. But there are still a lot of folks out there who think that the bare sentiment and the fear have gone way too far. Jeff Dorman from ARCA says it's one thing to frontrun some obvious and negative news because markets are forward-looking. It's quite another to start a full-blown panic three months before anything ever happens, way oversold. Not to mention, as we pointed out last week, the early years of a hiking cycle are usually bullish for risk assets, and only at the end of the tightening cycle do risk assets tend to

Starting point is 00:12:08 sell off if the Fed goes too far too fast. The likelihood of straight-down declines in a few weeks' time in the face of a long three-year-plus tightening cycle is very low. Now, in addition to Dorman's thoughts, there's also some skepticism out there that the Fed is going to be even able to see this through. Appmusing Trader writes current FinTwit mood. Know how usually the Fed hikes then hikes again until something breaks? well, what if this time shi breaks before they even start hiking? Still, overall, like I said, right at the top, it is a bearish mood out there, and a lot of people feel like we are on a precipice. Jim Bianco on Saturday wrote, I see the SPX at an inflection point

Starting point is 00:12:45 right here. If the trend is still up, the decline stops now. If not, the next break marks a full-blown bare market. In the last 48 hours, we are finally starting to see a bond risk-off rally. I take this as a signal that now the bond market is getting worried about the stock market so a risk-off bond rally is underway. If stocks are still in a bull market, when the bond risk-off rally emerges, that is the end of the stock market decline. It should be over now. If this is a new bear market, the bond risk-off rally means things are really about to get ugly and a full-blown equity bear, down 20% or more, is underway. If so, the Fed is about to unleash tightening to stop inflation, and if that means sacrificing the stock market, then so be it. I think the Fed is going

Starting point is 00:13:26 to get really aggressive, enormous political pressure Biden told us he approved. He approved them tightening. So instead of siding with the bears, now that we are at this inflection point, let the markets tell me what's coming next. Alex Kruger takes this into the crypto dimension. Quote, it should be 100% clear that crypto is following equities. Crypto may decouple briefly either up or down, but that's what's going on. So calling a bottom or whatever on crypto requires doing the same on equities, which is much harder. Next week, have the Fed's open market committee meeting and earnings. Equities could either skyrocket on a dovish surprise or unexpectedly strong earnings guidance, or do the exact opposite. I don't have an edge this time.

Starting point is 00:14:02 On the earnings side, the key is not actual earnings, but rather guidance, i.e. expectations. Scenarios-wise, thinking as follows. 25% chance S&P down 5% by March. 15% chance S&P down 10% by March. 50% S&P wide chop. 10% S&P back up by March. S&P dropping a further 5% to 10% by March could place Bitcoin at 30K or lower. Alts obliterated. The latter two scenarios send Bitcoin back over 40K. Why am I not more bearish? The market is already pricing in more than one hike for March and five hikes by December. That is extreme. Recall the Fed's latest dot plot indicating three hikes by December. Unfortunately, the super cycle reality changed when worst-case scenario materialized, the Fed doing a 180-degree flip

Starting point is 00:14:47 and going all-out hawkish in little time. What the burr giveth, the burr unwind can takeeth away. Now, on the flip side, some are pointing out that even if we are in a bare market, it's likely to be very different from the extended crypto winter in 2018 and 2019. Michael Ippolito from the block writes, we might be entering a bare market, but it won't be anything like the 2018 crypto winter. In fact, we've arguably been in a bare market for the last six months. Basically, since crypto's first bull run in 2011, two patterns have emerged. The cycles go on for longer periods of time, and two, the ROI of each cycle diminishes. This makes intuitive sense. In 2011, crypto was a much smaller and more liquid market. Relatively small inflows could cause huge price swings.

Starting point is 00:15:28 Today, the market is much deeper and requires more incremental dollars to make prices go up. Here are the peak-to-trovs and drawdowns of each bull run. 2011-800-X-R-I, draw-down 94%. 2013-600x, draw-down 91%. 2017-100x, draw-down 87%. 2020, ROI-25X, draw-down, question mark. The ROIs are diminishing, but so are the drawdown. downs. This also makes intuitive sense. The less intense the party, the more manageable the hangover.

Starting point is 00:15:58 Interestingly, I think Cryptoog's memories of extreme volatility are biasing them here. We didn't get the blow off top they remember, so maybe we don't deserve the deep winter. Crypto is already 45% off its all-time highs and is basically traded sideways since April. There's a good chance based on this cycle's rounded top and historically diminished ROI, that we don't have much farther to go. I think that Michael's point that this cycle is likely to be a little different than the last, just based on the evolution of the market is true. I'm not sure that we don't have more to go down. I think one of the biggest challenges for crypto investors is to get out of the psychology of

Starting point is 00:16:32 just because something has gone down a bunch doesn't mean it can't go down more. I will admit, like Arthur and Jason right at the top of this show, to being surprised by the massiveness and quickness of this move down. I also, like Jeff Dorman, think that there is a disequilibrium between the current sentiment and the likely reality of macro impacts. However, the X-factor for me is absolutely global instability caused by the potential of war in Europe. I will say, if you are going through this for the first time, talk to one of your friends who has been through a full cycle before. There's a lot to love about bear markets, even though they can be painful. And I would also caution against trying to ascribe any past performance as an indicator of what

Starting point is 00:17:14 happens next. There are so many new and variable factors that it's hard to say for sure what's going to All I can offer is that I will be here every day giving my best takes possible on what is going on. I want to say thanks again to my sponsors, nexo.io, Abra and FTX for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - After Bloody Weekend, Crypto Market Sentiment Goes Full Bear

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