Are we set to repeat 2000 or 2008 is an important markets question? Equity indices sold off at both of those points, but for distinctly different reason. The Dispatch sees a higher probability that we are facing a set up like the year 2000, where a subset of stocks became overvalued. The unwind of the overvaluation is now underway, helped by changes to global liquidity, discount rate and economic growth expectations. There are additional issues like the pandemic pulling sales forward, which may exacerbate overvaluation.
A 2008-like liquidity crisis is a lower probability, but the risk of a selloff morphing into a liquidity event is notably higher today than in 2000. This is because of the far greater financialization of our economy and meaningfully higher debt levels globally. Leverage is pervasive and risks lurk outside of the banking system. Volatility and rising correlations will be signs of increasing liquidity risk, but it’s best to hedge when the waters are calm. The moves in credit and rates markets this week are worrying.
The implication for cryptoland is that the vast majority of the >8,000 tokens in circulation today are likely to start the trend towards zero. This was always the likely path, and that trend has started. However, protocols gaining network effects due to utility will thrive over the coming years. 2022 will provide an excellent entry point into these assets. The Dispatch is sharpening our pencils. Some of the ponzi-like 1000% APR Defi yield protocols have already corrected 90%. There’s still 100% downside possibility!
Dispatch #3 on February 4th, 2022, has the following line up of stories.
- Are we set to repeat 2000 or 2008?
- $320m exploit of Wormhole crypto protocol
- Crypto tax selling?
- Complaint mount for El Salvador’s Chivo wallet
- Comedy corner with Jim Cramer
- Oil exploration leases overturned by federal courts
- “Bitcoin crashed the midterm elections”
Are we set to repeat 2000 or 2008?
The Dispatch won’t repeat the concern over valuation. You can read two recent Dispatches from December and January, where we discuss elevated valuations. The large cap indices remain expensive due to the resilience of mega cap companies. Some of that is coming undone as we saw with Facebook. Even the strong result at Amazon essentially led to the recovery of market cap losses of the two prior days.
The Dispatch sees a higher probability that 2022/23 is similar to the early 2000s. However, client portfolios are positioned for left-tailed event because of a combination of factors. What’s worrying today is the mixture of high leverage, sharply receding liquidity, expansion of shadow banking and positioning. Of these factors, leverage is most visible and highlighted in the following charts.
This chart from the IMF shows the long-term increase in debt relative to GDP.
The Institute of International Finance chart below puts the ratio beyond 350% of GDP
Lastly, here’s a granular look at countries where debt ratios deteriorated the most from pre-Covid to 3Q2020, where the bulk of fiscal and monetary policy activity took place.
Source: Visual Capitalist
With 2021 nominal GDP growth strong across the global, the ratios in the above chart would have deflated somewhat. Government balance sheets worsened the most, followed by corporate and then households.
Source: Visual Capitalist
Watch credit spread, cross-rates and volatility
The higher borrowings make corporates sensitive to credit spread and governments exposed to global liquidity. Furthermore, cross-rates matter because governments have to fund trillions Dollars of maturing debt without the help of central bank assistance while inflation remains elevated. The sharp increase in Eurozone sovereign rates this week is negative for Treasury yields, because the US is an importer of capital.
For the moment the Fed put (the idea that the Fed will cut rates and increase liquidity at first sign of trouble) is off the table, unless there’s ample evidence that core-inflation will move rapidly to the Fed’s 2.75% year-end 2022 target. The media will focus on headline inflation, but focus on core inflation, which we expect to be sticky.
$320m exploit from crypto protocol
The Dispatch is highlighting these unfortunate events with increasing frequency. Wormhole, a cross-chain protocol (this event targeted assets bridged between Ethereum and Solana networks), was exploited by a malicious entity. This Tech Crunch article provides the details.
For a glimpse of the complexity of smart contract code, read this tweet thread from blockchain security research @samczsun. For a non-programmer, it might as well be an alien process, but this just goes to show the complexity that’s embedded within increasingly sophisticated automated service functionality. Anyone trying to earn a yield on hard-earned savings, seriously consider the risk of permanent loss within the crypto ecosystem.
This exploit could have had a devastating cascading impact of Defi on the Solana ecosystem, had the deep-pocketed, high-frequency hedge fund owner recapitalized Wormhole with 120,000 Ether.
You bet this event will provide more ammunition for regulators and politicians to increase regulation and scrutiny on crypto. Sure, there was no loss to investors, but a lack of loss is an outlier outcome because Jump Trading was a backer of Wormhole. Had there been no traditional market backer with deep pockets, there certainly would have been an impact, and a possible wider knock on impacts from a collateral-collapse cascade. The industry owns these software-bug exploits.
Crypto tax selling?
This is not a scientific study, but Barry Silbert is the founder of Digital Asset Group, the issuer of GBTC and one of the largest companies in the digital asset ecosystem. He has 716K Twitter followers and this survey has > 35K participants.
Source: via Twitter
That the 60% of the sample has not raised cash to pay taxes illustrates the immaturity of the average digital asset participant. Just another data point for unfavorable 1H2022 funds flow.
El Salvador’s Chivo bitcoin wallet complaints
Earlier Dispatches flagged the growing popularity of the Chivo wallet and how there are more active users of the wallet than bank accounts in the country. Chivo is the government-backed bitcoin wallet deployed alongside bitcoin legal tender adoption in El Salvador. Now, though, there are many complaints on the Chivo wallet. This includes inability to access funds, unauthorized transactions, lost funds, transfer not working and slow responses from customer service. This The Block article has an in-depth investigation. One of the key complaints is slow customer service, which sounds similar to calling a federal government agency like the IRS. You just don’t get quick service. This is an important issue to follow as
El Salvador is test case for a sovereign adopting bitcoin. Mess it up and no other country will want to follow the path of diversifying beyond the US$ standard.
Related to bitcoin and El Salvador, the IMF has reiterated risks from bitcoin adoption. An anti-digital asset view from an institution established to safeguard the current monetary regime is not a surprise.
Crypto to prop up stocks – comedy corner!
This tweet from Jim Cramer just had to be shared because part of the tweet is preposterous. At the start of 2022, all of crypto assets were worth ~ $2.2tn (Coinmarketcap.com) and global stocks were valued at over $125tn at the end of September 2021. We just don’t see how digital assets that are less than 2% of the value of global stocks are going to impact the much larger asset class. As of February 30th total crypto asset market cap has dropped 22% to $1.7tn, but that has been of little help to US stocks.
Gulf of Mexico oil & gas drilling leases blocked by federal courts
Here’s ongoing evidence of the structural trends that will limit supply growth. US District Court Judge in DC invalidated 80m acres of Gulf of Mexico leases on the basis that Interior Department’s environmental impact determination was flawed. Several environmental groups have challenged the Federal lease auction. This WSJ article provides details.
While we remain confident of the longer-term direction of travel for energy prices, The Dispatch expects many counter-trend reversals. The breaking news that the Iran sanctions waiver could well be seen as bearish crude near term.
Potential near term news headwinds
However, there’s a wide range of opinion about Iran’s spare capacity among the oil analysts that The Dispatch follows. This tweet thread highlights both bullish and bearish views from multiple analysts. We veer towards the view that Iran has been producing, smuggling and selling as much as possible, but, we remain open to other views.
Even Saudi Arabia thinks this is a high price for crude because it’s floated the ideas of selling a $50bn stake in state energy company Aramco.
Ultimately, 2022 will see energy consumption surpass the 2019 peak, with further demand growth in 2023. We believe the gap between demand and supply will continue to widen over this period, and our preference is not to trade the shorter-term price cycles. The world will discover in the coming years if the announced spare capacity of OPEC is real. Just like the rest of the energy world, the Saudi’s haven’t invested to raise reserves or production, although their announced spare crude capacity has been steady.
“Bitcoin crashes the midterm elections”
This Politico article summarizes the many political candidates on both parties that are embracing crypto. One of the more interesting challenges is progressive teacher Aarika Rhodes, a supporter of digital assets, challenging incumbent Democrat Brad Sherman. Ms Rhodes was on a twitter spaces with Jack Dorsey on 02/04/2022 with 7,400 participants. Excellent nationwide publicity for a grassroots candidate. Ms Rhodes has leverage the enthusiasm of the digital assets community by appearing on multiple crypto podcasts to articulate her positions. She has an open mind about digital assets because the current systems is not benefiting most people she hopes to represent.
However, it’s an uphill task for challengers taking on an incumbent of two decades, as the money raised shows. How do you fight an incumbent sitting on the House Finance Committee with nearly $4m in the bank? Digital asset contributions, particularly via Bitcoin Lightening Network has kept fund raising modestly competitive, Ms Rhodes claims.
Funds raised by candidates running for CA-30 district
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.|