Bitcoin is coming to 401(k) retirement plans as Fidelity hopes to offer access to the 23,000 plans it administers. This move by the largest plan administrator, with $2.7tn in plan assets, should drive long-term bitcoin adoption. It will not, however, change the bear market that is currently underway in many assets. The pain in crypto was exacerbated by the collapse of the Terra Luna ecosystem that wiped out ~$50bn of value swiftly. This is the correlated sell off that the Dispatch had been worried about. It is now underway even before the Fed starts to withdraw liquidity from June 2022. Exponential upside comes with probability of hefty downside too. Position size and a long-term view are two of the most important levers to benefit from adoption-led growth while managing through downturns.
In traditional assets, with greater signs of slowing economic activity, we’ve lowered our high beta cyclical exposure. Our long-term thesis of strong commodity/energy prices remains in place, but we have tactically lower portfolio beta by reducing small cap exposure while adding large caps. We do not believe equity valuations have adjusted to attractive levels. Please note nothing in The Dispatch is investment advice.
Dispatch #11 on May 13th, 2022, has the following line up of stories:
- Bitcoin comes to 401(k) plans
- 4% retirement rule….might need rethink as inflation rises
- 3rd largest crypto stablecoin implodes
- SEC doubles crypto enforcement staff
- Housing unaffordability near 2007 peak
- Mix signals on energy from Biden Administration
- 13 more crypto hacks since April
Bitcoin is coming 401(k) retirement plans
Fidelity hopes to offer access to bitcoin later this year to plans participants. Savers could allocate as much as 20% of their account to bitcoin. The Dispatch sees such a high allocation as extreme for most savers, given the high volatility and the possibility of rising correlation between bitcoin and traditional assets. The Department of Labor that regulates 401(k) plans has already voiced opposition to Fidelity’s plan. It should not be a surprise that Elizabeth Warren is also against the plan.
As allocators of retirement savings, we are constantly evaluating options to protect future incomes. Having the option to add digital asset into the retirement asset mix may be beneficial over the long term. That evaluation should be done with your retirement advisors as they this is a highly volatile asset. This is not investment advice!
It’s worth noting that as savers own bitcoin through their 401(k)s, you will not see a rise in on-chain wallet addresses. This is important as network effect models (Metcalfe’s Law) show a correlation between the value of the network and network participants. The number of bitcoin wallet addresses equates to network participants. Fidelity’s solution is very likely to be centralized where multiple savers’ coins are commingled into a single on-chain wallet. As early adopters give way to the mass market, we expect to see fewer incremental on-chain owners, even as demand from savers grow.
4% retirement rule….requires a rethink with high inflation
Many retirees, and those close to retiring, have heard of the 4% rule. It is based on William Bengen’s 1994 article in the Journal of Financial Planning that said a retiree can safely withdraw 4% of the nest egg in the year-one and, thereafter, adjust withdrawal rate for inflation. Mr Bengen suggested recently that high inflation and elevated valuations may reduce the safe starting withdrawal rate as this WSJ article explains.
As with any financial prediction, there are many assumptions behind that rule. Just google “4% retirement rule”, and you’ll see 100s of articles and research paper dissecting the 4% rule. The 4% advice would have been conservative (and practical) in 1993. If you start at 4% today, then increase that withdrawal by inflation (currently 8.5%) while asset prices fall, the retirement nest egg could quickly run out. This Kiplinger article addresses the issue of 4% rule not fitting into today’s reality.
Since 1993, inflation has averaged 2.4% annually, plus both bonds and stocks have experienced historic bull markets. The outlook for the coming decade and beyond is likely quite different with inflation high, stock market valuations extended (slightly less now than at start of the year) and bonds having enjoyed a historic bull market as the Fed dropped rates to zero.
Stock market valuations remain elevated, especially as estimates could be revised lower
This S&P 500 forward price to earnings (PE) chart shows that valuations have fallen to median levels. However, The Dispatch believes the forward earnings projections are likely to prove inaccurate. As economic activity slows, it is normal to see earnings estimates being revised down.
A conservative approach to smooth out the cyclicality of earnings (strong earnings during rapid economic growth and weak earnings in recessions) is to use a CAPE ratio chart. Today’s CAPE valuation looks decidedly less attractive, as seen in the chart below.
3rd largest crypto stablecoin implodes
Terra USD stablecoin, most often called UST, was the fastest growing stablecoin over the past 12 months. It grew from ~$2bn to nearly $19bn in circulation over the past 12 months, nearly an 8.5x rise, despite all prior algorithmic stablecoin projects failing. LUNA/UST just happened to be of much larger size than the failures that preceded.
While not obvious on the chart above, UST collapsed in spectacular fashion over the past week, with the 1-to-1 pegs to the US$ unravelling as UST chart shows below.
UST was an algorithmic stablecoin, which meant that the peg to the US$ was held via a minting/burning mechanism against Terra’s LUNA token. When UST goes below the 1US$ peg, more LUNA is created to bring the peg back in line. As the peg worsened, LUNA became worthless, with the market cap dropping from a peak ~ $40bn to ~$10m. For a more details discussion of stablecoin and LUNA/UST, we point you to the always excellent Arthur Hayes and his recent article.
UST – a bank run without deposit insurance or regulatory oversight
There’s much more to this story, which The Dispatch won’t attempt to cover fully. There’s widespread speculation about how the Terra ecosystem collapsed. We veer toward the view that this was a venture experiment that unravelled due to loss of confidence. Weak global markets, ill-timed liquidity measures by Terra creators and markets testing the stability of UST/LUNA all played a part.
The result is widespread agony for many people in crypto, most of whom are novice investors. This was essentially a bank-run on UST without government deposit insurance or regulator to save participants. The UST collapse was highlighted by Janet Yellen this week and the event is likely going to be a lightning rod for further crypto regulation as explained in this Tweet Thread from CertiK, a blockchain security firm.
SEC Double crypto enforcement staff
The Dispatch would love to see the SEC prosecute frauds in both crypto and tradifi, but the institution has shown a penchant for going after large crypto companies like Blockfi or Coinbase instead of the many small crypto frauds. Algorithmic stablecoins are inherently risky, and that risk can’t be regulated away outside of banning such mechanisms in the US. Such a ban or a requiring regulatory approval to offer such a product to US consumers is a likely future outcome.
This week Chairman Gensler Tweeted this thread extolling the virtues of our ancient securities laws. Yes, the intent of those laws is excellent, but trying to squeeze decentralized digital assets/markets into those laws aren’t optimal. Gensler is a savvy Washington operative and will optimise to enlarge his mandate and bring crypto assets within the SEC umbrella.
Mixed signals on energy from Biden administration
In mid-April, on Good Friday/Passover, the Biden Administration quietly eased oil drilling restrictions. The timing of the announcement on a holiday weekend points to current conflicts within the administration. They want to be seen trying to ease energy costs, but not upset the progressives by supporting drilling. What then gets rolled out is a half-baked program. Yes, reopening federal lands is positive, but doing so at a higher royalty rate (18.75%, up from 12.5%) is a negative in an industry that invests on long time horizons.
Then this week, with all the focus on inflation, the Interior Department cancelled drilling lease sales, as the NY Times explains. Whatever the actual reasons, the Dispatch can’t think of a worse public relations move when the country is focused on inflation and gasoline prices.
The supply fundamentals don’t appear to be changing notably. Given our concern about the forward growth outlook, The Dispatch has lowered high beta energy exposure while partially offsetting that move with large cap energy exposure. Our conviction of a long-term bull market in energy and materials remains, but we have tactically adjusted to account for near-term demand softness. Longer term, a Republican President and Congress could change the supply demand balance, but our crystal ball can’t see into November 2024!!
More Crypto hacks
If the massive wealth destruction in LUNA/UST wasn’t painful enough, we’ve witnessed multiple crypto hacks over the past months. Here’s a list of events since the start of April from Rekt.
The constant stream of crypto hacks continues to buffet the industry. We wish there were better regulatory enforcement of the product/services that come to market. However, that’s a tough ask, given the breakneck development within blockchains. One sanity-check measure is to see if Nexus Mutual, a decentralized insurance service, offers coverage on the protocol you are trying to interact with. Nexus Mutual’s oversight of the blockchain code is an extra layer of eyes, but NOT a failsafe. The continued exploits that lead to consumer loss are a stain on the industry and one that should create long-term adoption headwinds for decentralized innovation.
US housing unaffordability near 2005-2007 peak
This chart comes courtesy of Fannie Mae’s April 2022 Economic & Housing Outlook. Fannie sees house prices easing with existing-homes-sales volume dropping 8.6% YoY in 2022. To us, this is not a particularly bearish view.
Fannie’s flat real price rise by end of 2023 not bearish because inflation today is above 8%. Therefore, an 8% rise in 2022 property price translates into zero real price increase!
It’s been a very turbulent period in markets. We expect volatility to remain high as the Fed starts to remove liquidity via QT. Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
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