Liquidity flooded into crypto in 2021 as venture capital flows into the sector were larger than all prior years. Yes, the industry is new and the history of flows is short, but the surge of capital into the sector has impacted valuations. The start of 2022 has seen established crypto assets start soft, however, there are a good number of tokens that have risen year-to-date (YTD). This is not a worrying start, but an illustration of how the older tokens like bitcoin and Ethereum are developing a higher correlation with traditional markets. That is not what just took place in January. If you struggled to stomach the recent volatility, it’s time to revaluate your asset mix.
The stock market sell off was similarly measured, with capital flowing from the most expensive sectors into value sectors. However, the S&P 500 Volatility Index (VIX) barely rose above 20, showing no sign of panic. The Dispatch continues to see risks of a sell off in risks assets where correlation spikes and all assets, both traditional and crypto sell off together. With the Fed set to ease liquidity and growth risks rising in 2022, it is prudent to assume a reasonable probability of a correlated sell off. We are happy to discuss specific probabilities and appropriate asset allocation individually.
The Dispatch is working on a new project, which led to the recent month-long hiatus. We will be announcing the project within the next month. This edition will be kept shorter than usual, and publication may be irregular for the rest of the first quarter. Dispatch #1 of 2022 covers the following stories.
- Benign January sell off. Are you prepared for a higher correlation sell off?
- 2021 crypto VC deals were greater than all other years combined
- Bearish 2022 crypto view from Bitmex’s Arthur Hayes
- Latest Census Bureau Household Income data illustrates widening income gap
- Update to inflation view & latest data
- Rising crypto ownership among elected officials
January sell off
We’ve seen a modest sell off thus far in 2022 with a rotation from growth to value sectors within stock market. A gradual sell off, where the VIX index barely got above 20, is a best case outcome. This will allow capital to rotate from expensive, over-owned assets to more attractive assets. Our worry, though, is of a sharper sell off where the VIX gets above 30. If that materializes, then correlation between risk assets rises towards one, and everything sells off. Such a sell off is NOT a certainty, but risk management consideration as Fed policy and growth outlook changes.
January also showed that the mature digital assets like bitcoin and Ethereum are more correlated with traditional risk assets. While bitcoin and Ether sold off, many crypto assets had strong performances YTD. The chart below shows a selection of some of the stronger performers vs. the bellwether tokens.
Liquidity flooded Crypto as VC deals in 2021 surpassed cumulative total of all prior years
Digital assets firms raised $33bn in 2022, more than in all prior years combined. Global liquidity forcefully entered digital assets in 2021, and valuations were correspondingly impacted. This Decrypt article provides names of some of the larger capital raises in 3Q21. The Galaxy Digital article, source of the chart below, highlights key takeaways for the year.
Cautious 2022 crypto view from Bitmex founder Arthur Hayes
The money flow story above connects with Hayes’ view about the risks to the sector as central banks tighten liquidity in 2022. If you want a very bearish view on the 2022 crypto outlook, look no further than these thoughts from Arthur Hayes, one of the founders of crypto futures exchange Bitmex.
There are plenty of dissenting voices to this cautious view. Much of that opposing view hinges on the fact that bitcoin rallied when the Fed last raised Fed Funds rate from near zero back in 2016. One of the better bullish takes comes from Arca Digital Assets CIO Jeff Dorman. A portion of Dorman’s view is below.
We also know that bitcoin reached a euphoric top at the end 2017 while the Fed was hiking rates, these proponents argue. The charts below illustrate point.
There is always a narrative to fit all viewpoints! As we said in the 2021 year-end Dispatch #40, risks are rising as central bank liquidity slows, and caution is warranted. Furthermore, there are many more signs of exuberance in equity prices today and valuations are meaningfully higher than in 2016. Additionally, the amount of liquidity injected by global central banks since Covid pales in comparison to their actions following the GFC. Markets rhythm even if they don’t repeat.
As we have repeated previously, keep your crypto asset exposure sized appropriately small to weather the high volatility, and take a long-term view to benefit from Metcalfe’s Law network growth.
Household income gap has expanded
The widening income and wealth gap is often quoted and the charts below provide an easy to absorb visualization. The obvious conclusion is that Central Banks’ quantitative easing since 2008 has benefited the top of the income pie more than the bottom.
This data should form the core of long-term macro analysis as the trends percolate into many aspects of investing. How can real consumption rise if the GDP pie accrues at a faster rate to the top brackets? Those experiencing the higher gains have a lower marginal propensity to consume, but will seek to save more. As a result, it should not be a surprise that asset prices have done well over the past decade, based on this narrow view.
It’s worth asking if the signs of faster wage growth in the past 12 months are a sign of this trend reversing. It’s too early to call, but it is worth watching how the bargaining power between capital (companies) and labor (workers) evolves.
Updated inflation outlook
The headline CPI index rose 7% year-on-year (YoY) in December a 39 year high. The Dispatch is unsurprised and expects one last potential upside risk to inflation from China shutting down more aggressively due to Omicron. China has already reported rolling shutdowns of multiple cities as it prepared to host the Olympics. Most of the world has shown that it is not possible to shut down for brief period to avoid Omicron. A combination of shutdown and wider Omicron spread in China could be a last inflationary surge that should play out over the next one to three months. We are inclined to fade the headline CPI surge as we see it decelerating later in 2022, but remaining well above the Fed’s 2.7% year-end projection.
ISM price paid has already turned down
However, we expect the core CPI rate to remain stubbornly high as rising rents flow through to the index. The Fed looks at the core CPI rate (Core PCE, really) to set policy. More importantly, inflation has become the Biden administration’s top focus as poll numbers fall. This, more than anything else, provides confidence that the Fed will lean towards easing liquidity to at least have the appearance of doing something about inflation.
Here are a few stories since the last Dispatch that are relevant to the inflation discussion. We are constantly seeking views to debunk our high inflation positions.
- WSJ on how household wealth might be impacting labor participation rate.
- Here’s a story about booming day laborer wages, and the US is granting 20,000 more seasonal H-2B visas for the winter season.
- Kellogg’s union workers, joined John Deere workers, to extract cost-of-living adjustment for wages. Only 6.3% of workers are in labor unions today, but there could be trickle down effects.
- Shipping and logistics prices are set to continue rising as most contracts are based on long-term prices. The higher spot price will feed through into those long-term contract prices in 2022.
Rising crypto asset ownership among elected officials and government advisors
One of our favorite subjects is the rising influence of the digital asset industry. There’s no better way for this influence to expand than to have our elected leaders with skin in the game by owning crypto assets.
Financial disclosures by elected officials and Biden Administration staff show that two senators (Cynthia Lummis of WY and Pat Toomey of PA), nine House members and at least five White House officials own crypto assets. Recent congressional debates and testimony have shown a growing understanding of the digital asset space among our elected officials. House hearings have been less partisan compared to Senate hearings, which is strange, considering the Senators are supposed to think longer term. This WSJ article has the details.
All the best in 2022. Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
|This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.|