It’s been a crazy couple of weeks in the markets and toilet paper aisles at supermarkets since we said that
The newsletter also stated that ‘the assumption of low, reduced or controlled volatility seems extremely dangerous in the circumstances worldwide. The assumption that a dip would be bought to recover seems prime for a continuation of any price weakness.‘
Since then, the equity markets have collapsed and buying the dip does not appear to be the strategy. A large market-making options trading firm habitually selling volatility is rumoured to have busted out Friday, a strategy that would have been fairly successful, until this uncertain, unknowable, unquantifiable risk. The buy the dip trade was also offside Friday afternoon.
Although there is an inevitable de-leveraging process as well as funding requirements and portfolio positions being re-assessed, the move is most likely not due to those things.
Although coronavirus is the trigger there is a bigger problem that is underlying the financial system.
Risk has been fundamentally mispriced – the S&P 500 had been paying 1.75% yield on an average of around 4.5%.
Equity yields before the crash in 1929 were over 3%!
The 1987 crash saw yields dip just below 3%!
Since Alan Greenspan and Ben Bernanke and their monetarist economics experiment, yields have consistently been below 3% – below both the 1929 and 1987 crash low-point since about 1995 – as low as 1.11% during the dot com boom, and 1.75% recently.
In the last 2 weeks, the S & P 500 yield has improved to just below 2%. If the S & P 500 fell 50%, it would still be below its long term average.
S&P 500 Weekly Chart
Fixed interest yields are suggesting that negative rates may be on the cards and the solutions and money flows must be very positive for Gold, with inflation on the horizon of potential solutions to the latest trouble as well.
A rebalancing of the systematic mispricing of risk can be triggered by Coronavirus, but the markets have successfully ignored a huge number of growing risks.
Coronavirus may be the thing that accelerates fear and hysteria around many other issues, even bringing them forward. They include Russia’s imperial ambitions with its guns and oil strategy and attempts to control Europe’s energy supply, instability in the middle-east including attacks on Saudi, sanctions on Iran, Russia in Syria, Turkey acting as a belligerant while a NATO member and with a US Nuclear base, massive demographic shifts in Europe, the yellow-vest protests in France, Chinese debt due, the chance of a Chinese militaristic venture to distract from domestic political pressure, the collapse of stable political narratives in the Western world and rejection of global institutions and so on, all of which become larger issues in a new way of seeing risk.
Part of the problem is the ‘end of history’ delusion a la Fukuyama, where in the relief of the collapse of the USSR (and it being representative of existential threat, an absolute victory over risk itself) the Western system was taken as the final form of cultural, social and political development. The taming of the market cycle – the taming of risk – is in the same instinct as is Greenspans interest rate pricing experiment that mispriced houses before the ‘end of history’ financial system, making its own rules without consequences created derivatives such as synthetic Credit Default Swaps e.t.c.
Why wouldn’t you own billions of dollars of synthetic Credit Default Swaps in the end of history?
In fact if we see a continuation of the equity market repricing drastically lower in the next fortnight, in spite of the Coronavirus, it is the failure of the ‘end of history’ idea. A paradigm shift in reality.
The pillaging of the working and middle class faced with an asset price bubble as a social and cultural issue has been attempting to correct itself through democratic politics in the election of Trump and popularity of Bernie Sanders (no longer front-runner).
But the imbalance to the economy of allowing massive asset inflation since Greenspan may now have to play out in markets and the financial system. It’s not about Coronavirus, it’s about a system without appropriate feedback measures to regulate itself, of the way it has been gamed. The system is not healthy, the assets do not relate to the economy or to the social, cultural or political reality in proper ways.
For example, the actions of the Fed removing price discovery mechanisms. The institution created a feedback mechanism within the system, a degenerative feedback loop that removes complexity in an attempt to control outcomes.
However it does appear here now that the fed is smart enough to know that if they tried to over-support the banks at this point, the Fed and the banks would own the worlds mispriced risk assets. And if you’ve seen the explosion of debt in banks, we would see that both parties are already deeply invested. They may have already bought the high.
If the GFC began act 1 for digital assets, somewhere in 2017 to early 2020 was act 2, then what is coming is act 3.
If what we’ve discussed above is the true state of affairs, then it may not be a pretty outlook for Digital Assets to begin with.
The tightening of institutional risk-taking, changing cash liquidity requirements, portfolio risk-taking tightening and general fear and hysteria will likely mean that the coupling of the traditional financial system with digital assets (to become simply, ‘The financial system’) will be postponed. The traditional financial institutions have a lot to think about, and digital assets could be low on their priority list.
If the traditional markets continue to collapse in the next fortnight then digital asset positions are likely to be one of the first cabs off the rank in positions to be sold-down in institutional portfolios. They are already hard to rationalise for portfolio managers in a set of investments and they will become very hard in a wider state of chaos. Digital assets are not ready to take over the financial system and this could mean that they are tested in the short and perhaps medium term.
So before we move on, let’s say that there is a risk, of seeing Bitcoin below late 2019 lows.
However! If this is what is going on in traditional markets, it is a deeply validating reality for the raison d’etre of digital assets.
It would be the specific circumstances playing out in which Bitcoin originally critiqued money, that of the laissez-faire policies of the Global Financial Crises, the monetarist Economics and political, social and cultural connection to the integrity of the financial system that failed then.
So as this plays out it’s going to be a very interesting time ahead to see if whatever organised and concerted effort is being planned between governments, international institutions and reserve banks is capable of doing anything besides adding to the problem in the first place.
In the meantime, the baton continues to be slowly passed. The specific problems inherent to traditional markets are what digital assets are reaching at solving. Digital asset projects are far more sophisticated with deeper philosophy and more developed cultural ideas than traditional finance has been for many years.
Is it time to burn the Golden Calf?
As we say this, Bitcoin has recently made a rounding top, has fallen to its trend-line, bounced and is headed back to it in a hurry.
The weekend equity indexes have been sold off, and it looks like next week may be the real carnage.
It’s hard to know what is going on behind the scenes in the greater context. We do not believe that Bitcoin has to act like a risk-off asset, or like digital gold because it is not integrated enough into the traditional financial system yet, and will be one of the first cabs off the rank in portfolio rebalancing.
If we believed that traditional finance understood what Bitcoin was, then we would expect it to explode through its highs. We think that it doesn’t, and that weakness is likely. If it does hold-up, if it simply does not take a beating, especially in the next week if equity markets do come off, then it could become a very highly performing asset in the next few months.
There is likely a time fast approaching that constructing a well-built digital asset portfolio is a game changer.
BTC/USD 1 hr Chart